This blog post is the third installment of a four-part series that examines the tactical and strategic case for investing internationally despite a multi-year period of U.S. equity outperformance.

Since the previous peak in Japanese markets, investors have long hoped for a so-called “virtuous cycle” to finally take root in Japan. Despite some of the most accommodative central bank policies in the world, Japan has experienced doggedly low levels of inflation and even disinflation. With prices forecast to be lower in the future, consumers are incentivized to forego consumption and increase their savings rate. For Japanese companies, this results in anemic sales growth and a headwind for earnings. This cycle may be ending now.

Like most other countries in the developed world, Japan has seen the lingering impacts of supply chain disruptions result in stubbornly persistent inflation. However, this has also had the effect of incentivizing consumption today rather than in the future. As economic activity increases, wages are also starting to rise. This combination of rising wages and consumption creates a positive feedback loop resulting in a virtuous cycle of investment, labor productivity growth and potentially higher multiples for Japanese stocks.

Big Catalyst: TSE Reform

For all of the reasons highlighted earlier, the same investment cycle also applies to companies. One of big thorns in the side of global asset allocators was that Japanese markets perpetually appeared cheap based on common value metrics such as price-to-book value. With future profits potentially crimped by low growth, many companies hoarded cash as opposed to reinvesting in their businesses. This resulted in a high percentage of companies trading at significant discounts to their book value. In response, the Tokyo Stock Exchange (TSE) sent a public letter at the end of January 2023 to listed companies imploring them to take steps to increase their book value per share through share buybacks, dividend increases and capex investment.

The TSE published a report titled, “Action on Cost of Capital-Conscious Management and Other Requests” at the end of March 2023. This required companies to (a) increase actions that are conscious of returns on equity (ROE) and cost of capital, (b) seek improvements in ROE through investment in human capital, capex and business line restructuring, (c) repurchase shares and hike dividends on a continual basis promoting long-term growth and (d) increase dialogue with investors about corporate targets and strategies for enhancing returns.

According to JPMorgan, at the time of the announcement in January, there were 922 companies trading below book value. Since then, 308 of these companies have announced share buybacks or dividend increases. It is also forecasted that many other companies such as banks may be poised to do more on this front once the turbulence from the U.S. regional banking crisis moves further out of memory. While many investors may fear that they have in effect “missed the trade,” we believe this may be the start of a multi-year process that starts to see fundamental changes to Japanese company fundamentals and multiples.

Looking under the Hood

As we show in the table below, one of the single biggest drivers of returns over the last year has been this focus on shareholder yield: increasing dividends and share buybacks.

1-Year Attribution: WisdomTree Japan Hedged Equity Index vs. MSCI Japan Local Index

WTUSMF - WisdomTree U.S. Multifactor IndexWTEPS - WisdomTree U.S. LargeCap IndexWTDGI - WisdomTree U.S. Quality Dividend Growth IndexWTQGRW - WisdomTree U.S. Quality Growth IndexWTLDI - WisdomTree U.S. LargeCap Dividend IndexWTDI - WisdomTree U.S. Dividend IndexWTHYE - WisdomTree U.S. High Dividend IndexWTSDG - WisdomTree U.S. SmallCap Quality Dividend Growth IndexWTMEI - WisdomTree U.S. MidCap IndexWTSEI - WisdomTree U.S. SmallCap IndexWTSDI - WisdomTree U.S. SmallCap Dividend IndexWTMDI - WisdomTree U.S. MidCap Dividend IndexWTEMSC - WisdomTree Emerging Markets SmallCap Dividend IndexWTEMHY - WisdomTree Emerging Markets High Dividend IndexEMXSOE - WisdomTree Emerging Markets ex-State-Owned Enterprises IndexINXSOE - WisdomTree India ex-State-Owned Enterprises IndexCHXSOE - WisdomTree China ex-State-Owned Enterprises IndexWTIND - WisdomTree India Earnings IndexWTEHIT - WisdomTree Europe Hedged Equity Index (TR)WTIDJTRH - WisdomTree Japan Hedged Equity Index (TR)EMCLOUD - BVP NASDAQ Emerging Cloud IndexWTCDG - WisdomTree Canada Quality Dividend Growth IndexWTMDIC - WisdomTree U.S. MidCap Dividend Index CADWTMDIHC - WisdomTree U.S. MidCap Dividend Index CAD-HedgedWTGDHY - WisdomTree Global High Dividend IndexWTGDXG - WisdomTree Global ex-U.S. Quality Dividend Growth IndexWTIDGH - WisdomTree International Hedged Quality Dividend Growth IndexWTDFA - WisdomTree International Equity IndexWTDFAHD - WisdomTree Dynamic Currency Hedged International Equity IndexWTDHYE - WisdomTree International High Dividend IndexWTILDI - WisdomTree International LargeCap Dividend IndexWTIDG - WisdomTree International Quality Dividend Growth IndexWTIMDI - WisdomTree International MidCap Dividend IndexWTISDI - WisdomTree International SmallCap Dividend IndexWTISDIHD - WisdomTree Dynamic Currency Hedged International SmallCap Equity IndexWTIDJH - WisdomTree Japan Hedged Equity IndexWTEDG - WisdomTree Europe Quality Dividend Growth IndexWTEHIP - WisdomTree Europe Hedged Equity IndexWTGEH - WisdomTree Germany Hedged Equity IndexWTESC - WisdomTree Europe SmallCap Dividend IndexWTESEH - WisdomTree Europe Hedged SmallCap Equity IndexWTJSC - WisdomTree Japan SmallCap Dividend IndexWTJSEH - WisdomTree Japan Hedged SmallCap Equity IndexWTMDPL - WisdomTree Growth Leaders IndexWTDFAH - WisdomTree International Hedged Equity IndexWTDGICT - WisdomTree U.S. Quality Dividend Growth Index CAD (NTR)WTDGIDCT - WisdomTree U.S. Quality Dividend Growth Index Variably CAD-Hedged (NTR)WTDGIHCT - WisdomTree U.S. Quality Dividend Growth Index CAD-Hedged (NTR)WTDXF - WisdomTree U.S. Dividend ex-Financials IndexWTEHITC - WisdomTree Europe CAD-Hedged Equity Index (NTR)WTEMI - WisdomTree Emerging Markets Dividend IndexWTEMXC - WisdomTree Emerging Markets Ex-China IndexWTGRE - WisdomTree Global ex-US Real Estate IndexWTIDGCT - WisdomTree International Quality Dividend Growth Index CAD (NTR)WTIDGD - WisdomTree Dynamic Currency Hedged International Quality Dividend Growth IndexWTIDGDCT - WisdomTree International Quality Dividend Growth Index Variably CAD-Hedged (NTR)WTHYECT - WisdomTree U.S. High Dividend Index CAD (NTR)WTHYEHCT - WisdomTree U.S. High Dividend Index CAD-Hedged (NTR)WTIDGHCT - WisdomTree International Quality Dividend Growth Index CAD-Hedged (NTR)WTIDXF - WisdomTree International Dividend ex-Financials IndexWTISDIH - WisdomTree International Hedged SmallCap Dividend IndexVS.MXJP - MSCI Japan Local Currency As of:12/30/201112/31/201212/31/201312/31/201412/31/201512/30/20166/30/20177/31/20178/31/20179/29/201710/31/201711/30/201712/29/20171/31/20182/28/20183/29/20184/30/20185/31/20186/29/20187/31/20188/31/20189/28/201810/31/201811/30/201812/31/20181/31/20192/28/20193/29/20194/30/20195/31/20196/28/20197/31/20198/30/20199/30/201910/31/201911/29/201912/31/20191/31/20202/28/20203/31/20204/30/20205/29/20206/30/20207/31/20208/31/20209/30/202010/30/202011/30/202012/31/20201/29/20212/26/20213/31/20214/30/20215/31/20216/30/20217/30/20218/31/20219/30/202110/29/202111/30/202112/31/20211/31/20222/28/20223/31/20224/29/20225/31/20226/30/20227/29/20228/31/20229/30/202210/31/202211/30/202212/30/20221/31/20232/28/20233/31/20234/28/20235/31/20236/30/20237/31/20238/31/20239/29/202310/31/202311/30/202312/29/20231/31/20242/29/20243/29/20244/30/20245/31/20246/28/20247/31/20248/30/20249/30/202410/31/202411/29/202412/31/20241/31/20252/28/20253/31/20254/30/20255/30/20256/30/20257/31/20258/29/20259/30/202510/31/202511/28/202512/31/20251/30/20262/27/20263/31/2026

Attribution Component

Average Category Weight

Category Performance

Category

Allocation

Stock
Selection

Interaction

Total
Attribution

Index
Weight

Benchmark
Weight

+/- Wgt

WT Index
Return

Benchmark
Return

Source: WisdomTree, as of 7/31/23. Past performance is not indicative of future results. You cannot invest directly in an index.

Over this period, companies ranking in the top quintile based on shareholder yield have outperformed companies in the bottom quintile by nearly 40%! Additionally, WisdomTree’s approach, which focuses on exporters and dividend payers, showed even more value versus a market cap-weighted approach.

While Japan has experienced periods of false dawns in the past, we believe that we are still in the early innings of a meaningful shift in Japanese corporate behavior that focuses on shareholder returns. After being challenged publicly by TSE officials, many companies have already responded. As profits continue to increase as part of a virtuous cycle of growth in Japan, we believe an even more meaningful shift may soon occur. For investors seeking targeted exposure, we believe the WisdomTree Japan Hedged Equity Fund (DXJ) may be poised to benefit from these trends.

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