Lion-Nomura Japan Active ETF (Powered by AI): The Future of Investing in Japan

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The Lion-Nomura Japan Active ETF (Powered by AI) is launching on the Singapore Exchange (SGX). There are quite a few firsts here that make this ETF particularly unique.

It is Singapore’s first active ETF and Singapore’s first AI powered ETF. Active ETFs do not track a benchmark index and are less constrained, potentially giving it more room to outperform the market. Passive ETFs track a benchmark index and are constrained by the index rules and methodology. This ETF uses proprietary artificial intelligence (AI) models to evaluate hundreds of factors, enabling the fund to identify quality stocks efficiently and invest effectively  

In this article, we will explain each of these unique features, starting with an exploration of why Japanese stocks are the focus.

Why invest in Japan?

#1 Japanese stocks remain undervalued despite a strong run

Japanese stocks experienced a strong performance in 2023 with the TOPIX Index gaining 25.1%, which outperformed the MSCI AC Asia ex Japan Index and the Straits Times Index by 13.6% and 16.3% respectively.

Additionally, Japanese stocks maintain reasonable valuations. Japanese stocks’ 12-month Forward Price/Earnings ratio, trailing Price/Book ratio and Price/Earnings-to-Growth (PEG) ratio remain lower than the US and India stock valuations.

In my analysis using Finbox data from December 2023, I found that 1,746 out of 4,053 stocks listed on the Tokyo Stock Exchange and Nagoya Stock Exchange are trading below their book values. This accounts for approximately 43% of the Japanese stock market, nearly half!

Therefore, despite their strong performance in 2023, Japanese stocks are not considered expensive.

#2 Policy changes to unlock value in Japanese stocks

One concern with undervalued stocks is their tendency to remain undervalued for extended periods until a catalyst triggers a rise in share prices.

Japanese stocks have been undervalued for a long time, but 2023 marks a year in which several catalysts have emerged. One significant driver in recent years is the reform initiated by the Tokyo Stock Exchange (TSE), targeting listed companies with a Return on Equity (ROE) below 8% and Price-to-Book (PB) ratios below 1 (source: Japan Exchange Group on 31 March 2023).

The management of these affected companies must assess the situation and develop plans to improve both the ROE and stock prices. Furthermore, they are required to disclose these plans and actively engage with investors. Traditionally, Japanese firms’ management has been known for their passive and less responsive approach to shareholder requests. This policy change has enhanced corporate engagement and will continue to do so.

Companies failing to comply will be placed under the exchange’s supervision and may even face delisting. These measures have prompted some companies to change their practices, thereby improving their image and share price, and potentially triggering a domino effect across the market.

With enhanced profitability and a higher share price, these changes will attract more investor interest, signaling that Japanese stocks are finally emerging from their period of inaction.

#3 Even Warren Buffett is investing in Japan

Another potential catalyst for the Japanese stock market is Warren Buffett’s investments in Japan. Buffett first invested in Japanese trading houses in 2020 and has since increased his positions.

Buffett is regarded as one of the most influential investors globally, and his investment choices are closely monitored. Moreover, Buffett rarely invests overseas, so his decision to invest in Japan is particularly noteworthy. This move speaks volumes about the perceived investment opportunities in Japan.

In year 2023, foreign investors bought JPY 3,600 billion of Japan equities as of 30 Nov 2023.

#4 Japan continues to stimulate economic growth and investments

While most countries raised interest rates in 2023 to combat inflation, Japan has maintained low rates. This decision stems from Japan’s strategy to exit deflation; thus, experiencing some inflation is seen as a positive sign.

As a result, Japan can persist with a loose monetary policy to foster economic growth, accepting a measure of inflation in the process.

This low interest rate environment is likely to drive increased investments. With the stock market experiencing a strong performance in 2023, Japanese investors may find it more appealing, especially as the expected returns have risen relative to the low interest rates for their savings or bond holdings. This could encourage more investors to shift their savings into stocks, further driving demand and elevating stock prices.

The cost of borrowing is so low that even investors like Warren Buffett have opted to borrow Japanese yen for investments in Japanese stocks, rather than converting their U.S. dollars cash holdings.

A significant benefit of these low interest rates is the ample liquidity they provide, which helps to support the Japanese stock market.

#5 Currency risk abating

A key concern when investing in Japan is the weakening yen. While Japanese stocks may appreciate, a declining yen could diminish overall returns when converted to an investor’s home currency.

This situation is a consequence of Japan’s low interest rates, especially when compared to other countries that are raising theirs. However, this trend is showing signs of reversal. Since November 2023, the yen has begun to strengthen against the USD.

This shift is largely attributed to expectations that the Federal Reserve (Fed) will cut interest rates in 2024. If this materializes, the risk associated with holding yen-denominated investments is likely to decrease.

Japan, therefore, may not need to raise its interest rates and can continue its loose monetary policy to stimulate the economy and markets, all while the yen strengthens.

How to invest in Japan?

If you’re considering investing in Japan, the most straightforward method is through an Exchange-Traded Fund (ETF). Choosing individual stocks can be challenging, given the vast selection of over 4,000 stocks, many of which may be unfamiliar to you. This lack of familiarity can increase investment risk.

Furthermore, investing in certain stocks may require a substantial minimum investment. For instance, if you’re a fan of Uniqlo and want to invest in its parent company, Fast Retailing, you would require a minimum investment of S$33,200 for a lot of 100 Fast Retailing shares. For some investors, this could represent an uncomfortably high exposure to a single stock.

ETFs, like the Lion-Nomura Japan Active ETF (Powered by AI), mitigate these issues. They provide a way to invest in the Japanese market without needing in-depth knowledge of individual stocks. Lion Global Investors and Nomura bring their expertise to the management of this ETF – Nomura is the largest ETF manager in Japan. Lion Global Investors, on the other hand, boasts extensive experience with its Lion Global Japan Growth Fund, which has won 28 fund awards in the past 19 years (see list of awards on Lion Global Investors website) and has consistently delivered top-tier performance over 3-year, 5-year, and 10-year periods.

The minimum investment during the IPO is S$1,000, based on a price of S$1 per unit and a minimum subscription of 1,000 units. This is a far more accessible entry point compared to the substantial capital needed for individual stock investments in the Japanese market.

What is an Active ETF?

Given that the Lion-Nomura Japan Active ETF (Powered by AI) is the first active ETF to be listed on the Singapore Exchange (SGX) and differs from typical passive ETFs, it’s crucial to understand what an active ETF entail.

Most ETFs are passive, meaning they track an index. The fund manager doesn’t select individual stocks but instead follows the holdings and weightings prescribed by the index.

In contrast, an active ETF involves the fund manager actively making investment decisions about what stocks to buy, sell, and how they should be allocated. While the manager may use an index as a performance benchmark, they do not simply replicate the components of the index.

Active ETFs have been gaining popularity in the United States. According to Morningstar, their assets have surged to $444 billion in 2023, up from $25 billion in 2020. The introduction of the first active ETF on the SGX is a significant milestone.

The Lion-Nomura Japan Active ETF (Powered by AI) utilizes both AI models and human expertise to select Japanese stocks. We will explain the investment process in the next section.

The burgeoning role of AI in stock investing

The interest in AI has surged in 2023, especially with the rise of platforms like ChatGPT. Everyday individuals have witnessed AI’s power, and yet this is only the beginning. It’s crucial for businesses and individuals to explore ways to leverage AI to enhance productivity and effectiveness.

In the realm of stock investing, adopting AI presents a significant opportunity. This is largely due to the extensive datasets available in financial markets, where AI can efficiently analyze data and identify patterns that might be overlooked by humans.

Lion Global Investors and Nomura Asset Management have collaborated to develop an AI engine. This engine employs various machine learning and deep learning algorithms to evaluate hundreds of factors, aiming to uncover hidden gems with strong growth potential. Some of these factors include:

• Valuation Metrics
• Technical Factors
• Growth Factors
• Profitability Factors
• Balance Sheet Factors
• Cash Flow Factors
• Shareholder Return
• Financial Quality

However, leveraging AI doesn’t mean that all investment decisions are made solely by the AI. Far from it. Human experts from both Lion Global Investors and Nomura Asset Managemnet review the AI’s findings and make the final decisions on the overall portfolio.

The flow chart below depicts the process where thousands of Japanese stocks are initially filtered. Subsequently, the AI evaluates these stocks based on hundreds of factors. Finally, the fund manager decides on the final portfolio composition, selecting between 50 to 100 stocks.

Lion Global Investors has given us a glimpse into what the portfolio might look like using the AI model (see screenshot below). Please note that the following portfolio allocation is not based on the actual holdings of the ETF. The model suggests that it is quite well-diversified, with exposure to ten different sectors. There is also a balance between large-cap and smaller companies.

Below is a list of the top 20 constituents in the model portfolio; again, this is not indicative of the actual ETF holdings. It includes well-known names such as Tokio Marine, Nippon Steel, and Mazda. Notably, almost half of the top 20 constituents are non-large caps, indicating that the stock picks aren’t solely dependent on market capitalization, unlike what a passive index would typically favor.

While we aren’t at a point where investments can be entirely AI-driven, the technology is constantly evolving and improving. The fact that fund managers like Lion Global Investors are beginning to incorporate AI into their processes is a promising sign for the future of investment management.

Subscribing to Lion-Nomura Japan Active ETF (Powered by AI)

The Lion-Nomura Japan Active ETF (Powered by AI) will be open for subscription during the period of January 5th to January 25th, 2024. It will be available in two denominations: one in Singapore Dollars (SGD) with the ticker symbol ‘JJJ,’ and the other in US Dollars (USD) with the ticker symbol ‘JUS’. The ETFs will commence trading on January 31st, 2024.

Investors interested in subscribing to these ETFs can do so through several channels. Subscriptions can be made via OCBC’s ATM, internet banking, and mobile banking platforms. Additionally, investors can subscribe through various brokers including iFAST, moomoo, OCBC Securities, POEMS and Tiger Brokers.

This article is written in collaboration with Lion Global Investors but the views belong to the author.

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Lion-Nomura Japan Active ETF (Powered by AI)

You should read the Prospectus and Product Highlights Sheet for the Lion-Nomura Japan Active ETF (Powered by AI) (“ETF”) which are available and may be obtained from Lion Global Investors Limited (“LGI”) or any of the appointed Participating Dealers (“PDs”), for further details including the risk factors and consider if the ETF is suitable for you and seek such advice from a financial adviser if necessary, before deciding whether to purchase units in the ETF. Investments in the ETF are not obligations of, deposits in, guaranteed or insured by LGI or any of its affiliates and are subject to investment risks including the possible loss of the principal amount invested. The ETF is an actively managed exchange traded fund. Please refer to the Prospectus for further details, including a discussion of certain factors to be considered in connection with an investment in an actively managed exchange traded fund.

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The ETF may, where permitted by the Prospectus, invest in financial derivative instruments for hedging or for the purposes of efficient portfolio management. The ETF’s net asset value may have higher volatility as a result of its narrower investment focus on a limited geographical market, when compared to funds investing in global or wider regional markets. LGI, its related companies, their directors and/or employees may hold units of the ETF and be engaged in purchasing or selling units of the ETF for themselves or their clients.

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