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Investors have for decades taken an 'Asia ex-Japan' approach. Some say that's 'obsolete'

Key Points
  • "Asia ex-Japan" is a widely used paradigm for analyzing the region’s economy and markets, and for making business decisions, but experts say that framework is fast losing relevance.
  • Japan was long the region’s top economy and remains a major player, but China is increasingly dominant and its financial markets are gaining fast.
  • Some, though, say the concept remains valid, citing characteristics that continue to set Japan apart, such as its status as Asia’s only fully advanced economy.
Tokyo skyline
Kiyoshi Ota | Bloomberg | Getty Images

The concept of "Asia ex-Japan" has been around for decades, but some experts say the approach of viewing Japan as a separate class from the rest of the region is starting to lose relevance.

The "Asia ex-Japan" approach traces its roots back to the 1980s and 1990s when the country was the most dominant player in Asia, and the size of its economy and stock market towered way above its neighbors.

Many investment banks and research houses still organize their strategy and coverage based on that concept. That's despite the fact that China surpassed Japan as the region's largest economy in 2010 — and now stands at more than twice as large — and Chinese stock markets have similarly grown in importance.

But some see the sands shifting under the edifice.

"We see over time with China getting more and more meaningful that the whole region would be looked at as one (Asia Pacific) region," Jim McCafferty, who heads Asia ex-Japan research at Japanese investment bank Nomura, told CNBC last week.

"In our forecast China will be bigger than Japan by 2023," Hong Kong-based McCafferty said, referring to Nomura's expectation for China and Hong Kong's combined weighting for equities in the MSCI AC Asia Pacific Index. "So at that point in time we think investors will really look at Asia as one holistic geography."

According to figures provided by Nomura, as of May 30 last year, China and Hong Kong had a total weighting in the index of 23.7 percent while Japan was at 38.7 percent. In 2023, Nomura expects China and Hong Kong will rise to 43.4 percent, while Japan will slip to 29.5 percent.

McCafferty and others said that a kind of silo effect has taken hold whereby analysts, for example in South Korea, would focus on their own companies such as Hyundai and Kia without considering how they related to Japanese competitors or fit into the broader regional and global context.

"I think that as economies develop then the country and region becomes less important and the sector becomes more important," Jesse Lentchner, co-CEO for Asia Pacific for financial services firm BTIG, said on Wednesday.

With China's rise, it is easy to forget how dominant Japan once was in the region.

Throughout much of the latter half of the 20th Century, Japanese economists and officials frequently expressed a "flying geese" worldview wherein their country flew in the lead position of the "V," guiding other Asian countries' development.

But Asian countries have made strides in catching up and are converging with Japan in interesting ways, such that they are even beginning to face challenges that Japan's economy has long confronted due to its head start.

"I think everyone is turning Japanese slowly, one way or the other," Trinh Nguyen, senior economist at French investment bank Natixis, said on Tuesday, citing countries including China, South Korea, Singapore and even Thailand that already are increasingly grappling with Japan-style issues such as slowing growth and aging populations.

'Legacy things'

For sure, Japan remains an important market. Its corporations and banks are global in scale, it is a major investor and the world's largest creditor nation. But its share of the world economy is destined to shrink further as its population precipitously declines and other countries grow faster.

Standard Chartered on Jan. 8 released long-term GDP forecasts which project Japan would slip from its current third-place ranking to fourth in 2030, overtaken by India, with China beating out the United States for the top spot.

Still, the view of Japan as a separate category has its defenders, who cite the size of its equity market, developed economy status and even cultural issues such as language and ways of doing business.

"The concept is not outdated in the sense that we have to understand that the Japan market is quite different from the rest of the region," William Ma, chief investment officer at Noah Holdings, said on Tuesday.

"It has its own kind of investment philosophy and discipline that is not really the same for the Asia ex-region," he said.

Stefan Hofer, chief investment strategist at LGT Bank in Hong Kong, acknowledged the idea can be questioned, but said there are still compelling reasons to consider Japan separately. Those include its membership in the Group of Seven advanced economies — the only Asian country to belong — and the large number of economies in the region still classified as emerging.

"Japan is clearly not, so there are some very, very basic differentiators there that I still think are valid," Hofer said on Tuesday, adding that he sees the concept lasting at least another five years.

"Legacy things can be very powerful," he said.

Viktor Shvets, head of Asian strategy for Macquarie's commodities and global markets team, bluntly called Asia ex-Japan an "obsolete idea," but was quick to add it is not the only one, with other categorizations such as "emerging markets" having also lost much of their meaning.

Such terms persist, he said, due to factors including simple inertia and the human propensity for benchmarks.

"The new model, in my view, should be global," he said on Tuesday.