14th December 2015
Japanese funds have been some of the best performers in 2015 and there are no signs of this trend abating in the year ahead, according to a snap survey of leading fund groups.
Fidelity International’s Personal Investing team canvassed the investment opinions of four fund groups including Franklin Templeton, Miton Group and Rathbones.
Each multi asset/global manager was asked to provide an investment outlook highlighting potential opportunities and headwinds for 2016.
While question marks remain over the success of Abenomics, which celebrates its third anniversary this week, three of the four managers surveyed are backing the world’s third largest economy in 2016. However, the threat of market volatility looks set to continue as investors keep a watchful eye on the Fed and China.
On the opinions expressed Tom Stevenson, investment director for personal investing at Fidelity International, commented: “I am not surprised that Japan is back on investors’ radars. The Tokyo market has been a strong performer in 2015 but the outlook remains attractive.
“The focus of attention has shifted from the first two ‘arrows’ of monetary and fiscal stimulus to the structural reforms that will return Japan to regional and global economic relevance. In particular, a new focus on corporate governance and improving returns on equity in Japanese boardrooms means earnings growth can remain a stand-out in a low-growth world.”
Fund manager outlooks:
David Jane, fund manager, Miton Multi Asset Team: “Our preferred asset class for 2016 remains equities, especially in Japan where self-help from internal reform and valuation make the story slightly less dependent on global economic activity than other equity markets. We are particularly cautious regarding bonds as the twin headwinds of rising short term interest rates and deteriorating credit quality may make positive returns difficult to come by.
“Over the course of 2015 the world economy has suffered from the combined headwinds of falling commodity prices and weakness in China. Despite this, the world economy has continued to grow strongly. Headwinds for 2016 are more likely to come from the bond market, where there is increased evidence of corporate stress, not just in resources related names but now spreading out more broadly. Despite this, we remain broadly positive on economic growth but believe a higher level of vigilance is appropriate following this extended period of economic growth.”
Toby Hayes, portfolio manager, Franklin Diversified Income and Franklin Diversified Growth funds: “For UK investors looking at diversified multi asset portfolios, we believe that Japanese equities will continue to offer an attractive investment opportunity over the next year. Japan has moved to the next phase of the most extraordinary monetary experiment of all time.
“With Japan’s first rounds of QE, the bank of Japan bought Government bonds at an eye watering rate, expanding its balance sheet in order to drag the economy out of years of persistent deflation, with yen devaluation being the primary target as a means to import inflation.
“Japanese profits responded by exceeding expectations, leading to consistently positive earnings revisions by analysts. The most recent round of QE, however, has been used to buy assets as well as government bonds and combined with the reweighting of the GPIF portfolio (the world’s largest pension fund) towards equities, it is clear that the bank of Japan is now targeting asset price inflation. With one more QE round expected in April, further depreciation of the currency by bond market purchases is less likely, placing further emphasis of QE towards equity market support.
“However, while Japan reflates, the world deflates. Western markets inflation rates are moving perilously close to deflationary levels, partly due to cheaper Japanese exports, but also due to low aggregate demand, deleveraging and falling commodity prices. While lower energy and consumer goods prices represent a significant tax cut to hard pressed consumers and should boost consumer spending, markets could be spooked at the threat deflation poses to debt affordability or of the threat higher US rates poses to indebted emerging markets.
“Given this risk and even if the Fed raises rates, it makes sense to continue to hold some core government debt, especially in higher yielding core markets that are still in a rate cutting cycle such as the commodity linked bond markets of Australia and New Zealand.”
Nick Peters, portfolio manager, Fidelity Solutions: “Japanese equities could be strong performers in 2016. Japan benefits from a broadly supportive backdrop of loose central bank policy and a weak currency. While the economy slipped back into recession in the third quarter, this should prove temporary, with the third quarter having also shown a pick-up in consumption.
“Even if economic growth does disappoint, then Japanese equities stand to benefit from bottom-up drivers of growth. These include a friendlier shareholder culture, increased dividend payout ratios and increased equity allocation among government pension funds.
“As well as potentially being strong enough to overcome the impact of any economic weakness, these bottom up drivers of growth should help to narrow the historic gap in the Return on Equity (ROE) between Japanese and global equities. In the ten years through to 2013, for example, the ROE on the Topix averaged just 6%, compared to 12.6% for the MSCI World Index*.
“Overall, equities continue to be our asset class of choice for 2016. We remain in a low growth, low inflation environment that favours equities, with the ECB and BoJ continuing their large scale QE programmes. However, given the potential for volatility around rate rises by the Fed and the pace of China’s economic slowdown, markets could be more volatile in 2016 than 2015. In this context, it is important to be diversified across asset classes, as this helps to mitigate key risks and can help deliver a less volatile portfolio.”
James Thomson, manager, Rathbone Global Opportunities fund: “Although there have been improvements, I don’t feel I’m still getting great flow of shareholder-friendly information from corporate Japan, and after decades of bear markets, the analyst community seems to have hollowed out in this market.
“I also have concerns that the pace of structural reforms in Japan may take longer than western investors can stomach. It may even be abandoned all together in the face of traditional opposition. The US makes up 60% of the portfolio, a controversial stance for those who believe the region is overvalued. I disagree. A combination of low commodity prices, low inflation and a strong dollar should continue to push valuations higher than most people think.
“Firstly, I’m paying for quality names – that’s the innovation, differentiation and unique business models that you simply can’t get elsewhere in the world. US companies are also benefitting from falling input costs and buoyant consumers. As a nation of consumers, the scale of spend for the typical US family on food and gas is well chronicled, so the cheaper those remain, the happier the average American is likely to be. And that usually leads them to splurge on other things as well.
“But this could be de-railed on the back of a resurgence in China – a completely unexpected scenario right now, which makes the possibility seem all the more dangerous. If China turns itself around quickly, global demand could rise sharply, meaning the cost of gas and food could spike again. I don’t think this is likely to happen, as China has too many structural problems to contend with, but crazier things have happened. That would leave many unhappy Americans, and you can bet that would upset global markets as well.”