Isa options: The case for investing in Japan and some funds you might choose

6th February 2014

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Japan funds posted some excellent returns last year. Have they had their moment in the sun or is there further to go for investors. Investment journalist Cherry Reynard assesses market.

Description of sector

Japan has been, if nothing else, a capricious sector. The country has endured a double-decade decline in economic activity and its stock markets have frequently followed suit. There have been many false dawns for Japan, but ‘Abenomics’ – the economic policies put in place by Prime Minister Shinzo Abe – has prompted many investors to believe that this time it may really be different for Japan. Stock market and fund returns appear to bear this out.

Two main Japan sectors – Japan and Japanese Smaller Companies. Japanese equities are usually benchmarked against the main Nikkei index.

 The range of fund strategies within sector

Given the overall weakness of Japanese markets, until recently it has been a tough sector in which to be an investor.

Nevertheless, a number of groups have performed well in spite of the difficult conditions, particularly groups such as Baillie Gifford, Invesco Perpetual and Legg Mason. Hedging the currency has also made a material difference to returns. The recent moves by policymakers have significantly and indeed intentionally weakened the yen. Therefore those funds that were hedged have shown stronger returns than those that were not.

Most funds take a pure stock picking approach, but there are strong growth funds and strong value funds. Growth funds, such as the Baillie Gifford Japanese fund, will seek out high quality businesses that can grow their earnings and cashflow. There are also a number of growth funds with a smaller companies bias, such as the Legg Mason Japan Equity fund, in addition to the dedicated smaller companies funds. These tend to do very well at times of market expansion but may struggle at times of market weakness.

There are also ‘value’ driven funds, such as the Invesco Perpetual Japan fund. These are looking for companies trading on low multiples where there is the scope for recovery. Depending on movements in the yen, funds will often move from favouring exporters to domestic stocks.

The is also an increasing number of Japan Income funds, such as the one offered by Jupiter. Japanese companies have historically been poor dividend payers, but that is changing as Japanese corporate management starts to pay much more attention to the needs of international investors.

Recent performance

Over the past five years, the average fund in the Japan sector has grown by 35.5% and in the Japanese Smaller Companies sector by 73.8% (to 31 January). This compares to average growth from the UK Equity Income sector of 101.5%, and from the Global sector of 74.5%. Both Japan sectors saw very strong performance in 2013 as investors re-examined Japanese markets in light

 

of the structural reforms implemented by the Government. More recently growth has stalled, as investors have sought more tangible proof that the reforms are having an effect for the long term.

As in other equity markets, the strongest funds have tended to have a bias to smaller companies. However, neither the value or growth style has predominated, with skilled managers delivering strong performance using both styles. Tracker funds dominate the bottom of the Japanese sector, largely because they are geared to larger capitalisation companies that have fared badly. Japan is a market that rewards active stock picking.

When does it perform well/badly?

Japan is a sector that marches to its own tune. Although the large export sector will rise and fall with global growth trends, the market as a whole has often performed very differently to other developed markets. While historically parts of the market have responded well to improving investor risk appetite globally, it will be buffeted by the machinations of domestic policymakers.

What sort of investor does it suit?

For some time, Japanese equities fell off the radar of investors. Even now, many investors feel there is no compelling reason to hold a Japanese fund. That said, it can bring much needed diversification to a portfolio because of the unique characteristics of the Japanese stock market and economy. There is a fund to suit all investor tastes, from growth to income.

How much of a portfolio for low/mid/high risk investor?

Japan is still the second largest economy in the world and 8.7% of the MSCI World index. As it is not generally a dividend paying market, it tends to suit growth investors rather more than income investors, but this is changing.

Popular funds

Top 10 by performance (5 year) – Japan

Legg Mason Japan Equity

Melchior Japan Advantage

CF Morant Wright Nippon Yield

Baillie Gifford Japanese

JPM Inv Japan Select Equity

M&G Japan

Old Mutual Japanese Equity

Capital International Japan

Martin Currie Japan Alpha

Aberdeen Japan Equity

Questions for investors to ask themselves or their advisers

Is the fund hedged back into sterling?

Is the manager based in Japan?

Is it run with a value or growth style?

How similar is it to the index?

The view of investment advisers and fund selectors

Rob Burdett, joint head of multi-manager at F&C Investments

“We are overweight in Japan and have been for some time. It was been one of the best markets in 2013, particularly if you hedged the currency. Also, unlike a lot of other markets, share price growth in 2013 was driven by an improvement in company earnings, rather than an expansion in valuations.”

Burdett’s fund picks

Coupland Cardiff Japan Alpha fund

Gavin Haynes, investment director, Whitechurch Securities

“Japan has had a difficult start to 2014 after an exceptional year last year. Markets have rallied strongly on the prospect of reform, but now investors want proof of strong and improving profits from Japanese companies.”

Haynes fund picks

Jupiter Japan Income

Neptune Japan Opportunities

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