Following the implementation of “Abenomics”, Japan was one of the surprise packages of last year, with the average fund in the IMA Japan sector returning 25 per cent. However, this year the tables have turned, and it has been the worst performing regional IMA sector in 2014, with losses of 2.55 per cent.
Performance of sectors in 2014
Source: FE Analytics
Many investors have taken the decision to sell their stake in Japan funds, with the majority of them questioning whether Prime Minister Abe will be able to successfully fire his “Third Arrow” of structural reform.
However, Scott (pictured) has used the recent pull-back to increase his Japanese exposure in his PFS Hawksmoor Vanbrugh fund.“We increased our exposure to the JOHCM Japan fund yesterday,” Scott said.
“I think a lot of the funds in the cautious managed sector would have a 0 per cent weighting to Japan, so the fact that we have around 6 per cent is a pretty positive statement.”
Simon Evan-Cook, senior investment manager at Premier, says that Japan funds are “the place to be” for value investors.
“We are always valuation driven and Japan, to us, looks very interesting at the moment,” Evan-Cook said.
“If you look over the last year, company earnings have been growing but share prices haven’t moved that much, meaning that they are as cheap, if not cheaper, than they were before.”
His thoughts are echoed by Scott who says that, unlike the UK and US, earnings in Japan have grown ahead of company share prices.
“Japan has gone from being valued at a premium to global equities to a discount,” he said.
“That would be right if the prospects for Japan weren’t as good as elsewhere in the world; however, we think that there is scope for earnings growth in Japan to be stronger because margins are lower and because the impact of “Abenomics” should continue to feed through.”
The first two “arrows” of Abenomics – monetary and fiscal reform – attempted to end nearly two years of crippling deflation.
Both of them had an almost immediate impact, with the added liquidity and weakening yen sending the equity market skywards.
Scott says that returns have been poor this year because investors have been waiting for the “third arrow” of structural reform, which will inevitably take longer to implement.
Though frustrating, he says there are reasons why investors can afford to be positive on Japanese equities.
“We have been disappointed by how Japan had performed this year up until May. I think you can attribute that to overseas money flowing out after a period of strong gains and the impact of ISAs and the interest of domestic buyers taking time to come through.”
“There are signs that domestic interest is increasing, though as the national pension fund has increased its equity allocation from very low levels.”
Scott’s comments reflect those of FE Alpha Manager Steve Russell, who has an overweight position in his CF Ruffer Total Return portfolio.
He told FE Trustnet back in March that he saw 50 per cent upside in Japan over a three year period.
Other global funds betting big on Japan at the moment include Lindsell Train Global Equity and R&M World Recovery, which have 27.7 and 15.3 per cent invested in the country, respectively. CF Ruffer Total Return has a 17 per cent weighting.
Scott’s favoured fund, which makes up around 3 per cent of his Vanbrugh portfolio, is JOHCM Japan.
The £612m fund is headed up by Scott McGlashan and Ruth Nash, and has been the sixth best performer in the sector since its launch in May 2004.
Performance of fund vs sector and index since May 2004
Source: FE Analytics
It has also outperformed over one, three and five years.
JOHCM Japan tends to invest in smaller and medium-sized companies, rather than the largest members of the Topix, It has an ongoing charges figure of 0.85 per cent and a performance fee of 15 per cent.
Despite Scott’s bullishness, Japan is still regarded as a contrarian play.
Headwinds such as an ageing workforce are seen as big structural headwinds to Japan’s long-term outlook.
The need for inflation is also clear and John Greenwood, chief economist at Invesco, says that Japan’s recent economic growth will not be sustainable if it doesn’t happen.
“So far most of the inflation can be attributed to the weaker yen and higher imported commodity prices – especially energy products and food items – not stronger domestic demand,” Greenwood said.
“While the weaker yen may help to achieve Prime Minister Abe’s goal of 2 per cent inflation in the short run, unless wages and personal incomes rise more than 2 per cent on a continuing basis, the result could simply be an episode of temporary imported inflation, followed by a resumption of weak domestic spending and growth as inflation subsides again.”
Evan-Cook says it is too difficult to predict whether the authorities will be successful in bringing about inflation.
Instead, he says investors should focus on Japan’s attractive valuations.
He uses a variety of funds for his Japan exposure, but one of his favoured is CC Japan Income & Growth – an offshore-domiciled portfolio managed by Richard Aston. According to FE Analytics, the $145m fund has returned 28.91 per cent since its launch in February last year.
As a point of comparison, the Topix has returned 16.31 per cent.
Performance of fund vs index since Feb 2013
Source: FE Analytics
Evan-Cook is hedging his bets with the fund as not only does he think that it will benefit from improved confidence towards Japan – he says its focus on dividend paying companies should stand it in good stead if inflation picks ups.
“The manager doesn’t really change the portfolio that much that shows to us that there is a growing demand for income stocks,” he said.
“Domestic investors have usually just held JGBs [Japanese government bonds] for income, especially as recent deflation have made them look an attractive investment.”
“However, if inflation were to pick up to 2 per cent – and with JGB’s yielding lower than that – investors will be much more inclined to focus on a portfolio of good quality income stocks that yields 3.5 per cent.”
The fund’s management fee is 1 per cent and again has a performance fee of 15 per cent.
