Business performance in Japan over the past 10 years has been much better than generally perceived, and sustainable growing companies with strong business models should prosper regardless of the political backdrop.
For strategically oriented investors, the Japanese equity market is at an intriguing juncture. The high valuations of the past are no more and the market is now trading below US and European price-earnings (P/E) ratios; a situation which has not been seen for a long time.
Performance of indices over 2yrs
Source: FE Analytics
There are also many indications that medium-term earnings growth prospects are at least as good for Japan as for the United States and Europe.
Many firms have stepped up their global activities and are doing business beyond Japan's borders, diminishing the importance of the domestic economy. The weaker yen has also given back some of the competitive advantage that many Japanese companies previously enjoyed.
It is not widely known that aggregate net profits of publicly traded firms have increased at an annualised rate of 8 per cent since 2005 in local currency, which is comparable to the United States and ahead of Europe.
The second phase of the VAT increase planned for 2015 presents the risk of a drag on the equity market. History has shown us that VAT increases can trigger V-shaped patterns, which can also present attractive investment opportunities. Japan is set to go through such a movement on two occasions; once this year and most likely at the start of next year. It will take until 2017 for subsequent distortions to be eliminated from economic and corporate data.
However, it is unlikely that the tax increases will have a fundamental impact on consumer or corporate behaviour and we predict that net profits could grow by 10 per cent or more annually.
As fundamental, bottom-up stock pickers, we are focussed on the industrial and consumer goods sectors in Japan, where numerous companies can be found with above-average prospects and whose shares are worth holding for the longer term.
These include leading firms such as SMC Corporation and Daikin Industries. SMC is the world leader for high-tech pneumatic solutions, and Daikin is a world leader in air conditioning systems. Both companies have rock-solid management, including a strict focus on controlling costs.
Another company we like is Shimano Inc, the number one global manufacturer of bicycle components, which is being propelled forward as incomes rise and the recreation market in Asia continues to grow.
We are also finding upside potential in Japanese financial services companies, which are showing low valuations due to a lack of investor vision for their growth prospects. Interest margins are thin due to low interest rates and operating cost reductions are for the most part no longer possible, however even a slight rise in lending activity could yield record profits for financial corporations.
Ernst Glanzmann manages the JB EF Japan Stock fund with Carlo Capaul, Reiko Mito and Stefan Fröhlich. The views expressed above are his own.
Since a new approach was adopted in June 2008, JB EF Japan Stock has returned 26.55 per cent, outpacing the 5.22 per cent rise in the MSCI Japan index and an average loss of 8.28 per cent in the offshore FO Equity Japan sector.
Performance of fund vs index and sector since May 2013
Source: FE Analytics
The four FE Crown-rated fund’s largest sector weighting is to industrials, which account for 23.9 per cent of the portfolio. Financials have a 23.5 per cent allocation, consumer discretionary 21.1 per cent and information technology 8.9 per cent.
JB EF Japan Stock has a total expense ratio of 1.91 per cent.