A very strong yen, a deflationary spiral, an ageing population and political issues have all meant Japan has been a very difficult place for equity investors over the past 30 years or so. Our data on the Nikkei goes back to 1983 and over that time it has gained 309.79 per cent, compared to the MSCI World index’s return of 1,880.68 per cent.
Performance of indices since Jan 1983
Source: FE Analytics
In fact, since December 1989, the index is down 40 per cent.
However Taylor, manager of the £465m Neptune Japan Opportunities fund, says this is all about to change as he thinks Abe will be successful in weakening the yen even more which, in turn, will unlock the potential of Japan’s highly profitable multi-national companies.
“The big thing here is Japan has, rightly, missed out on the last 30 years of the global bull market because structurally it has been screwed by politics, the economy and the demographics. But if they get it right, they will close that gap,” Taylor (pictured) said.
“Going way back to August 1982, the world is up 28 times and Japan is only up three times. It will close this gap. If they get this right, it’s not a question of the market doubling after 18 months, you’ll make roughly 10 times your money in five to seven years but you must hedge otherwise it won’t happen.”
‘Abenomics’, which is a three-pronged policy to reflate the Japanese economy, had an immediate impact in 2013 as Abe’s monetary and fiscal reform was successful in devaluing the yen. This translated into strong equity returns, as the Nikkei was up 26 per cent in 2013.
However, concerns about Abe’s “third arrow” of structural reform, a sales tax hike, concerns about the longevity of the Bank of Japan’s (BoJ) quantitative easing (QE) programme and the fact the country moved into recession have all contributed to the poor performance of Japanese equities so far this year.
Performance of indices in 2014
Source: FE Analytics
However, Taylor says now Abe has been re-elected, he expects the BoJ to keep up its massive QE programme and the yen to continue to weaken.
Moreover, the manager says the currency needs to continue to fall or else it will have serious ramifications for the country’s economy – which is currently in major trouble considering its ageing population.
“Japan is in the situation where there is only one way out to avoid bankruptcy and that is to get tax revenues up and that’s primarily corporate profits driven – there is nothing else that can do that,” he said.
“The Japanese have only five to seven years to avoid bankruptcy; they run out of money otherwise. It’s as simple as that. The foreign exchange reserves give them a couple of extra years, but it’s not much. This is the problem, the tax take has collapsed but the spending has gone up and up and up.”
He says a weaker currency will push up corporate profits, which will in turn increase tax revenues. While the chance of bankruptcy may seem like a serious headwind for investors, Taylor says it is almost a one-way bet that the yen falls significantly from here.
Speaking two days before Abe’s election victory over the weekend, Taylor said: “If he gets in, more of the same, the yen gets trashed again.”
“You’re pushing on an open door here. The QE that they have already executed means they have actually created and spent more money in 18 months than the Americans did in five years on an economy that is a third the size.”
“The amount of money they are throwing at it is unprecedented and they will just do it again. This is the key thing: medicine isn’t done until the whole thing is over.”
The major reason why Taylor is so bullish is because he says Japan is littered with market leading multi-nationals. He is frustrated that most investors still don’t realise that they are the driving force behind Japan, pointing out that overseas production and sales are far more important to the county than exports are.
He says that as the yen falls, it will unlock the huge profitability of these businesses which will not only drive the market forward, but save the economy as well.
“Japan is the leader when it comes to earnings growth, historically. These are very good companies that dominate their sectors and they got plenty of cash on the balance sheet long before western companies did [after the financial crash].”
“That is because they self-financed their growth and recovery and it’s really this which is terribly misunderstood. It powers the earnings growth, which people understate, and that makes the country a bargain.”
“These companies are multi-nationals; they are not exporters, so yen weakness doesn’t matter. Not in the sense of boosting exporters, what it does is boost the yen value of all these overseas earnings. It avoids all the problems at home of a shrinking market and high expenses – you are focused in on all the growth across the world.”
He added: “This money comes back home to reflate the domestic economy.”
Taylor is considered one of the best Japanese equity managers available to UK investors.
He took over his four crown-rated Neptune Japan Opportunities fund in May 2005 and, according to FE Analytics, it has topped the IMA Japan sector over that time with returns of 177.55 per cent, beating its TOPIX benchmark by 122.82 percentage points in the process.
Performance of fund vs sector and index since May 2005
Source: FE Analytics
Those figures include a staggering 84.26 per cent return in 2008 when the sector average lost 3.84 per cent and a 50 per cent return last year, which were double the gains of the sector. The fund is also top quartile so far in 2014.
Taylor added: “What we’ve got is this market which is structurally cheap whichever way you cut it.”
“It is totally misunderstood and they have to get earnings up otherwise they don’t have the tax to rescue the country financially.”
“I can’t emphasise how important the hedging is because this yen weakness is here to stay. To save the country, it’s got to keep coming down and Abe is going to get in for another four years. You’ve got to hedge, if you don’t you’re going to kiss off 30 to 50 per cent of the available return.”
Neptune Japan Opportunities has an ongoing charges figure (OCF) of 0.88 per cent.
