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What to expect from your Japan fund in 2015

30 December 2014

Japan has disappointed investors in 2014, but a number of fund managers and other industry experts believe 2015 could be a strong year for the country.

By Gary Jackson,

News Editor, FE Trustnet

From strong gains in 2013 as the market was swept along by the euphoric mood that came with ‘Abenomics’, Japanese equities have faced a rather subdued 2014 as investors tackled disappointing economic data and the consumption tax increase in April.

In 2013 the Nikkei 225 gained 26.53 per cent, in sterling terms, as investors backed prime minister Shinzo Abe’s ambitious economic reforms, which are designed to break the deflationary cycle that has blighted the world’s third largest economy for over two decades.

This means Japanese equities beat the 20.52 per cent gain the MSCI AC World but trailed the 29.10 per cent rise in the S&P 500.

However, doubts that ‘Abenomics’ will ultimately prove successive in kickstarting economic activity has hampered Japanese equities this year with the Nikkei rising just 1.18 per cent. In contrast, the MSCI AC World has advanced 11.92 per cent while the S&P 500 is up 21.98 per cent.

Performance of indices over 2014



Source: FE Analytics

So have the recent struggles of Japanese equities left them looking even more attractively valued with the strong likelihood of upside, especially after the Bank of Japan announced a surprise expansion of its quantitative easing (QE) programme.

Or are they heading into more uncertainty unless its reform package makes serious headway?

Philip Saunders, John Stopford and Michael Spinks, co-heads of multi-asset at Investec Asset Management, say Japan now stands out amongst developed equity markets, many of which are seen as expensive.

“We believe Japan offers the best combination of value, earnings growth, earnings upgrades and central bank liquidity among developed markets, so we expect recent strength to continue,” they explained.

“Monetary policy is set to remain very supportive and the fact that domestic institutional buying led the recent market advance suggests that the current cycle differs fundamentally from the foreign-led bear market rallies that have punctuated Japan’s secular bear market.”

Saunders, Stopford and Spinks recommend a “material” allocation to Japanese equities on a currency hedged basis. In his Investec Managed Growth fund, Saunders has 3.9 per cent in Sarah Whitley’s Baillie Gifford Japan Trust, making it the second largest holdings.

Hiroyuki Ito, portfolio manager of the Fidelity Japan fund, believes the headwinds thrown up in 2014 are now priced into the market, leaving a number of positives to push forward stock markets in the coming year.

“As we have moved through 2014, concerns about the impact of the sales tax rise and global growth have gradually been digested by the market, while a second sales tax rise for October 2015 has been pushed back by 18 months.”

“Meanwhile, the Bank of Japan’s recent move to expand its quantitative easing programme boosted my confidence that Japan is on the right track to escape from its deflationary spiral,” he said.

David Coombs, head of multi-manager investments at Rathbones, has “low” fundamental resolve when it comes Japanese equities but remains overweight because of valuations.

“Before this sounds like too much of a contradiction, the political situation looks less stable and the economy is creeping back into recession. Ultimately, this means a murky visibility of earnings,” he explained.

Citing the “huge” QE programme and a potential postponement of the sales tax rise until 2017, Coombs added: “We are sticking with Japan for now but will not hesitate to reverse our decision if earnings start to deteriorate. As with Europe, the boundaries between long-term structural problems and more cyclical ones may become confused, so experienced stock-pickers are crucial.”

For his Japan exposure Coombs uses Nicholas Weindling‘s JPMorgan Japanese Income Trust, which he holds in his Rathbone Multi Asset Strategic Growth Portfolio.

Valuations aside, Luca Paolini (pictured), chief strategist at Pictet Asset Management, says the Japanese stock market looks attractive for a number of reasons.

“First, export-oriented companies stand to benefit from the weak yen, which is trading below its purchasing power parity rate for the first time,” he said.

“Second, domestic stocks should receive a strong boost from a change in investment policy at Japan’s biggest public pension fund, the GPIF, which is to increase its allocation to Japanese equities to 25 per cent from a current target of 12 per cent.”

“Third, the BoJ has expanded its bond purchase programme, which should prove supportive for growth. Lastly, reforms set in motion by prime minister Shinzo Abe promise to improve country’s corporate governance.”

Considering where the specific opportunities can be found, Shogo Maeda, head of Japanese equities at Schroders, says a number of sectors will benefit from strong corporate earnings growth and a weak yen in 2015.

“Where will we be looking for opportunities in 2015? Sustainable mid to long-term earnings and valuations are what we are focusing on when we look at which companies to invest in.”

“This would preferably come through company-specific growth drivers as opposed to just betting on the cyclical recovery or macroeconomic tailwinds such as only on a weaker yen,” Maeda says.

“We are finding cyclical stocks including autos, electrics, and some parts of machinery attractive, given their potential for upward revisions to earnings, while being mindful of valuations.”

“We also like trading companies and financial stocks given their cheap valuations. Turnaround opportunities among out-of-favour stocks are also an area where we see additional investment ideas as we go into 2015.”

Darius McDermott, managing director of Chelsea Financial Services, is positive on the outlook for Japanese equities, highlighting FE Alpha Manager Chris Taylor’s Neptune Japan Opportunities and Sarah Whitley and Matthew Brett’s five crown-rated Baillie Gifford Japanese funds as his preferred plays.

“The case for Japanese equities is simple: most other developed markets look fully valued in comparison,” he said.

“Japan is an exception; Japanese shares trade at a 1.3 price-to-book ratio, less than half that of US stocks. The stocks are cheap relative to their own history. Japan’s stock market currently has a price-to-earnings ratio that is only 37 per cent of its 10-year historical average.”

“The unprecedented flow of QE is also a tailwind for the Land of the Rising Sun. For once, Japan may not flatter to deceive, which is positive.”

 
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