Following the so-called lost decade in Japan due to a crippling debt-deflation cycle, prime minister Shinzo Abe came to power in late 2012 with a pledge to revive the country’s economy and financial markets via his three-pronged reformist policies which have since been dubbed ‘Abenomics’.
His first two arrows of Abenomics – fiscal stimulus and monetary easing – had an immediate effect as large-scale quantitative easing from the Bank of Japan, which in turn produced a weaker yen, caused a snap rally in the Nikkei in 2013 with certain funds in the IA Japan sector delivering returns of more than 50 per cent that year.
However, due to the VAT hike in spring last year, concerns about Abe’s third arrow of structural reform and the fact the economy moved into recession last year meant many Japan funds had to hand back some of their gains in 2014.
This year has been far more positive, though. Following Abe’s super-majority election victory in December and even more central bank bond buying, the IA Japan and IA Japanese Smaller Companies sectors have been the two best performing open-ended peer groups in the IA universe with returns of more than 15 per cent in just three months.
Performance of sectors versus index in 2015
Source: FE Analytics
While some investors may be concerned that the easy money has already been made in Japan, Tinker expects the market to keep rallying.
“The one market that is looking particularly interesting at the moment in my view is Japan, which is showing a number of very interesting developments, both top down and bottom up,” Tinker said.
The manager says two of the biggest positives for investors in Japan are the effect of the lower oil price, which is down 35 per cent over six months, and the increasing strength of the US dollar is having on the country’s economy.
“First, and most obvious, is that Japan is highly exposed to the global economy and as investors start to move away from ‘depression obsession’ the attraction of cyclicals will be reassessed,” he said.
“In particular, the two big defining macro stories of the last nine months have been the sharply higher dollar and the dramatically lower price of oil, more specifically the bursting of the commodity bubble.”
“Japan is a particular beneficiary of both of these trends. However, what is ‘different this time’ is that this is likely to be more of a domestic story than an export one. This is less of a world of exporting capital equipment to China and more of a world in which you export services, particularly tourism.”
However, the major reason why Tinker is so positive on Japanese equities is due to the increasingly favourable bottom-up ‘technicals’ which are now at work.
Firstly, he says that due to the negative bond yields on offer thanks to the Bank of Japan’s QE, the largest state pension fund – which has typically had very little in Japanese equities – is being forced out of fixed income and into risk assets.
“The outline guidance for the giant Government Pension Investment Fund [GPIF] effectively sets the rates for most other pension funds to follow. They are being required to have higher weightings in the assets that the rest of the world are being told are ‘too risky’ mechanics,” he said.
“Moreover, the Bank of Japan itself is buying Japanese equities, and is now the second biggest holder after the GPIF, making for the type of buy on the dips bull market conditions that have benefitted fixed income markets for much of the last decade.”
Now that domestic investors are turning towards the Japanese equity market, he expects international investors to follow suit.
He says that huge interest in Japanese equities from foreign buyers was one of the major catalysts for the Nikkei’s initial rally in early 2013. However, international investors started pulling their money in late 2013 and in 2014 but will now be looking to re-enter the market.
“After a sharp Q2 2013 rally in dollar terms, the market then moved essentially sideways until a couple of weeks ago, which is why, it is breaking higher and now once again on the radar for the international institutional investor,” Tinker said.
Performance of index indices since May 2013
Source: FE Analytics
“A catalyst may simply be that as the Japanese authorities continue buying and the technicals trigger international participation, or it could be hung on a macro event such as one of the various trade deals circulating at the moment.”
Tinker is also bullish on Japan as due to the launch of the JPX Nikkei index 400, which is a government initiative to try and align the interests of management with those of investors, particularly through the idea of return on equity.
As result, there has been a marked increase across the board in the use of dividends and buybacks to return cash to shareholders.
While Japanese equities are the leading asset class so far this year, the likes of Hawkmoor’s Ben Conway warned that a lot of value had already gone following the Nikkei’s stellar gains over recent weeks.
However, there have been a number of experts who have become very bullish on the country’s equity market.
For example, FE Alpha Manager Chris Taylor recently told FE Trustnet that investors will make 10 times their money in Japan over the coming seven years if Abe is successful in weakening the yen even more as, in turn, it 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.”
For those that investors who are willing to take a long-term view on Japan, Square Mile recommends Andrew Rose’s Schroder Tokyo fund which carries the investment groups’ highest AAA rating.
“The fund is a core Japanese equities proposition that plays to the strengths of the manager and supporting team. It has remained a competitive proposition across a range of market conditions and we would view this fund as a very solid and wholly viable option for exposure to the asset class,” Square Mile said.
Performance of fund versus sector and index since April 2004
Source: FE Analytics
According to FE Analytics, the now £1.7bn fund has been a top quartile performer and has beaten its Topix benchmark since Rose took charge in April 2004 with returns of 88.29 per cent. The fund, with its value bias, has also outperformed the sector in eight out of the last 10 calendar years.
Schroder Tokyo has an ongoing charges figure (OCF) of 0.92 per cent.