A two-pronged approach is likely to be the best way to profit from a depressed Japanese market, says Hargreaves Lansdown’s Rob Morgan.

Japan has been shunned by all but the bravest of investors for much of the last two decades. High levels of national debt, a very strong Yen and a problem with sentiment have all been a significant drag on the Japanese equity market. 

However, Morgan, an investment analyst at Hargeaves Lansdown, says that after years of fits, starts and false dawns, the tide could finally be starting to turn in favour of the Japanese stock market, especially in relation to other developed markets.

“There are a record number of companies on the Japanese stock market that have high levels of net cash as well as strong trading profitability but are trading below book value. Now that the Bank of Japan has changed tack and embarked on an aggressive programme of quantitative easing there is a real sense that it could ignite a rally.”

 Asset purchases by the government, like in the US and UK, has the effect of devaluing the currency. This is really positive for investors in the export-driven Japanese economy because it makes goods more affordable. 

To take advantage of this Morgan recommends the £253m Invesco Perpetual Japan fund.

“The fund is focused on the biggest companies in the TOPIX index and is making a real play on the exporters,” he said. “If the yen weakens substantially then you could see these stocks going ballistic. In a sustained bull rally I’d expect this fund to be right at the top of the performance table.”

The fund is headed up by FE Alpha Manager Paul Chesson and co-manager Tony Roberts. It lists Tokyo Electron and Honda in its top-10 holdings.

The fund has been among the top-performers in IMA Japan over the medium and long term. According to data from FE Analytics, it has returned 7.17 per cent over five years and 29.28 per cent over 10. This compares to a loss of 7.55 per cent and a return of 13.42 per cent from the average fund in the sector over those periods.

Performance of fund versus sector over 10 yrs

Source: FE Analytics

“The next tier down is another exciting area,” adds Morgan. “Mid-cap companies have had a very difficult time in recent years but the market is primed for a huge amount of opportunity. Most of the companies in this area of the market have lots of cash on their balance sheets but are trading at below book value.” 

“A fund like JOHCM Japan is well poised to take advantage of growth here. Scott McGlashan and Ruth Nash, who manage the fund, have a value-centric approach and this plays into the some of the policy decisions the government is taking – like raising consumption tax in 2014, for instance.”

 Data from FE Analytics shows that the fund has returned 11.98 per cent over the last five years. Only four funds have returned more over that period.

Performance of fund versus sector over 5 yrs

Source: FE Analytics

Morgan warns that the Japanese market is dependent on a catalyst before it really takes off and that there are still the traditional problems in Japan such as an ageing population and high levels of government debt.

 “If the economic headwinds delay the start of the rally then I think having exposure to a fund like Jupiter Japan Income as well as something a bit racier should give a bit of protection on the down side.”

“Strategies focusing on sustainable yields have stood up reasonably well in all market conditions, giving access to some growth on the upside and allowing the dividends to see them through leaner spells.”

The £461m Jupiter Japan Income fund is headed up by Simon Somerville and Dan Carter. Our data shows that the fund has been significantly less volatile than the sector average over the last five years.

Furthermore, a headline yield of 2.4 per cent is better than all but one fund in the sector.