The two Japanese long-term heroes but short-term laggards you should stick with

Investing in 2022 has been tough for any investors caught out by the move from growth to value.

While the issues faced by companies in the US and UK are well known, however, the same fate has befallen fund managers elsewhere as well.

Japan, for example, has also gone through a significant shift this year and managers have not escaped the move away from high-growth stocks into more value-orientated names.

So severe have the past 12 months been, some of the IA Japan sector’s most-loved funds have dropped to the bottom of the rankings over three years.

As the below chart shows, Axa Framlington Japan, Baillie Gifford Japanese, GAM Star Japan Leaders and JPM Japan – all top-quartile performers over 10 years – have plunged over three years.

We have also included the FTF Martin Currie Japan Equity fund (formerly Legg Mason), which was in the sector but has been moved to the IA Unclassified sector. It was the best performing Japan fund over the decade but has been the worst over three years.

Total return of funds vs sector over 3yrs

Source: FE Analytics

All invest with a broadly high-growth style, while the Martin Currie fund typically also has a penchant for small and mid-sized companies.

When put to professional fund pickers, two of the funds emerged as their favourites.

Kamal Warraich, head of equity fund research at Canaccord Genuity Wealth Management, said that all had performed “in-line with expectations” as they are all “different flavours of growth”.

While this has hampered returns, he noted that things have picked up recently over the past three months for all the funds, suggesting that none have moved away from their approach.

His pick however was JPM Japan, which adopts a concentrated, ‘aggressive growth’ approach targeting long-term structural trends in Japan, including e-commerce, autonomous vehicles, medical equipment and renewable energy.

“The focus on these trends biases the fund towards specific sectors (e.g. healthcare and technology), longer-duration cash flows and higher valuations. These are factors which typically underperform during value rotations,” he said.

“However, the fund is managed by an experienced team with strong knowledge of the Japanese equity market. Pleasingly, over five and 10 years the fund remains top quartile.”

Total return of fund vs sector and benchmark over 5yrs

Source: FE Analytics

Ajay Vaid, investment research analyst at Square Mile Investment Consulting and Research, said his pick would be the Baillie Gifford Japanese fund.

The portfolio, like other growth-oriented funds in its peer group, has struggled even though Japan is insulated from the decade-high inflation experienced in the West.

“As this fund takes a low turnover approach, it has faced short-term headwinds, although it has proved slightly more resilient relative to a comparable stylistic index, such as the MSCI Japan Growth,” he said.

“Specifically, the fund’s allocation within consumer discretionary, industrials and communication services have been areas of weakness, with companies such as Rakuten and Misumi being amongst its largest detractors.”

Vaid added that some of its holdings have been de-rated but that the managers would argue that Japanese growth companies tend to trade on smaller premiums than their peers in other developed markets such as the US and so valuation is less extreme.

“We rate this fund highly and expect that over the longer-term it will recover, once the market again focuses on the idiosyncratic attributes of the companies held in its portfolio and the long-term trends at play in Japan. For example, automation and robotics, their ageing demographics, and a consumer preference for premium brands,” he said.