The Japanese government has embarked on a massive quantitative easing spree that will see the Bank of Japan massively expand its balance sheet, even more so than the US Federal Reserve has done. Gray (pictured), manager of the CF Miton Special Situations fund, says that the Japanese policy is as doomed as the American one.
"I do not think central bank money-printing is a solution and I am sure it’s just building up problems for the future one way or another," he said.
"It doesn’t resolve the debt problems of the country; in fact it’s increasing them."
Gray says that there was a brief period after the financial crisis when the global consensus seemed to shift towards paying down debt to set budgets on a surer footing, but that all seems to have ended already.
"People were wanting to repay debt whether that was corporates or governments but that has reversed and now we are just encouraging people to borrow and speculate," he said.
Record low interest rates compound the problem, Gray added, as they make it so cheap to borrow and spend.
Data from FE Analytics shows that since the election of the new government late last year the value of the currency has fallen and the stock market has soared.
The TSE Topix index is up 22.36 per cent over the year while the yen has lost 15.8 per cent of its value against the pound.
Performance of currency vs index over 1yr
Source: FE Analytics
Gray says that this artificial pumping up of the market is creating the illusion of rising prosperity.
"Are they creating real growth? I don’t think so. The trouble will happen when the printing presses stop. How long can central banks keep gearing up their balance sheets?"
The Japanese market is not the only one to be rising, of course, and Gray is equally sceptical of the reasons behind similar trends elsewhere.
"GDP growth will likely disappoint this year having done so last year in all regions of the world," he said.
"The equity rally is not driven by corporate earnings but expanding P/E ratios. P/Es explain all of the upside to the markets and perhaps more."
"I have no idea what the final outcome will be. Are they creating real growth? I don’t think so. The trouble will happen when the printing presses stop. How long can central banks keep gearing up their balance sheets?"
CF Miton Special Situations has been cautiously positioned since 2006, and its defensive stance in 2008 served it well, with the fund among the few to have made positive returns in that year.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The fund has 28 per cent in cash, and has been benefiting from the weakening Yen in those positions.
It also holds GLG Japan Core Alpha in its top-five holdings.
Gray says that in the short-term he is holding these positions, even if he thinks the long-term prospects for the country are still poor.
"We are happy to run with it for the moment, it’s at a very early stage and we are seeing a lot of speculative money move in and I think we will see more local money moving in too."
"The Japanese are famous for investing overseas," he said.
Kwok Chern-Yeh (pictured), Aberdeen’s head of investment management in Japan and leader of the team on the Aberdeen Japan Growth fund, is also wary about the effects of the policy on the economy.
Although he says that the attempt to tackle deflation is probably the right thing to do, and he is not as bearish as Gray on the eventual outcome, he says that it is difficult to model the long-term outcomes. While the monetary policy is likely to support markets in the short-term, any lasting recovery will depend on whether the country can carry out the structural reforms promised by the government.
Chern-Yeh also warns that much of the money that is currently entering the country is going to the wrong companies.
"We think that at some point investors will focus more on fundamentals, but when that will happen I’m not sure," he said.
"We have seen lots of ETF buying in the last few weeks. When there’s a rush there’s always a risk that certain things are getting overvalued."
Aberdeen Japan Growth has a good long-term record compared with other funds in the sector, but has not kept up with the pace of the rally.
Chern-Yeh says that this is because the money has been rushing into companies that are seen as more sensitive to the weakening Yen rather than to those that have proved themselves to be durable and profitable.
One of the sectors the fund avoids is large cap banks, which the manager says have longstanding issues.
The FTSE Japan General Financial is tearing away from the FTSE Japan index, according to data from FE Analytics, and the sector makes up a large part of Japan market ETFs.
Performance of indices over 1yr
Source: FE Analytics
"Japan is over-banked," Chern-Yeh said. "It’s quite tricky, for example, if mortgage-lending increases and everybody rushes in but we are concerned about margins. We think the smaller regional banks are less risky."
Aberdeen Japan Growth has the second-best record in the sector over three years and the third-best over five, returning 61.09 per cent over the latter period while the TSE Topix index has grown just 27.26 per cent.
Chern-Yeh says the fund’s success is down to its focus on company fundamentals, and that is what many investors are forgetting in their rush to profit from the short-term boost to the markets.
"A lot of people think of the market as a macro play but we look at the companies," he continued.
"Good companies do not become bad and bad companies do not become good because of the yen weakening or the economy improving."
The manager stresses that his team invests in companies that have found a way around the country's demographic and economic problems, either by outsourcing to find new labour pools or selling into China to cope with sluggish demand in Japan.
"We would rather be invested in a good company because predicting the outcome of the current policy is tricky – you are always waiting for fundamentals to catch up," he said.