UK investors should give up their historic bias against Japanese equities and add exposure as fundamentals continue to improve, according to Baillie Gifford’s Sarah Whitley.
Foreign investors have been net sellers of Japanese equities for the last two consecutive calendar years, missing out on healthy returns, she says.
Indeed, since the start of 2015 the TSE Topix index is up by 48.22 per cent, compared to a 43.8 per cent return for the S&P 500 and a gain of 19.1 per cent for the FTSE 100.
Performance of indices since January 2015
Source: FE Analytics
Whitley, who has managed the three crown-rated Baillie Gifford Japan Trust since 1991, says there have been a number of developments signalling change in the Japanese market more recently.
She said: “I think we are at a really interesting time in Japan at the moment and though everybody knows that Japan is not an economy that is going to grow particularly fast, there are a lot of things forcing Japan to change at the moment.”
The first major change identified by Whitley is in the corporate governance of the companies, which has improved greatly with the addition of independent directors added to the boards.
“The number of independent directors has been increasing and i think it started out with ‘you must have an independent director’ and that was taken on board and then it was more than one and that is now the vast majorities of companies,” the manager said.
“It’s an evolving process and you can see that in four or five years’ time it is going to be quite different.”
As well as this, Whitley says Japanese companies are flush with cash and could increase their dividends significantly should they wish to do so.
“They could if they wanted to pay out special dividends and disperse the cash to shareholders so more focus on shareholders is something that we are hoping will emerge as these boards develop,” she said.
“I think people have the perception of Japan as a country where nothing is happening but timescales can sometimes be a bit short. This - as with any major change - takes a while to play out and doesn't happen overnight.”
Another area where developments are happening faster is in the Japanese labour market which she says is having a material impact on the way the economy is improving.
“Japan now has the tightest labour market it has had since the 1990s,” Whitley said. “It's a major trend. Unemployment is 2.8 per cent, female participation in the labour market is above quite a lot of developed country levels and there is not a lot of give in the labour market.
“We’ve got a few companies that we invest in that are temporary labour companies - Temp Holdings is one and Recruit is another.”
Whitley highlights “more mundane economic data” such as GDP growth, which has been positive for the past four quarters.
She added: “Inflation is ticking up so we think the economy is generally reflating on the back of the global reflation and that all looks good to us.”
Yet investors remain unwilling to add to their positions in the country, she says, with two consecutive years of net outflows from foreign investors.
“The reasons that people haven't invested in Japan are gone,” explained Whitley. “I was looking at Topix in sterling terms and since 2009 it has been a good bull market: companies are now more shareholder-focused, the market is cheap relative to other international markets and Japan is well represented in a few growth areas.”
Performance of Topix since 2009
Source: FE Analytics
James Budden, director of marketing and distribution at Baillie Gifford, said: “I think people have been very underweight Japan and I think that is still the case if you look around wealth managers and IFAs compared to the size of the market they are very underweight.
“The ones that have caught on have done very well but there is still quite a bit to go I think. It’s an historic bias, I think.”
Whitley added: “I made a point at a general ethical investing conference and someone asked ‘what can you expect in Japan when the market is still half of what it was in 1989’ but that has no relevance at all.
“That was quite a long time ago and had nothing to do with the point i was making but people are still anchored on that.
“Yes, that was a very strange bubble but it was quite a long time ago and should people leave that out and get on with what Japan is now: it’s done.”
She said: “The companies have done a lot of work to cut costs in the last 10 years so the breakeven rate has fallen, corporate profits on aggregate are at record levels.
“Foreigners have been net sellers of the Japanese market for the last two fiscal years so underweights must be even lower now and there’s no obvious fundamental reason for it.”
The £566m Baillie Gifford Japan Trust has been the best performing fund in the IT Japan Equities sector over one, three, five and 10 years.
Over 10 years the fund has returned 169.68 per cent, compared with a 119.64 per cent gain for the average IT Japan Equities sector trust and a 77.84 per cent rise in the benchmark Topix index.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
The fund is currently trading on a 3.81 per cent premium and is 17 per cent geared, according to data from the AIC. It has a clean ongoing charges figure of 0.88 per cent.