Investors could be missing out on strong growth opportunities if they rely on passive strategies to gain exposure to the Japanese market, according JP Morgan Asset Management Nicholas Weindling.
Weindling – a co-manager on the JPM Japan, JP Morgan Japanese Investment Trust and JP Morgan Japan Smaller Companies Trust – said the Japanese market had performed strongly recently against the global growth backdrop.
Indeed, the Tokyo Stock Exchange’s Topix index has been one of the best performers of developed markets in 2017, in sterling terms, as the below chart shows.
TESE Topix vs FTSE 100 & S&P 500 YTD
Source: FE Analytics
“In terms of the overall outlook for Japan right now, it’s pretty good for a number of reasons,” he said. “There are a few different factors coming together at the same time, but broadly speaking the Japanese economy is getting better.”
“We feel that the global economy is getting better and Japan will benefit as that continues to happen.
“At the same time, the outlook for other markets there are concerns about valuation in the US but Japan is at low valuations. P/E [price/earnings], P/B [price/book], and dividend yield all look good compared to other developed markets.”
Weindling said the Japanese labour market had tightened to levels not seen since 1974, while corporate earnings had been very strong more recently.
Changes in corporate governance have also made the market more attractive for international investors, said the manager, with firms slowly increasing the number of independent directors on boards.
Other changes have also taken place with the dividend culture in Japan, which Weindling said has much improved in recent years.
“When I started my career, I was embarrassed to talk about dividend yield, it was woeful. But it has come a long way and I think it’s going to continue,” he said.
As well as changes to the way companies operate, there has been a shift in the types of companies that are poised for growth in the current environment.
Weindling said the multi-national corporations that investors traditionally associate with Japan may not necessarily be the best opportunities now.
“When it comes to investing in Japan, I think the point is that there are very strong company and very exciting prospects, but not necessarily the companies the average man on the street in London might associate with Japan,” he said.
“Most people think of Toyota, Nissan, Fujitsu or Panasonic. These were great companies 10-20 years ago but they might not necessarily be in the future.
“Some of them have very big problems competitively with Korea and Japan. They would have structural problems were people not to buy the products anymore.”
Weindling said investors who seek exposure to Japan via a passive strategy may not get exposure to the future growth companies and instead be saddled with the former giants.
He said: “There are a different set of companies [that] we think are exciting in Japan. [Indeed] there are very strong reasons to invest in active managers rather than an ETF.”
The manager said while a passive fund can offer good exposure to the broad market, it may not offer as much to smaller companies in strong growth areas.
An additional advantage Weindling said it has over passive strategies is that while Japan, a developed market, has featured in global portfolios for some time, it remains a “very undercovered and not well understood” market.
“It has got some very good bottom-up opportunities, particularly when you start going down the market cap scale,” he explained.
Focusing on themes, the manager said Japan’s leadership in the field of automation was one area that could present opportunities for investment in the future.
Japan’s ageing population and tight job market have led manufacturers to invest heavily in robotics and automation to replace some functions.
While an ageing populations may present other challenges for the economy, for the manager it could also lead to new investment opportunities.
Weindling said that the population is forecast to fall from 127 million people to just 95 million people by 2050.
“[It will be] bad for a lot of companies but very good news for a small number of companies,” he said. “All we care about are companies that will benefit from that trend. It’s a multi-year trend but highly unlikely to change.”
Areas directly and indirectly exposed to elderly care are likely to benefit from the trend, according to Weindling.
He said one of the areas of the market that could benefit from the trend are among chemists where the top 10 companies have a 30 per cent market share compared with the UK where two companies cover 60 per cent of the market. Weindling said the market is dominated by “mom and pop stores” and could prove an interesting sector for M&A activity.
Other areas that could benefit are areas such as the pet insurance industry – as older, more lonely people spend more money on their pets.
Over five years the £422.8m, four FE Crown-rated JPM Japan fund has returned 142.99 per cent compared with a gain of 103.63 per cent for the average IA Japan fund and a 108.89 per cent rise in the benchmark.
Performance of fund vs sector & benchmark over 5yrs
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 0.93 per cent.