As global markets have shed money over the year, Japan has been one of the top three performing markets – largely thanks to a well capitalised banking sector that has already dealt with a decade of deflation and poor economic conditions.
The IMA Japan sector consists of 60 funds with a remit to invest at least 80% of their assets in Japanese equities, and these funds have been the top performers over the last month, achieving by a sector average one month gain of 16.3%.
Extending this horizon to a year, however, the average fund loses 10.5% - although not highly impressive on an absolute basis, the loss is less severe than that suffered in the West.
At this point it is also worth noting that the TOPIX index lost 33.2% over the year, and that every fund in this sector outperformed this index – this is a result of the majority of Japanese funds holding large amounts of cash – a force of habit from poor market sentiment over the last decade – helping the sector limit full exposure to the drop in Japanese indices.
Given that Japan remains the second largest economy in the world, risks are fairly low – reflected by an average one year volatility of 15.4%, with funds ranging between 25-10%. The R-squared criterion also poses an inverse relationship with fund returns, as those which have been less correlated to the sector average or the TOPIX index have been the best performers over the year.
Fund Selection
To isolate the funds we view as providing the best risk-return combinations we created a mean-variance optimization model and plotted an efficient frontier, using three year monthly data to November 2008.
Point P on our efficient frontier highlights our minimum variance portfolio – which seeks to maximise return and minimise risk. If an investor held portfolio P over this horizon they would have lost an annualised 5.1% given a risk of 10.7% over a three year horizon – a combination that outshines the sector’s average annualised loss of 8.4% given a risk of 14.4%. Portfolio P’s four constituent funds are displayed in the table below alongside their individual return and volatility;
|
Name |
Portfolio Weight (%) |
3 Yr Return (%) |
3 Yr Ann. Vol. (%) |
|
85.1 |
-12.6 |
10.8 |
|
|
5.7 |
22.3 |
20.7 |
|
|
4.8 |
-3.1 |
15.3 |
|
|
4.4 |
-30.8 |
15.7 |
Despite the overwhelming 85.1% weight towards the Morant Wright Japan fund, the Neptune Japan Opportunity fund is also worth looking at.
Neptune’s fund has been head and shoulders above the rest with a one year return of 53.1%. The fund is the only to have posted a positive Sharpe ratio of 1.25 over the year, and has generated capital growth by investing in a concentrated portfolio of Japanese securities. The fund manager aims to attain top quartile performance and maintains a high exposure to industrials (21.6%) and consumer discretionary (20.6%) sectors, with a high 18.3% weight towards the Japanese money market – understandable in an environment where indices are plummeting.
Morant Wright Japan is also impressive, as the second best performer over the year at half the volatility of Neptune’s offering. The fund has returned 7.9% over the year, boasting a more diversified portfolio, resulting in more consistent performance – earning the fund a 3 Crown Rating.
Outlook
Japan has experienced over a decade of poor economic growth, having already been through a banking crisis like the one now affecting the West. This has meant that Japanese equities have already experienced mass write-downs and corporate deleveraging has been a focus, giving Japan a minimal direct exposure to the credit crisis.
Given that 80% of stocks are trading at below book value, Japan is perceived by many as the cheapest economy in the world – this is further supported by a price to book ratio of the average equity in the TOPIX index in the region of 1.5x – its lowest ever.
The biggest drawback on the Japanese economy is its dependency on exports – a result of the deflationary environment caused by low domestic consumer spending and a weak Yen. Given that the Yen is set to strengthen with the USA and China continuing to reduce imports – the Japanese economy could be in for a rocky ride in forthcoming months.
Japan remains a highly cyclical economy and thus the effects of the global credit crunch can still pose a strong impact against returns. Therefore wise investors would not want to be sucked into a hope for a swift Japanese resurgence – as there have been many false dawns in the past.
Neptune’s Japan opportunities fund should nevertheless continue its prosperity given that the fund has topped the tables in tough market conditions – which clearly reflects the fund manager’s superior stock selection abilities. This is further supported by a low R-squared of 0.12 against relative benchmarks – meaning that the fund has been rewarded from fraying away from the typical investments that have plagued the performance of its peers.
*Source of data: Financial Express Analytics