Investment Trust Review: All change in Japan

On Sunday 30 August, the Democratic Party of Japan won a historic victory in elections to the country's lower house, sweeping aside the Liberal Democratic Party which had governed Japan for all but 11 months since 1955. The DPJ now faces the uphill struggle to drag the world's second-largest economy out of its worst and most prolonged slump since World War II. Hitherto shunned by many investors, Japan could conceivably reclaim its long-ironic epithet: the land of the rising sun.

The Association of Investment Companies (AIC) has taken soundings from a group of trust managers, to assess how these developments could affect the investment landscape.

Most of the managers agreed that the DPJ's victory is generally good news, with the main policy shift expected to be towards a more consumer friendly, 'economic revival through higher living standards' stance. But managers are more divided on how enduring any positive impact on the stock market might be.

Opinion varies between those who believe that the election result will have significant implications for the Japanese stockmarket almost straight away, stimulating a strong recovery, and those who say 'not yet, and not without substantial shifts in policy.'

The AIC reports the view of Andrew Rose, fund manager of the Schroder Japan Growth fund, who is in the former camp. He says that the short-term market response is likely to be positive, based on the prospect of change, which a DPJ-led government could be construed as representing. This is likely to reinforce the recent improvement in market sentiment in the short term.

Someone who remained cautious about predicting a positive outcome for the economy at this stage is Sarah Whitley, portfolio manager for the Baillie Gifford Japan trust. She said that the Japanese election result has the potential to be highly significant, as it represents a change to a genuine two-party state.

But then goes on to say: "Given the significance of the election it is probably wise to wait and see. Nevertheless, the DPJ victory unifies the lower and upper houses and therefore makes passing legislation easier, and significant political reform more likely. As is usual during an election, the political debate has been focused more on winning votes than dealing with difficult issues, and we will have to judge the government that is formed by their actions.”

Pinakin Patel, client portfolio manager for JPMorgan Japanese Investment Trust and JPMorgan Fleming Japanese Smaller Investment Trust does not believe that the elections will have an economic impact at this stage.

He commented: "The more important consideration for us is whether this DPJ victory will lead to a significant policy shift which would have a sustainable impact on the economy and corporate sector profitability. In this regard, we are inclined to believe the answer is ‘no’ at least for the time being, and as such the DPJ victory in itself is neither a clear buy nor a sell signal for Japan, beyond the observation that investors never like uncertainty and now the election is out of the way that factor will no longer weigh on markets.”

So the question appears to hang on whether the new government is ready to implement any new policies. The trust managers are expecting a few policy changes that might impact their investments.

Andrew Rose again: "The main policy shift is to be a marginally more consumer friendly focus at the expense of producer interests. Emphasis looks likely to be placed more on redistribution than boosting growth per se. In the medium term there must be some doubts on the DPJ's ability to execute given the virtually untried nature of key decision takers and the disparate composition of the party."

Pinakin Patel's view is that he DPJ has differentiated itself from the LDP in its pro-consumer policies 'economic revival through higher living standards' (it has committed to not considering the introduction of a new consumption tax for 4 years) and promising various forms of transfer payments such as higher child benefits and a wider social safety net.

The DPJ claims they can fund these initiatives through aggressive cuts in non-productive public spending (a cut in public works expenditure) while maintaining the current 5 per cent consumption tax rate. In as much as this represents a commitment to shift stimulus away from the public to the private sector it represents a departure from some of the LDP’s longer held sacred cows. But at this moment, the DPJ’s agenda doesn't address any of the structural issues facing Japan that have caused caution and scepticism towards Japan amongst foreign investors.

The view of this analyst is that there will be some initial exuberance during the honeymoon period. Whether this registers on the Greenspan 'irrational' scale has yet to be tested. But bear this in mind: even in its headiest party-frock moments Japan remains a deeply conservative society. The DPJ may now have its grip on the Diet, but we cannot know yet whether it has a grasp of the reforms needed to break the Lilliputian structural bonds that have pinned progress down.