Japanese equities got off to a flying start this year. The rally was spurred on by cheap valuations and ultra-loose monetary policy from the Bank of Japan with the intention of reflating the economy and weakening the yen.
Performance of indices year to date
Source: FE Analytics
While the Nikkei had returned close to 40 per cent by late May – as the graph above shows – since then the index has moved roughly sideways.
However Chesson (pictured), who manages the Invesco Perpetual Japan fund, says he is keeping a high exposure to more economically sensitive stocks and that the current lull should just be viewed as an entry point into the market. "Our outlook for Japan, well it’s bullish," he said. "We are keeping high exposure to cyclical and reflationary areas of the market as they are cheap compared to expected profits growth."
"There has been a significant improvement in corporate profits as well as a weakening yen and certainly monetary policy from the Bank of Japan will continue to be supportive for equities," he added.
The manager says that both internal and external economic fundamentals are supportive of a higher risk strategy when investing in Japan.
He also says the recent pull-back was understandable given the strong gains many investors saw, but that there is no need to change his current positioning because he expects further gains from the market.
"In terms of portfolio activity, we have done very little," he continued.
"We have taken some profits from some of the strong benefactors of the move upwards. However, we still remain well invested in those areas and have even added to some manufacturers. Though the fund has been adjusted a little, the names remain unchanged."
He says that this approach has meant the fund has struggled post the May sell-off, although this is nothing to be concerned about as he expects equities to move a lot higher over the short- and medium-term.
"Over the short-term, since the market peaked, we have given back some performance," he explained.
"Unsurprisingly, some of the higher-beta names – which are well represented in this fund – have struggled over the past few months. But this is just a short-term correction in our opinion and we are sticking with the bullish view."
"There are improving economic fundamentals both at home and abroad along with attractive valuations. The outlook continues to improve and so this correction should be seen as a pause in an upward trend," he added.
Chesson has managed the £302m Invesco Perpetual Japan fund since February 2000.
According to FE Analytics, his fund has been a top quartile performer in the IMA Japan sector over 10 years with returns of 80.39 per cent, nearly doubling the returns of the average fund in the sector over that time.
Performance of fund vs sector over 10yrs
Source: FE Analytics
The fund has also participated strongly in the recent rally and has been the third-best performing portfolio in the sector over one year.
Manufacturing stocks make up a hefty 62 per cent of the fund’s assets, while his exposure to domestically orientated companies remains low.
He says that the reason he is ignoring domestic names, such as retailers, is because the depreciating currency, along with the proposed increase in VAT, will put pressure on the Japanese consumer.
He adds that some of the domestically focused companies could fall short of earnings forecasts if wage growth does not keep up with real inflation.
"If you look at retailers, it all depends on how much of a drag consumption tax has on the consumer. If we see the end of deflationary forces but a lack of wage inflation, then they could have a difficult problem."
"It is difficult to know what is going to happen, but I am cautious on retailers as I fear they could bear the brunt. The simple answer is that a weaker yen and increased taxes will make it difficult for domestic focused companies as they will be passing those problems onto the consumer," he added.
One of the main drivers of the rally, as Chesson pointed out, has been the weakening of the yen. He says this trend will continue, but he doesn’t expect the currency to depreciate excessively.
"Our view about currencies is that their movements are unforcastable as you are only dealing with predictions."
"If the yen’s weakening goes too far, there will be political pressure as it is in no-ones interest for it to lose too much value. The international community would certainly become uncomfortable," he said.
"But, Bernanke is not going to be put off reducing QE while [Haruhiko] Kuroda – governor of the Bank of Japan – won’t be put off his aim of ending the forces of deflation. So there will be downward pressure on Japan, but by how much, who knows," he added.
The Invesco Perpetual Japan fund has an ongoing charges figure (OCF) of 1.69 per cent and requires a minimum investment of £1,000.
