Brett, who manages the £396m Baillie Gifford Japanese fund, points out that although the market is not as cheap as it was a year ago, the fact that company earnings have risen in line with equity valuations suggests the rally is sustainable.
When asked whether investors should be concerned about buying into Japanese equities now, the manager was confident in his reply.
"We did say 12 months ago that Japanese equities were very cheap – now we would say they are not expensive, which is obviously less good than 'very cheap'," Brett said.
"Year to date, the Japanese equity market has been the best-performing developed market, but unlike other areas, it is still lowly rated on a P/E basis. That is because earnings growth has been so fast."
"So no, I don’t think there is anything to be concerned about," he added.
According to FE Analytics, the TSE Topix has returned more than 30 per cent over the last 12 months, which is higher than the returns of both the S&P 500 and the FTSE All Share.
This has come at the price of higher volatility, however.
Performance of indices year to date
Source: FE Analytics
The manager says that the weakening currency has and will continue to have a massive impact on Japanese companies’ profitability.
"From a macro perspective, Japan is a very different place to what it was two years ago," he said.
"Haruhiko Kuroda [governor of the Bank of Japan] and Shinzo Abe [prime minister] have had their money-printing idea, which has meant the yen is much weaker. Sectors such as manufacturers have seen their operating profits rise several-fold."
Brett believes that changing attitudes to equity investment should also support this rally in Japan – for example, he says the introduction of the NISA (Nippon individual savings account) should encourage average investors to hold shares.
The manager adds that the fact the Bank of Japan’s stimulus has driven Japanese bond yields so low could also be very beneficial.
"What could also be different this time is that the big Japanese pension funds are considering increasing their equity allocation. There is a lot of money in fixed income in Japan and if that were to change, it would be very helpful," he added.
Brett joined Sarah Whitley as co-manager of the Baillie Gifford Japanese fund in June 2008.
Our data shows that over that time the fund has been the fourth best-performing portfolio in the sector, with returns of 52.72 per cent, beating its Topix benchmark by more than 25 percentage points.
Performance of fund vs sector and index since June 2008
Source: FE Analytics
Baillie Gifford Japanese is also a top-quartile performer over one, three and five years. Brett says that he and Whitley try to run a diversified portfolio of secular growth, cyclical growth and special situations-style stocks.
The portfolio is made up of 61 holdings, with industrials the largest sector weighting, at 30 per cent of the portfolio.
Although Brett is positive on Japanese equities, he says the next major question will be to see whether the third arrow of Abenomics – structural reform – will be as successful as the other two arrows of monetary and fiscal reform.
On top of that, the manager says there is another long-term headwind facing the Japanese economy, namely its demographics.
"It’s a bit of a worry," he said. "I find it fascinating how people can fall in and out of love with regions. India, for example, is so far out of favour, but if Japan had its demographics then it would be fantastic. Japan’s demographics haven't come up much recently, but it is still an interesting issue."
"It has an ageing population, low growth rate and an absence of immigration, meaning its population will decline," he added.
Brett says that the core problem is that although the birth rate in Japan is on a par with the likes of peripheral Europe, because many Japanese women are past child-bearing age it will be the younger generation who need to have twice as many children to stop population decline.
He also points out that attitudes to immigration in Japan are "not great".
Despite these concerns, he says there are ways of playing the ageing population from an investment point of view. For instance, in Baillie Gifford’s small cap portfolios the team holds a number of nursing homes.
Brett is also considering investing in Japan’s leading producer of adult nappies, as these now outsell children's ones.
Baillie Gifford Japanese has an ongoing charges figure (OCF) of 1.55 per cent and requires a minimum investment of £1,000.
