The manager of one of the highest-performing and most volatile funds in the Investment Association universe says the factors leading to hefty drawdowns in his portfolio several years ago will “never happen again”. 
Hideo Shiozumi (pictured), who has run the five crown-rated Legg Mason IF Japan Equity fund for more than 20 years, attributes losses he experienced between 2006 to 2009 to a combination of highly unusual market movements which he says simply won’t occur going forwards.
Legg Mason IF Japan Equity is currently the top-performing fund out of 1,818 funds in the Investment Association over five years, outperforming the second top-performer by more than 40 percentage points with a total return of 279.37 per cent.
It is also the best-performing fund out of the 65 funds in the IA Japan sector over one, three, five and 10 years, having more than doubled the returns of its average peer over each of these time frames.
Since Shiozumi launched the fund in October 1996, it has outperformed its sector average more than six times over and outperformed its TSE TOPIX benchmark more than seven times over with a return of 429.61 per cent.
As shown in the below graph though, these high levels of return have been accompanied by significant bouts of volatility and sizeable drawdowns. This might be expected given the portfolio’s small- and mid-cap bias.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Over the last decade, the fund has achieved the highest maximum drawdown (which measures the money lost if bought and sold at the worst times) within its sector of 63.45 per cent.
It is also has the highest annualised volatility in its sector at 24.66 per cent compared to its average peer’s volatility ratio of 14.62 per cent, which is broadly in line with the volatility of the TSE TOPIX index.
During three out of the last 10 years, the fund has fallen into the bottom decile for its performance on a discrete annual calendar basis. Its biggest loss was experienced in 2006 when it was down 50.56 per cent compared to its sector average’s loss of 13.74 per cent and its benchmark’s loss of 10.48 per cent.
While the fund is no means best-suited to the more risk-averse investor, Shiozumi says the fund’s disappointing performance between 2006 to 2009 – when it lost a total of 74.6 per cent – is unlikely to happen again.
“The TSE Mothers market [the index of high-growth and emerging stocks] was created in 2003 which included a number of poorly-managed companies. But in January 2005, Livedoor, which was the most popular stock among individual investors, collapsed and that affected all other small-cap stocks,” he explained.
“Individual investors left small-cap markets. At the same time, in 2005 to 2006, we were experiencing a substantially weak yen so, not only domestic individuals but domestic institutions shifted their money in a big way into high-yielding fixed income rather than equities.
“During those particular years, the emerging countries such as China, India and Brazil were booming, so a substantial amount of money went into those emerging countries.
Performance of index 2005 to 2009
Source: FE Analytics
“After they left the Japanese small-cap market, they shifted their money into large-cap manufacturers because they were aiming to benefit from the weakness of the yen. So when the yen started to strengthen later in 2008, the situation changed. Since then, even the quality in management of small-caps has started to improve.
“That will never happen again, I don’t think. We experienced a very unusual market environment from 2006 to 2009.”
Shiozumi’s fund requires somewhat of a strong stomach from investors. Its FE Risk Score is 198, which estimates that the fund has been more than twice as risky as buying into the FTSE 100 index.
However, the manager says investors need to adopt a genuinely long-term time horizon and ignore short-term market noise in order to reap the benefits from their investments.
“I can’t avoid the short-term fluctuations because I am a long-term investor. The market can sometimes become value-oriented and then become growth-oriented. Also, shares sometimes shoot up very sharply and then, after that, enter a correction,” he reasoned.
“We don’t take short-term profits. As long-term investors, we stay with the companies in which we strongly believe. Stocks or markets cannot keep going up forever, they’re bound to enter corrections. Even when a stock or market as a whole enters a correction, I don’t sell it.
“That’s why I can’t avoid short-term volatility. Most fund managers will follow markets. They invest in value stocks then switch to growth stocks. So their volatility may be less, but they can’t achieve the long-term returns, in my view.
“I hope investors will also remain long-term oriented and not focus so much on short-term performance.”
Ryan Hughes, head of fund selection at AJ Bell, says the Japanese equity market looks attractive from both a macroeconomic and a stock-specific perspective, as many firms in the country have increased cash levels on their balance sheets over recent years due to weakening currency.
Not only does he say that more companies are cash rich, he says there have been signs of dividend growth, a pick-up in share buybacks and more M&A activity taking place.
“[Shiozumi] is further down the cap scale and so he’s very much looking at long-term, company-specific opportunities. That comes with some excitement and some opportunity but it also comes with risk,” he warned.
“It’s one just to tread carefully on. I think it’s the type of holding that’s good as a small weighting and to get that exposure to Japanese mid and smaller companies, but it’s certainly not something that should make up a large part of anyone’s portfolio.”
Shiozumi launched Legg Mason IF Japan Equity 20 years ago during the throes of the ‘Lost Decade’ in Japan, when economic stagnation and price deflation contributed to a highly volatile market. Between 1991 and the end of 2001, the Nikkei 225 fell 39.3 per cent and suffered a maximum drawdown of more than 60 per cent.
Performance of index during the ‘Lost Decade’
Source: FE Analytics
Rather than turning pale on Japanese equities though, Shiozumi saw this as an opportunity to capitalise on the huge economic shift happening in his home country.
“When I set up my company [Shiozumi Asset Management] in Hong Kong in January 1990, my investment strategy was to focus my portfolio on companies of the ‘New Japan’,” he said.
“At that time, the whole of Japan started to go through a restructuring phase and then enter two decades of deflation. I thought that the position of Japan was changing from being manufacturing-oriented to service-oriented and from a regulated economy to a deregulated economy.
“I started to invest in companies of the ‘New Japan’ and, when this fund was launched in October 1996, this aim was continued – I look for new growth companies of the ‘New Japan’.”
For instance, almost 40 per cent of the fund’s portfolio is in healthcare stocks, as one of the themes of ‘New Japan’ is its ageing population. Out of 39 holdings, his largest portfolio allocation is to biopharmaceutical firm Peptidream, which accounts for 9.13 per cent of the £670m portfolio.
However, he says these themes focusing on ‘New Japan’ are distinctly long-term and are not influenced by market noise or behaviour.
“My investment process is very simple. I have a long-term and consistent investment process to forecast on growth companies of ‘New Japan’ with an aging society and I have never, ever been influenced by market trends,” Shiozumi said.
“Most of our core holdings we have held for more than five years and we normally hold them between seven and eight years, so this long-term, consistent process has produced long-term returns for investors.”
Legg Mason IF Japan Equity has a clean ongoing charges figure of 1.76 per cent.