With the Japanese electorate likely to stick by prime minister Shinzo Abe in this weekend’s snap general election the outlook for the market looks optimistic, according to several fund managers, although an upset could cause some short-term problems.
The prime minister’s so-called Abenomics programme – a package of measures designed to reinvigorate the Japanese economy – have had several positive impacts and drawn broad support.
Abe called the election at the end of September to take advantage of a bounce in his approval rating from a record low over the summer and a disorganised political opposition.
Since Abe came to power five years ago the MSCI Japan index has risen by 107.66 per cent, marginally outperforming the MSCI World’s 105.01 per cent return, as the chart below shows.
Performance of indices over 5yrs
Source: FE Analytics
However, there have been some concerns that upstart political movement Party of Hope could eat into the Abe’s Liberal Democratic party vote share.
Joel Le Saux, portfolio manager of the Oyster Japan Opportunities fund at SYZ Asset Management, said an electoral upset “would create short-term turmoil in markets”.
“A loss of leadership could precede the departure of Bank of Japan’s governor Haruhiko Kuroda next spring, effectively signalling the end of certainty around the central bank’s monetary policy,” he said. “The associated risk of this scenario is an upward parallel shift in the yield curve.”
But he said any imminent political shifts as a result of the election would not derail the investment case for Japan.
Archibald Ciganer, portfolio manager of the T. Rowe Price Japanese Equity fund, said it would be “effectively impossible” for Abe to be removed from power as opposition parties have too few candidates to fill seats.
However, he warned that Abe’s move to alter Japan’s pacifist constitution in the face of renewed missile testing by North Korea has received some opposition.
He said: “As for markets, the Abe government has made corporate reform one of its primary objectives, targeting improved standards of governance, including the mandatory hiring of external directors, better returns on equity and higher returns for the providers of capital.
“The fruits of these reform efforts are beginning to reveal themselves and the impact on company profitability and capital allocation policy has been significant.”
Ciganer added: “This has occurred in the absence of any real significant change in domestic macroeconomic conditions and in spite of modest sales growth.
“With global economic conditions now showing both stability and modest improvement, double‐digit earnings growth is being delivered in Japan in 2017, with forecasts continuing to show a superior profits growth outlook in Japan versus Europe and the US.”
Louise Dudley, global equities portfolio manager at Hermes Investment Management, said a victory for Abe “would deliver a fresh mandate for Abenomics”.
“While the efficacy of Abenomics has been under scrutiny since it was unleashed on a Japanese economy in the doldrums, it has begun to bear fruit; corporate profits have recovered, the jobs‐to-applicants ratio has improved and the Nikkei stock market is at a 20‐year high,” she said.
“Moreover, the ‘third arrow of Abenomics’, structural reform, has heralded in a new era in corporate governance.”
Adrian Lowcock, investment director at multi-manager Architas, said the ‘third arrow’ and its attempts to implement structural reform had proven difficult and the Japanese recovery story had petered out for some investors.
“In reality this was always going to be the hardest part of his plan as making changes to the way a country operates is a huge task and the rewards are never immediate and often unclear,” he explained.
However, Lowcock said some of Abe’s policies since 2012 had already begun to work, with inflation under control and unemployment continuing to fall.
“Overall the picture is looking increasingly positive for Japan, corporate earnings are growing and returns to shareholders have been improving,” he said. “If Abe can secure his re-election then the country, and its markets, could be set for a further boost.”
As such Lowcock has backed three funds for Japanese exposure: Man GLG Japan Core Alpha, Baillie Gifford Japanese and Pictet Japanese Equity Opportunities.
The £2.1bn Man GLG fund is managed by Stephen Harker, Neil Edwards, Jeff Atherton and Adrian Edwards. The team actively look for companies that are out of favour, picking companies with strong fundamentals with the opportunity for a turnaround.
“Stephen Harker is a contrarian investor, actively looking for companies out of favour with investors,” said Lowcock.
“He uses valuation measures including price-to-book, dividend yield and price/earnings ratio to identify such stocks. He selects companies with strong fundamentals where he believes there is the opportunity for a turnaround.”
The £2bn four FE Crown-rated Baillie Gifford Japanese fund has more of a long-term growth focus, which Lowcock said can result in short-term underperformance and volatility.
Performance of funds over 5yrs
Source: FE Analytics
“The managers Matthew Brett, Donald Farquharson and Sarah Whitley look at a company’s fundamentals, in particular a sustainable high return on capital,” he said.
“They are looking for companies with steady growth, special situations, cyclical stocks and secular themes.”
Finally, the Pictet Japanese Equity Opportunities backed by Lowcock employs a long/short equity strategy, allowing managers Adrian Hickey, Sam Perry and Serena Robinson to bet against areas of the market they expect to fall.
“The ability to short the market is used more for capital preservation than to add outperformance through stock selection,” he explained. “The fund takes a growth at a reasonable price approach looking for companies where the price does not reflect growth potential.”
The best performer of the three since Abe returned to power in 2012 with a mandate for Abenomics is the Baillie Gifford fund, which has risen by 161.85 per cent compared with a 113.61 per cent gain for the average IA Japan sector fund and a 117.89 per cent return for the Topix index. During the same time frame, the Man GLG fund is up by 138.96 per cent, while the Pictet fund has risen by 127.15 per cent.