Investors emboldened by the re-election of prime minister Shinzo Abe in October should be careful about investing in style-specific Japanese equity funds as returns have been particularly lumpy this year, according to several industry experts.
Over the past few years investors have been turned on to the region after years of nervousness thanks to the introduction of Abenomics – the eponymous programme of economic reforms.
After his election in December 2012, Abe took immediate steps designed to generate inflation and restructure the Japanese economy. These included an extreme change in monetary policy, encapsulated by an enormous quantitative easing policy and tax reforms.
While results have been slow to come to fruition there are signs that reforms are starting to be felt in the market.
Among the most important policies, from an investor perspective, are the structural changes to the corporate environment, which Abe has now won backing and a mandate for.
Gill Hutchison, research director at The Adviser Centre, said: “These structural changes are meaningful but they will take time.
“The gradual pace of Abe’s reform agenda can be at odds with the expectations of the investing community who are often looking for more rapid results.”
Rathbones’ head of collectives research Mona Shah said the firm has been overweight Japanese equities for five years – around the same time that Abe came to power – on the assumption of an Abenomics-based turnaround.
“Whilst Abenomics hasn’t necessarily delivered on all of its arrows yet, we are starting to see shareholder-friendly reforms coming through,” she said.
“That includes managements of companies that have never paid a dividend before starting to pay dividends to shareholders. With the re-election of Abe last week we continue to run that overweight to Japan,” she said.
However, Abe’s reforms have triggered a new phase for markets, Hutchison added. While the market typically mean-reverts over the long-term – benefitting the value style – since 2012 growth stocks have outperformed.
Indeed, over the last five years the MSCI Japan Growth index has returned 130.79 per cent while the MSCI Japan Value index is up 106.58 per cent.
Performance of indices over 10yrs
Source: FE Analytics
However, over a 10-year period the value index has outperformed the growth index, as the above chart shows.
This has increased this year, with growth outperforming value by more than double, although the trend has narrowed in recent weeks.
As more investors look further afield for growth, Japan has become a trendy overweight position, but with market dispersions appearing wider this year, below, FE Trustnet asks several market commentators which funds they are backing over the long term.
JP Morgan Japanese investment trust
Rathbone’s Shah said she is backing the three FE Crown-rated JP Morgan Japanese investment trust run by Nicholas Weindling and Shoichi Mizusawa.
“It is kind of like a non-Japan, Japan fund in the sense that he is investing in global secular themes, some of which Japan just happens to be the best market to play,” she said.
“For example, Japan has a big problem with [an] ageing population, so it shouldn’t surprise that the biggest manufacturer of adult nappies globally is based in Japan and that would be an example of a company that he owns.
“Robotics is another theme. Japan has always had an edge in robotics and there are a number of excellent companies there.
“They’re not necessarily thinking about the world in terms of how to best play Abe’s third arrow, they are noticing that a lot of global themes have an interesting hunting ground for stockpicking in Japan.”
Performance of fund vs benchmark over 5yrs
Source: FE Analytics
The £842m trust has returned 171.88 per cent over the last five years, beating the Topix index by 43.08 percentage points.
Despite this, the investment company’s shares are on a 12.7 per cent discount to net asset value (NAV), according to the data from the Association of Investment Companies, making it a “very interesting” proposition for investors, according to Shah.
The fund has ongoing charges of 0.74 per cent.
Charles Stanley Direct’s Rob Morgan said he would back the £2.1bn Man GLG Japan Core Alpha fund run by Neil Edwards, Stephen Harker, Jeff Atherton and deputy manager Adrian Edwards.
“Not an original choice, I'm sure, but it is a fund with a very particular, high-conviction style, which can undergo periods of underperformance and is not suited to all market environments,” he said.
“In particular, it tends to struggle in relative terms versus its peers and benchmark in a market that prioritises certainty of earnings from companies rather than cheap valuations.
“However, the longer-term record is impressive and the fund is worth consideration by those looking for exposure to out-of-favour Japanese firms.”
The fund has struggled this year as the growth trade has been particularly strong, sitting in the bottom quartile of the IA Japan sector and lagging the Topix benchmark by 6.23 percentage points.
Performance of fund vs benchmark over 10yrs
Source: FE Analytics
Yet it is a top quartile performer over five and 10-year periods, returning 151.18 and 199.11 per cent respectively, as the above chart shows.
The Adviser Centre’s Hutchison noted: “The important thing to point out is that fund performances have diverged dramatically this year, depending upon investment approach and style.”
For example, while the Man GLG fund has struggled this year, returning 8.47 per cent, the more growth-orientated Legg Mason IF Japan Equity fund has returned 25.23 per cent.
“These performance outcomes are great illustrations of market dynamics in Japan so far this year; smaller cap and growth styles have benefited, while value-orientated styles have underperformed,” said Hutchison.
“As it happens, these trends have shifted over the very short term – with cyclical sectors doing relatively well – which has seen the Man GLG fund outperform the Legg Mason fund [in recent months].
“The conclusion of this is that investors should be aware of any strong style biases when they select funds, a comment that is particularly relevant to all equity markets this year.”
The fund has an ongoing charges figure (OCF) of 0.90 per cent.
The final selection is from Chelsea Financial’s Darius McDermott, who said he prefers the five crown-rated Baillie Gifford Shin Nippon investment trust run by Praveen Kumar.
The £353m trust was run by John MacDougal before he stepped down in 2015 with Kumar taking over. Under his tenure the investment company has returned 87.7 per cent, beating the MSCI Japan Small Cap benchmark by 35.09 percentage points.
“It aims to provide long-term capital growth by investing in smaller companies listed on the Japanese stock market,” McDermott noted.
“Shin Nippon means ‘new Japan’ and this trust focuses on emerging or disrupted sectors, where the manager sees innovative growth opportunities.
“The team are prepared to bide their time while these companies reach their full potential and, while the trust can be highly volatile, patient investors have been richly rewarded.”
The trust is trading at a 10 per cent premium to its NAV, however. It has ongoing charges of 0.96 per cent, according to the latest data from the AIC.