In recent years Japanese equities have gone from being a relatively unloved part of the market to a key overweight and funds such as AXA Framlington Japan, Lindsell Train Japanese Equity and Legg Mason IF Japan Equity have surged as a result. 
Mindful of having their fingers burnt in the Japanese asset bubble that collapsed in the early 1990s, investors had tended to avoid the country as it endured a two-decade long deflationary spiral.
However, the election of Shinzo Abe as prime minister in 2012 saw the country benefit from an aggressive stimulus package that brought investors flocking back.
Professional investors are positive on the outlook for Japan. The latest edition of the Bank of America Merrill Lynch Global Fund Manager Survey found that a net 26 per cent of asset allocators are currently overweight Japanese equities.
FE Analytics shows the TOPIX index posted a 115.78 per cent total return between the start of 2013 and the end of 2017 while the average member of the IA Japan sector was close behind with a 113.01 per cent gain. Global equities, as represented by the MSCI AC World in index were up 110.67 per cent.
Performance of fund vs sector and index over 5yrs to end of 2017
Source: FE Analytics
As with the other articles in this series, FE Trustnet reviewed the IA Japan sector for cumulative five-year returns up to the end of 2017, the annual returns of 2017, 2016 and 2015, annualised volatility, alpha generation, Sharpe ratio, maximum drawdown and upside and downside capture relative to the sector average.
In order to see which funds have stood up best relative to their peers, we then worked out the average decile ranking for these 10 metrics for each fund in the sector to see which have most consistently been at the top of the group.
The chart above shows the fund that has taken top spot in this research. AXA Framlington Japan, which is headed up by FE Alpha Manager Chisako Hardie and holds five FE Crowns, achieved an average decile score of 1.6.
In doing this, the £257.5m fund put in top decile numbers for five-year performance, its returns in 2015, alpha generation, maximum drawdown, Sharpe ratio and downside capture; it’s also second decile for 2016 and 2017 returns as well as upside capture. In fact, the only metric where it’s not in the top two deciles is for annualised volatility (where it is fourth decile).
Hardie focuses on long-term structural growth businesses, with the top holdings of her portfolio at the moment being Yamashin-Filter Corp, Outsourcing Inc and GMO Payment Gateway. In her latest outlook, the manager said: “We believe that many Japanese stocks are still undervalued. Companies are now more aware of the importance of good corporate governance and maintaining strong investor relations. We believe that Japanese stocks will start attracting more foreign investors.”
As the table below illustrates, AXA Framlington Japan is out in front by quite a margin. The fund in second place is T. Rowe Price Japanese Equity with an average decile ranking of 2.1 after posting first or second decile numbers for a range of metrics including five-year returns, Sharpe ratio and maximum drawdown.
The €227.8m fund is managed by Archibald Ciganer and has the aim of finding “the best investment opportunities across the Japanese equity spectrum”, with top holdings including Daikin Industries, Daio Paper and Mitsubishi Electric. “We firmly believe that the valuation case for Japan still holds and that Japanese corporate earnings growth is likely to exceed global peers. This view underlies many of our preferred stock ideas today,” Ciganer said.
Source: FE Analytics
In third place is the highly respected Lindsell Train Japanese Equity fund, which is headed up by FE Alpha Manager Michael Lindsell. The five FE Crown-rated fund has an average decile ranking of 2.2, thanks in part to top decile results in five-year returns, alpha generation, upside capture and downside capture; it is bottom decile for volatility, however.
The manager runs a high conviction portfolio with a long-term horizon, rarely adding new holdings or disposing of existing positions. Top holdings include Kao, Nintendo and Takeda Pharmaceutical; consumer franchises, media and pharmaceuticals are his preferred hunting grounds.
Lindsell recently told FE Trustnet that he can understand why Japan has been overlooked, but maintained the country is home to some compelling investment opportunities: “If you want to go and look in Japan to find some great companies then you will find some but you might just find a lot more in the US. [However] that doesn’t mean to say that there isn’t a selection of companies in the Japanese market that might earn you far higher returns and it is our job to identify those.”
The IA Japan fund that has made by far the highest returns of the past five years also finds itself towards the top of the table in this research. Hideo Shiozumi’s £932.5m Legg Mason IF Japan Equity fund, which is in eighth place with an average decile ranking of 3.1 has made a 333.4 per cent total return over the five years in question, compared with a 113.01 per cent gain for its average IA Japan peer.
Shiozumi has more than 30 years of experience in running Japanese equities and tends to focus on smaller companies that are linked with the ‘new’ Japanese consumer. The fund’s biggest sector allocations are to healthcare, industrials and information technology.
Of course, not every fund can be at the top of the peer group on all 10 metrics. Our data shows that of the 56 IA Japan funds with a long enough track record, only 20 of them have an average decile ranking of less than 5.0 for the five-year period.
Performance of funds vs sector and index over 5yrs
Source: FE Analytics
JPM Japan Select Equity sits at the very bottom of the table after scoring 8.4. The fund is in the sector’s bottom decile for five-year total returns, alpha generation, Sharpe ratio and downside capture. It has, however, scored well for volatility and is in the third decile on this measure.
Fidelity Japan and LF Canlife Japan both ended the five years in question with average decile rankings of 8.3. LF Canlife Japan posted the peer group’s lowest five-year return at 82.17 while Fidelity Japan is not far behind with a 82.59 per cent return.