The IMF has predicted that the Japanese economy will grow by 1.2 per cent in 2018. While this is down on its 2017 figure of 1.7 per cent, it follows on from an eighth consecutive quarter of economic expansion in the final period of 2017, the country’s longest streak of growth since 1989.
Nicholas Price, manager of the Fidelity Japanese Values trust, said that a variety of factors have contributed to these figures – well above the average annual GDP figure of 0.9 per cent since 2000.
“Labour markets are now at the tightest level in several decades and participation rates among women and also seniors over 65 have risen sharply,” he said.
“The number of people in employment is now close to the record high of 65.8 million set in 1997, which is helping to mitigate the impact of changing demographics. Meanwhile, foreign visitors are coming to Japan in record numbers (28.7 million in 2017 versus 8.4 million in 2012, prior to the advent of Abenomics) and are on course to reach the government’s target of 40 million by 2020, the year of the Tokyo Olympics.
“All of these factors have positive implications for the domestic economy, through higher total employment income, stronger consumer confidence and ultimately consumption.”
Price pointed out that aside from the positive macro conditions, Japanese stocks are relatively cheap globally in terms of corporate fundamentals and valuations. Combined with a positive earnings environment, he said this suggests a reasonable level of upside for the market in 2018.
“Although Japanese stocks have performed strongly in recent years, the market has been driven predominantly by growth in corporate earnings rather than by an expansion in valuation multiples, as has been the case in other developed markets such as the US,” he added.
“As corporate Japan continues to make progress with governance reforms and enhancing shareholder returns, returns on equity could approach similar levels to those seen in Europe.”
However, the manager said the environment is not without risks, citing as key threats issues such as policy missteps by major central banks; the re-emergence of trade protectionism, particularly in the US; a faster than expected slowdown in China; and geopolitical tensions.
He added that while core inflation remains subdued, speculation that the Bank of Japan may change its policy could lead to periods of yen appreciation, which would negatively impact the performance of equities in the region.
“However, the Japanese economy is experiencing its longest period of growth in more than a decade and the policy mix remains accommodative,” Price continued.
“Corporate profits are at record highs and companies are increasing their capital spending. Given this environment and the relatively undemanding valuations in Japan, we believe there are attractive investment opportunities in the equity market.”
Here are three funds that may be suitable for anyone who shares Price’s optimism on Japan.
Sheridan Admans, investment manager at The Share Centre, is a big fan of Legg Mason IF Japan Equity, holding it in his TC Share Centre Multi Manager Cautious, Balanced and Adventurous funds.
“Japan remains one of our preferred regions and this particular fund seeks to benefit from the economic, demographic and structural changes that the country is continuing to face into,” he said.
“The portfolio will vary between 25 to 60 stocks, with the lower the number clearly indicating the strength and conviction the manager Hideo Shiozumi has in those companies. Around 80 per cent of the portfolio will be seen as core long-term holdings, while the remaining 20 per cent will be used for more short to medium tactical investments. The fund has the flexibility to invest across the entire market cap spectrum, albeit generally focuses on those between £330m and £1bn.”
Admans warned that investors should be prepared to accept a higher degree of volatility with this fund, but said it is suitable for anyone seeking the potential for strong growth.
Legg Mason IF Japan Equity has made 591.68 per cent over the past decade, compared with 125.41 per cent from the TSE Topix index and 121.45 per cent from its IA Japan sector average.
It is £1bn in size and has ongoing charges of 1.02 per cent.
While Andrew Rose’s fund has returned far less than Legg Mason IF Japan Equity over the past decade – 152.85 per cent – it has been far more consistent, beating the sector in seven of the past 10 years.
Performance of funds vs sector and index over 10yrs
Source: FE Analytics
FE Invest said this fund’s ability to limit losses in down markets such as 2009 and 2011 means it can be used as a core holding in investors’ portfolios.
“Andrew Rose has an extensive track record in Japanese equity investing, beginning in 1981 as a Japanese equity analyst at Schroders,” the FE Invest team said.
“This breadth of experience has spanned multiple market, economic and political cycles, which is a valuable asset with an investment process focused on long-term stock-specific investment cases.”
Rose and his team focus on identifying individual companies that offer a long-term opportunity. They favour businesses with a strong brand that drives above-average returns, sound finances that involve safe levels of debt, management interests aligned with investors and a valuation that is cheap enough to be attractive if long-term growth expectations are met.
“The resulting portfolio is constructed with the market benchmark in mind, which helps limit the risk the fund takes with its industry positioning,” FE Invest added.
Schroder Tokyo is £2.5bn in size and has ongoing charges of 0.91 per cent.
Baillie Gifford Japanese Smaller Companies
Japanese small-caps receive little broker coverage compared with their peers in the US and UK and, as a result, this is an area where active managers can add a great deal of value.
The FE Invest team’s favourite fund in this sector is Baillie Gifford Japanese Smaller Companies, which looks for stocks with the greatest long-term growth potential. Its managers Praveen Kumar and Felicia Hjertman are happy to pay high prices for these if they think the prospects are good enough.
“The fund could suit an investor seeking aggressive equity exposure in Japan and who is looking to capture the huge growth potential in early-stage tech and online companies,” the FE Invest team said.
“However, large price swings are common and the fund buys stocks for the long run and is willing to hold them through periods of underperformance, so the fund will only suit an investor with a long-term time horizon and an above-average willingness to take risk.”
Baillie Gifford Japanese Smaller Companies has a bias towards the internet, advanced technology, pharmaceuticals and manufacturing sectors such as robotics and automation.
The fund has made 401.59 per cent over the past 10 years, compared with 262.82 per cent from the IA Japanese Smaller Companies sector and 210.47 per cent from the MSCI Japan Small Cap index.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
It is £706m in size and has ongoing charges of 0.64 per cent.