Conal Gregory: Shining a light on investing in the Land of the Rising Sun

Rollercoaster: The Nikkei index of the top 225 companies has shown great volatility.
Rollercoaster: The Nikkei index of the top 225 companies has shown great volatility.
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Japan has perplexed investors for years. It offers a balance of unique heritage and culture which contrast with the sprawling metropolises of the globe’s most advanced technological nation.

It is not one island but composed of 6,852 isles. The Land of the Rising Sun may have ancient castles, serene gardens and opulent temples and shrines, as well as the awe-inspiring contemporary landscape of cities like Tokyo but it requires an experienced stock-picker to find good value companies.

Next week Japan honours its emperor’s birthday but not all investors will be in celebratory mood. The Nikkei index of the top 225 companies, first published in May 1949, has shown great volatility. From an all-time low of 85.25 in June 1950, it rose to a dazzling 38,915 in December 1989. In the last 12 months the index has oscillated between 16,592-20,592.

Those taking a tracker index approach should consider the annual gain or loss in recent years. With dividends excluded, annual increases were recorded (on a per cent basis) of 7.1 last year, 56.7 in 2013 and 22.9 in 2012 but losses of 17.3 and three per cent in 2011 and 2010.

For investment trusts that specialise in Japan, there have been good results over the last three and five years, averaging 95 and 103 per cent respectively. The stars over three years were:

• Baillie Gifford Japan 137.3 per cent

• Baillie Gifford Shin Nippon (meaning New Japan) 131.5 per cent

• JP Morgan Japanese 84.9 per cent

• Schroder Japan Growth 84.6 per cent

Investment trusts have the ability to borrow (gearing) when they see an opportunity and can also retain profits to pay out in dividends later, thereby smoothing their growth.

When Shinzo Abe was elected Prime Minister in late 2012, he promised monetary easing, fiscal stimulus and economic reforms, coined the ‘three arrows’ under the wider banner of ‘Abernomics’.

In stock market performance, the action has been successful. Quantitative easing has been 10 times the level used in the US with an economy just a third of its size. More QE can be expected next year. Inflation has returned for the first time in two decades. Corporate profitability has improved and should be helped by tax cuts in 2016.

Quoted companies are becoming more shareholder friendly. An amazing £500bn in cash is sitting on the balance sheets of the 1,800 companies that form the stock market. Yet more is now being returned to investors with Japan now showing one of the fastest annual dividend growth rates in the world at 22 per cent.

Not all stockbrokers are enthusiastic. Jonathan Baker, Leeds-based Investment Director at Charles Stanley, says: “Abenomics doesn’t appear to be working well.”

He would rather opt for “good quality smaller companies/mid cap funds with better potential return than the boom and bust of Japanese funds”.

Some savers dislike Japan on ethical grounds. Earlier this month it again defied international convention by sending out its whaling fleet although the practice has been ruled illegal by the International Court of Justice. It plans to kill 4,000 minke whales but claims it is for scientific research.

There are still significant problems and risks for the economy with an ageing population. To combat it, there is an official pro-creation policy with employees given financial rewards to have children.

The IMF forecasts just 0.6 per cent GDP growth this year and one per cent in 2016 against a global 3.3 and next year 3.8 per cent. Government debt in Japan stands at an eye-watering 240 per cent of GDP. Much though is held domestically.

A more optimistic view is taken by Eric Verleven, global chief investment officer at SGPB Hambros, who predicts growth should be 1.6 per cent in 2016. “Unemployment is at its lowest point for 20 years and wage increases, a strong support to consumption, should gradually materialise,” he says.

Verleven does not expect the Japanese currency to depreciate any more and says his firm is exposed to the yen in their portfolios.

Japan is a world leader in a range of sectors, notably robotics and medical equipment, and “has long since shed its image of simply copying Western technology,” says Robert Hughes, investment manager and Beverley branch manager at Redmayne-Bentley.

He says buying Japanese shares has difficulties, not only in terms of time zone differences but contending with currency fluctuations and that much information is only available in Japanese.

For these reasons, Hughes prefers collective investments for a stock market that “looks relatively cheap”. They favour JP Morgan Japanese for large-cap exposure and Baillie Gifford Shin Nippon for smaller firms.

Darius McDermott, of Chelsea Financial Service, tips three funds: Baillie Gifford Japanese, Neptune Japan Opportunities and Schroder Tokyo, up 63, 82 and 50.6 per cent respectively over three years. Only the Neptune one has shown stunning triple figure growth in a decade at 107.6 per cent.

Yet McDermott warns that: “China has a much bigger impact on the Japanese economy than many people assume and so all eyes are on the Asian Dragon!”

The QE programme has “proven to be extremely effective in weakening the yen, making the nation’s significant export industry more competitive”, says Martin Payne, Leeds director of wealth manager Brewin Dolphin.

He notes that a new corporate governance code came into effect earlier this year which encourages more shareholder-friendly behaviour.

Schroder Tokyo is a £1.1bn fund favoured by Payne. It has been managed by Andrew Rose since 2004 and should be considered a core holding with its bias to large cap companies and a general value focus, according to Payne.

Of the several good quality investment trusts available, he highlights Baillie Gifford Japan which has slight bias to mid and smaller-sized firms.

Its team tries to uncover companies that should deliver sustainable earnings growth either through strong competitive positions or by operating in high growth industries. It currently has a gearing level of 15 per cent.

Inflation remains a challenge in Japan, says Adrian Lowcock of AXA Wealth. Although its politicians target a stable higher figure, Lowcock says it is unlikely with low oil prices and weak wage growth.

He says: “Japanese shares remain attractively valued, particularly following the sell-off in the summer over concerns of the strength of the Chinese market and fears of weaker global growth.”

Lowcock likes GLG Japan Core Alpha whose manager has a “strong value and contrarian approach to investing, looking for companies unloved by the rest of the market”.

It has a large exposure to Japanese banks and should be considered a long-term buy.

Lowcock’s other favourite fund is Schroder Tokyo for its focus on domestic Japan with a strong focus on motors and parts.