Conal Gregory: Japan can reward perceptive savers

Investors are often fascinated by a country with such a diverse heritage that has become one of the most advanced economies in the world. This enigmatic nation can reward the perceptive saver.

At US$5.2 trillion, its economy is the third largest after the US ($21.4tn) and China ($14.1tn). For comparison, the UK is seventh ($2.8tn).

It is home to some of the best-known businesses on the planet: Toyota, Honda, Panasonic and Nintendo to name a few.

Private client stockbroker J.M. Finn says that long-term structural concerns are similar to those in Europe and continue to inhibit domestic economic growth. It maintains a neutral rating to the country.

Unlike most of Asia, Japan has a mature, developed market economy but is facing the challenges of an ageing and declining population.

Jason Hollands, from Tilney Investment Management, sees Japan “as less of a growth story and one more about structural reform and the ability to pick up global companies on relatively modest valuations”.

On the negative side, Japanese firms were considered notoriously hierarchical, not noted for being shareholder friendly and with a propensity for hoarding vast amounts of cash.

This catatonic behaviour has changed under the current Prime Minister, Shinzo Abe, who leads the Liberal Democrat party. Corporate governance has improved, dividends are not unusual and share buybacks have become more commonplace.

Hollands says this means that over time he “expects Japanese company valuations to come further into line with international peers”.

Despite gradual improvements in its domestic economy, “Japan is not out of the woods just yet as the Bank of Japan tries to manage the country out of deflation”, warns Sarah Coles from Hargreaves Lansdown. Coles warns investors not to over allocate to the region.

“Japanese equities have enjoyed a solid run of outperformance over the last two months,” says Martin Payne, senior investment manager at Brewin Dolphin in Leeds. This is partly through the US-Japan trade deal, which is limited as it excludes motor vehicles, but also yen weakness following rising global bond yields.

There have been some problems notably resulting from the US-China trade war, resulting in exports declining for nine consecutive months. The planned rise in consumption tax from eight to 10 per cent, due later this year, will not help.

However, Saul Fulda, investment analyst at Redmayne Bentley in Leeds, is encouraged by the low 2.2 per cent unemployment. He says Baillie Gifford’s Japan Trust is a “stand-out performer”, helped by borrowing (gearing) of 12 per cent which has propelled the growth.

Fulda also likes Legg Mason IF Japan Equity whose manager, Hideo Shiozumi, provides significant experience and expertise in the field, and LF Ruffer Japanese for more risk-averse savers, posting significantly lower three-year volatility levels than its competitors.

The Man GLG Japan CoreAlpha fund is tipped by both Coles and Payne. It aims to achieve capital growth by selecting from 300 of the largest quoted firms, notably those out of favour and by extension cheap – more than 40 per cent underperformance over four to eight years – and then sell once the stock returns to greater popularity. Over five years, it has grown by 72.2 per cent.

For capital growth, Payne’s other selection is Baillie Gifford Japan. Its manager seeks up to 70 medium to smaller companies, looking for above average growth prospects over three to five years. Over five years, the fund has jumped 130.8 per cent.

With dividends under pressure in the UK, many savers are looking afield for income. One collective aiming for both long-term income and capital growth is Jupiter Japan Income. Payne says it uses convertible bonds, cash, deposits, equities and money market instruments, favouring large companies which form almost 69 per cent of the portfolio.

Technology and financial form the largest sectors, helping the fund to grow by 106.5 per cent over the past five years.

Hollands favours three funds:

CC Japan Income & Growth, an investment trust launched 2015 (including Shin-Etsu Chemical, Nippon Telegraph & Telephone, Toyota)

Morant Wright Nippon Yield, founded 2008, with 61 holdings (such as Canon, Honk, Mitsubishi)

Baillie Gifford Japanese, established 1984, now with 64 holdings (including SoftBank, Inpex for oil and Rakuten for electronic commerce).

“Japan is perceived as being full of industrial export companies that are reliant on the health of the global economy but the make-up has changed,” says Darius McDermott of Chelsea Financial Services. He recently met Dan Carter, manager of Jupiter Japan Income, who considers the country will be more defensive during the next global recession, particularly as it is still cheap compared with other developed markets.

McDermott reveals that twice the amount of profits are coming from non-manufacturing firms compared to manufacturing ones. With its politics stable, he feels Abe – who was previously Premier in 2006-07 – has not had the credit deserved.

Adding in the supportive central bank, his firm likes the Japanese stock market and recommends Baillie Gifford Shin Nippon Investment Trust and three open-ended collectives: AXA Framlington Japan, Comgest Growth Japan and T Rowe Price Japanese Equity.

Those considering smaller firms may like to heed the warning from Rebecca O’Keefe, head of investment at Interactive Investor, that they can be “quite volatile in a way which is often uncorrelated with other major markets”. Yet such a divergence may make them “a great place to invest as part of a balanced portfolio.”

Whilst corporate giants are well known to foreign investors, smaller firms receive scant research coverage and so this is “where some of the strongest gains can be made”, suggests O’Keefe, who tips Baillie Gifford’s Shin Nippon Trust.

For low cost entry to the Japanese market, a tracker index is the answer, particularly as it is a tricky market for active managers to get right. O’Keefe selects the HSBC Japan Index, which seeks to replicate the FTSE Japan Index with its 500 constituents.

One of the benefits of such a fund is that it does not concentrate money in just a small number of companies.

An alternative, favoured by Coles, is the iShares Japan Equity Index, run by BlackRock. It has an ongoing fee of just 0.16 per cent which Hargreaves Lansdown will reduce to 0.11 per cent.

Hosting the Rugby World Cup and Olympic Games within a year will bring yet more attention to Japan.

Whether looking at robotics, consumer staples or health care innovation, “the case for investing in Japanese stocks remains intact”, says the enthusiastic manager of Aberdeen Japan Investment Trust, Kwok Chern-Yeh.

He is likely to be proved very right.

Conal Gregory is AIC Regional Journalist of the Year.