Economic sun rising in Japan once again

In recent years Japan has not commanded the same investment attention as the rest of either the developed world or emerging nations.

This is because its equity market has fallen by 70 per cent in the past 20 years and its economy has shown zero nominal economic growth over that period.

Yet the picture may now be about to change. Jeremy Beckwith, chief investment officer at wealth managers Kleinwort Benson, notes: "Japan now enjoys its first corruption-free government, the quality of Japanese products is world-renowned and the valuations of Japanese equities are cheap both in absolute and relative terms compared with other equity markets."

For too long Japan has been obsessed with boosting its manufacturing side. It provides around one-fifth of GDP (by comparison with an eighth in the UK) but its two-tier labour market has had the effect of declining wages. The second tier is formed of part-time and non-contract employees who receive lower wages and no benefits.

Meanwhile, the government has overlooked the service sector which needs to be deregulated.

After 54 years, a fresher-looking political power achieved office last August – the Democrat Party of Japan under Yukio Hatoyama, who has promised less bureaucracy, a reformed welfare state and a more balanced approach to China and the US.

Deflation is Japan's greatest issue. The Bank of Japan has lowered interest rates to almost zero and massively extended funds to the banks via emergency loan programmes but the problem has not been arrested.

However, there are encouraging signs for investors:

n retail sales rose for first time in 17 months in January;

n 11th consecutive gain in industrial output reflects buoyant demand from China, principally vehicles and construction equipment;

n leap in exports;

n robust economy with 4.6 per cent expansion in fourth quarter, compared to a year earlier.

As a result, Japanese equities are on the rise. In February, the FTSE AW-Japan index increased 6.5 per cent, "largely attributable to the yen's strength against struggling sterling", says Legal & General, which remains neutral on Japan.

Over the past 12 months, the Tokyo Nikkei 225 index has not been stationary. It has oscillated between 8,493-11,339 and is towards the top end now.

Tracking an index is the cheapest way to follow a stock market. With no initial or exit charges and an annual management fee of only 0.65 per cent, Legal & General's Japan Index Trust should be considered.

It tracks the FTSE World Japan Index and over five years shows a cumulative 19.6 per cent growth.

By sector, the greatest holdings are in consumer goods (23.9 per cent), industrials (19.8 per cent), financials (17.2 per cent) and consumer services (8.2 per cent).

The leading stocks are household names here: Toyota, Mitsubishi, Canon, Honda, Sumitomo, Sony and Panasonic.

"Japan is likely to surprise positively in the future and investors should not disregard this opportunity," tips Jonathan Schessi, who has successfully managed the Ashburton Asia Pacific Fund for 10 years.

Earlier this month, the fund was renamed the Ashburton Japan Equity to reflect its new concentration.

Schessi likes the Japanese government's "long overdue change" to help the domestic economy, rather than an emphasis on exports.

Martin Payne, Leeds based director of stockbrokers Brewin Dolphin, notes that more companies are issuing positive earnings and that the market has rallied strongly – up 55 per cent – since its March 2009 low.

He likes three funds:

n Schroder Tokyo which focuses on companies with strong track records and solid profits growth. It is $1.1 billion in size.

n Melchior Japan Advantage, launched late 2007, holding 100m.

n JP Morgan Japanese Investment Trust, which stands at 15 per cent discount to asset value and seven per cent 'gearing' (borrowing).

The Schroder manager has been at the helm for six years but has been investing in Japanese equities for over 25 years.

Schroder has a noted research team for the fund which has been running over 20 years.

Across at Charles Stanley stockbrokers, Jonathan Baker is not currently a supporter of Japan but, if asked by clients, has selected a trio of funds:

n Aberdeen Asia Pacific & Japan which is diversified across 40-60 mid-cap firms.

n Martin Currie Pacific managed by John Millar, who is also responsible for the Japanese assets. Volatile and currently on a wide discount.

n Schroder Oriental Income with good performance in rising markets.

Simon Kaye, divisional director at Rensburg Sheppards Investment Management in Leeds says: "Investing in Japan now is one of the most contrarian things it is possible to do."

Yet he says Japan is "the cheapest of the developed world markets" with strong balance sheets.

He tips both GLG Japan Core Alpha and Jupiter Japan Income.

According to Lipper research for the Yorkshire Post, the top fund over three years on a net basis (after charges and with dividends re-invested) was Invesco Perpetual Japan Acc, which rose 25.5 per cent, followed by M&G Japan Smaller Companies, up 7.85 per cent. Sadly though, many collectives fell during the same period.

Over one year to March 31, the top performers were FF&P Japan Equity (up 44.8 per cent), Clerical Medical Japanese Focus 1 (up 42.8 per cent), Schroder Japan Alpha Plus (up 40.4 per cent) and Invesco Perpetual Japan Acc (up 40.2 per cent).

FF&P Japan Equity unit trust started in August 2003 and has over 29m assets. Its main holdings are industrials (37.5 per cent), consumer goods (22.9 per cent) and financials (18.3 per cent).

For the investor who is confident enough to decide when to move in and out of Japan, the HSBC MSCI Japan exchange traded fund is the most cost-effective solution. It has a management fee of only 0.40 per cent.

Geographically, Japan should not be ignored as it commands 10.4 per cent of developed equity markets. Yet it is often under-represented (such as only five per cent in BlackRock Global Equity Fund).

This indicates that for a balanced portfolio, a specialist fund or ETF should be held to ensure you are not underweight in this key economy.