Investors have had bumpy ride as volatility hits Japan returns

Regarded as a day of respect and patriotism, Showa means ‘enlightened peace’ and was the name chosen by Emperor Hirohito after seeing the devastation caused by the First World War.

Hirohito was the longest reigning Japanese emperor, choosing to change his position from divine ruler to a human figurehead, and saw the country rise to become an economic superpower.

Aberdeen Asset, specialists in Asia, say valuations in the region look attractive both historically and in comparison with other markets. Its head of investment management for Japan, Kwok Chern-Yeh, feels optimistic about the rising dividends being paid by Japanese companies.

Prime minister Abe’s economic programme, termed ‘Abenomics’, started three years ago with the aim of creating inflation to break the country of its deflationary mindset. A whole generation has only known deflation and it will take time for the Japanese to believe wage growth is here to stay and for the consumer to become more confident.

With his ‘three arrow’ approach, Abe has implemented a Government spending package, targeted inflation through printing money and launched a programme of business reforms. Success is already beginning to show despite the change in global energy prices.

However, the Bank of Japan has postponed the date when it expects to meet a two per cent target for inflation. “Risks also remain about the strength of the yen, which appreciated in 2016 despite the efforts of the Central Bank to prevent it,” says Martin Payne of wealth manager Brewin Dolphin in Leeds.

Japan relies on a strong export market and a buoyant currency is a risk to the Abenomic growth plan. With a ‘loose’ monetary policy, equity prices look relatively appealing, particularly with signs that structural reform will change Japanese attitudes on profitability and minority shareholders.

“Japan is a little off our radar,” says Jonathan Baker, investment director at Charles Stanley in Leeds. To achieve a diversified portfolio, he prefers a strong Asian fund to gain exposure to the markets there. If a client specifically wants Japan, Baker opts for the Schroder Japan Growth fund but warns about its volatility.

Investors have certainly had a bumpy ride. Between 2012-14, the Topix stock market index rose 106 per cent but the total return for UK investors was just 32 per cent. Many challenges are still to come.

“In the short term, a big threat is a lack of global economic growth as Japan is highly correlated to the rest of the world. In the longer term, there are huge debt and demographic challenges to address,” says Garry Ibison, chartered financial planner at adviser Chase de Vere in Leeds.

Crispin Odey, known for having contrarian views on stock markets but generally a very successful fund manager, has increased exposure to Japanese banks, such as Mitsubishi UFJ and Sumitomo, which he feels has been undervalued by other investors.

Coupland Cardiff Japan Income and Growth is tipped by Payne. It is a £470m fund which seeks firms paying at least 1.5 times the market yield. Manager Richard Ashton has constructed a relatively concentrated portfolio of high quality companies which Payne says have the ability to grow their dividends over time.

Whilst the fund will always have a bias towards defensive firms, it has recently increased exposure to more cyclical areas including financials and a domestic construction company. The yield is 3.2 per cent.

Payne also likes Baillie Gifford Japan, a £500m investment trust managed by Edinburgh-based Sarah Whitley. It favours mid to smaller capitalised companies and the team tries to uncover firms that should deliver sustainable earnings growth either through strong competitive positions or by operating in high growth industries. The result is a quite concentrated 40-60 holding out of a possible 3,500 companies.

“The trust has delivered excellent long-term returns for shareholders and currently trades close to its underlying net asset value but there is no income yield,” says Payne.

“Japan is one of the more attractive areas of investment for equities at the moment,” says Juliet Schooling Latter, research director at discount broker Chelsea Financial Services. She says the strong dollar has weakened the yen, benefitting Japanese exporters.

The demographic position is still an issue with a huge ageing population, says Schooling Latter, “but at the same time this opens up investment opportunities in healthcare and care home providers.”

She tips Schroder Tokyo and Baillie Gifford Shin Nippon Trust. Launched in 1989, the former is the more cautious and has only had two managers in its lifetime. In a market which has performed poorly for over two decades, the fund has gained from a quality-orientated strategy.

Shin Nippon means ‘new Japan’ and the Baillie Gifford trust focuses on emerging or disrupted sectors where innovative growth opportunities are seen, notably in small cap companies.

The Nikkei 225 Index peaked at almost 39,000 points in December 1989 and has since declined by 50 per cent.

Ibison says that from an asset allocation perspective, there is a strong argument to have exposure to Japan. He likes Baillie Gifford Japanese for its good quality growth stocks and strong out-performance, as well as the HSBC Japan Index, a passive fund which gives broad exposure and lower charges. It aims to replicate the FTSE Japan Index and has an annual charge of only 0.21 per cent.

He also likes Schroder Tokyo for consistent long-term returns, achieved by a disciplined approach which utilises the extensive in-house research resources of Schroder’s investment team.

Jason Hollands from Tilney Bestinvest has identified five under-performers which he calls ‘dog’ funds: Standard Life Japanese Equity Growth, CF Canlife Japan, Fidelity Japan, Threadneedle Japan and Cavendish Japan. Instead their research reveals four ‘pedigree’ funds: Legg Mason IF Japan Equity, AXA Framlington Japan, CF Morant Wright Nippon Yield and CF Morant Wright Japan.

The three-year return on £100 invested was £129-£137 for the poor ones but £159-£193 for the recommended funds.

Nicholas Weindling, manager at JP Morgan Japanese, says the long-term outlook is positive and they will continue to focus on structural growth areas such as internet shopping, the ageing population, factory automation and Japanese companies expanding in Asia as well as firms which prioritise improving shareholder returns.

Ben Kumar, investment manager at Seven Investment Management, says: “The Japanese equity market has been making fools of investors for decades but each attempt at economic revitalisation has brought new hope.”

They have recently raised their allocation to “overweight” and say valuations are relatively attractive compared to other developed markets.

Two collectives stand out for Adrian Lowcock, investment director at Architas: boutique Man GLG Japan CoreAlpha which seeks large cap firms which trade at a significant discount to their net asset value and Schroder Tokyo.