Options for buying into a Japanese resurgence

Japan faces economic headwinds, but it could have one of the world’s most attractively-valued stock markets.

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  1. Rob Morgan

Japan is facing some tough economic challenges. Its large exporters are vulnerable to stagnating global growth and exposed to the trade war between the US and China. Japan’s electronics firms are major suppliers of components for Chinese goods, which are then shipped around the globe. Thus far the Japanese economy has been quite resilient with growth holding up, but the possibility of US tariffs on auto imports from Japan also threatens, as does an increase in domestic consumption tax.

To make matters worse, the unsettled economic backdrop has driven many investors to back Japan’s currency, the yen, which has increased in value. This drives up the price of Japanese exports and weakens demand for the country’s goods, as well as reducing corporate profits.

 

Good value and a resilient underlying picture

So should we expect tough times for Japan’s equity market? Based on the economic headwinds you might think so, but we don’t think its clear cut. With corporate earnings rising faster than share prices Japanese companies have been becoming progressively cheaper for some time. This reflects investors growing more nervous about the risks, and it could mean that Japan has one of the world’s most attractively-valued stock markets right now.

In general, Japan’s companies have strong balance sheets with little debt. What’s more, following government measures to make companies more shareholder-friendly, earnings are increasingly translated into greater company profits and returns for investors. Firms are allocating capital more efficiently, paying higher dividends, and increasing share buybacks. In addition, business practices and governance standards, previously reasons for some investors to avoid the market, have improved.

An environment of modest global growth could continue to help corporate Japan perform well, and the current trade tensions might provide an attractive opportunity in the longer term provided they subside.

 

Options for buying into Japan

The past couple of years have seen a significant divergence in fortunes for ‘value’ and ‘growth’ investing styles in Japan, as has been the case elsewhere. Growth investing – targeting faster or reliably growing (but more expensive) company shares – has been in the ascendency. Meanwhile, funds seeking out cheaper shares in anticipation of improving or recovering prospects have lagged behind.

The two active funds on our Foundation Fundlist of preferred investments representing this sector fall firmly into the ‘value’ camp.

Man GLG Japan Core Alpha’s Stephen Harker is excited about the potential for the very cheap shares in car makers, manufacturers and financials in particular. Meanwhile, Ruth Nash of JOHCM Japan is confident economic recovery in Japan is self-sustaining and not dependent on the value of the Yen or demand from China. Furthermore, she hopes investors will start to appreciate some of the smaller, less well known and deeply undervalued Japanese companies that stand to benefit from domestic reforms.

Both funds are part of the Foundation Fundlist because they do something entirely different to a straightforward passive approach of tracking the market. Man GLG Japan Core Alpha takes a highly focused and contrarian approach investing in a relatively small number of the cheapest and unfashionable larger Japanese shares available. The managers have a strong record of harnessing returns from underappreciated shares as they go on to eventually rebound, but the process takes resolve and patience. As a consequence, it can be prone to periods of underperformance when the style is at odds with prevailing market sentiment.

JOHCM Japan also targets unloved, cheap companies but has a bias towards smaller and medium-sized enterprises. Here the level of research coverage by the investment community tends to be very thin, meaning it is possible to unearth bargains through diligent research. Ideally, the managers invest where there is a catalyst for change or wider recognition that triggers a share price rise. This part of the market has been in the doldrums for a number of years, but in the long term we believe the fund could reward patient holders.

For investors wanting simpler, broader market exposure at low cost, Fidelity Index Japan is a passive fund on our Foundation Fundlist. This fund aims to track the performance of the MSCI Japan Index as closely as possible after allowing for charges, which at 0.1% a year are highly competitive.

 

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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