A yen for the contrary
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GLG Japan CoreAlpha manager Stephen Harker has spent the majority of a 30-year investment career focusing on Japan, evolving his contrarian value stockpicking strategy.
In basic terms, he buys stocks disliked by the rest of the market - typically after a period of underperformance - and therefore cheap.
These companies usually have a low price-to-book ratio and high-dividend yield and Harker is seeking to buy them at the bottom and sell when they hit the peak of recovery.
Since moving his CoreAlpha portfolio to a large-cap focus in 2006, the fund has produced top-decile returns against very different market backgrounds. “Japan is the best pure value market among developed nations and this strategy tends to outperform in the region,” says Harker.
“Value stocks in the UK and US can go out of favour for several years but this has not happened in Japan, possibly because there is little M&A activity. Falling companies in other developed markets are usually taken out before the price gets too low but M&A is not central to how Japan runs.”
Harker does not look for specific catalysts to improve share prices share like other contrarians.
“If you look at our process like a manufacturing business, we are looking to buy our raw materials at the lowest price and sell our output - share price appreciation- at the highest level,” he adds.
He avoids making large macro calls on yen strength or interest rates, and even fore - casting earnings or revenues, simply seeking cheap stocks with potential to recover.
That said, there are two major structural calls on CoreAlpha, the large-cap focus and general lack of exposure to companies dependent on the Bric nations, both in place as contrarian stances.
Neither of these themes has worked as yet and Harker’s outperformance has been down to tactical switching in the large-cap space between economic defensives (such as pharmaceuticals and railways), technology and financials.
At the end of 2008, he saw opportunities in sold-down technology stocks and increased risk on the portfolio, then gradually took profits as these companies led the rally throughout last year.
“We have moved overweight in financials and defensives, basically barbelling the high beta of the former with lower beta of the latter, as the market has turned against these areas,” he says.
“From an aggressive bet in exports through tech nology, we are now skewed towards the domestic economy, which should continue to benefit from yen strength. Financials have been largely out of favour in Japan for the last 20 years, so it is hard to avoid the sector as a contrarian.”
Favoured defensive holdings include Seven & i, which has the 7-11 franchise in Japan, plus positions in the East, West and Central Railway businesses.
Overall, Harker believes the Western consensus view on Japan is far too pessimistic and the market has beaten the FTSE and S&P500 in five of the last 11 years.
He admits this is data mining to an extent and the period up to 1998 was very poor but still notes that over the whole period, the Topix has beaten the S&P 500 and run in line with the All-Share.
“People often claim Japan has been a disaster for years but the reality is quite different, although a high proportion of returns has come through currency,” he says.
Overall, Harker said Japan has been a conservative country for over a decade and continued government cuts have led to a slow-growth economy. “But exports to China are growing quickly and comments that the economy is not functioning are preposterous,” he says.
“The corporate sector has also been deleveraging for over 30 years and that is more than enough to offset any debt issues on the government side.”
Japan has been running a current account surplus for several years, in stark contrast to other developed countries, preparing for its demographic timebomb of an aging population. “Economic growth is slow but that is priced in and there remain plenty of cheap companies able to improve performance in this environment,” says Harker. “The index as a whole is now trading at around 1.1 times book value compared with 0.9 a year ago but the dividend yield is 2 per cent against 1.3 per cent in 10-year bonds, indicating slow growth is priced in.
He adds that Japan remains an unpopular investment destination and should benefit from some portfolio rebalancing when people realise its pariah status is unwarranted.
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