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Can the show go on?

Matt Davis asks whether Japan and emerging markets will continue to deliver

Last year saw stellar returns for Japan and emerging markets funds, according to the Investment Management Association’s figures.

Will 2006 see this trend continue or have investors looking at these sectors missed the boat?

The best-performing fund of 2005 was Dalton Strategic Partnership’s Melchior Japanese opportunities fund, which posted growth of 88 per cent. Japanese funds accounted for five of the top 10 performers, with Scottish Widows Investment Partnership’s Japanese smaller companies fund, Legg Mason’s Japanese fund, Neptune’s Japan opportunities fund and Invesco’s institutional Japanese fund all returning over 65 per cent.

Invesco Perpetual’s Latin American fund came in at seventh, returning 68 per cent, while global emerging markets funds including the Baillie Gifford emerging markets Accelerando and JPMF emerging markets funds, dominated the rest of the top 100.

Melchior manager Ken Nishizawa is optimistic about the prospects for Japan this year. He says: “The outlook for Japan in 2006 remains good, particularly at the individual corporate level. Cashflow is high and much of the debt incurred during the bubble years has been paid off. This situation leaves significant room for corporations to increase further their domestic capital expenditure programmes as well as giving them scope to continue to increase dividend payouts and to fund stock buybacks.”

Nishizawa also foresees significant merger and acquisition activity and other forms of corporate action in 2006, meaning stockpicking will be crucial.

Neptune Investment Management managing director and chief investment officer Robin Geffen is confident that Japan and emerging markets will continue to outperform the developed markets of the West this year.

Geffen, who runs the group’s managed, Japan and Greater Russia funds, says despite strong performance last year, the Nikkei 225 index remains at 15,500, well below its 39,500 peak in 1989, meaning that the market is not overvalued in historic terms.

He says domestic investors are only now starting to dip their toes back into equities and when local buying picks up this will help support the market. He notes that the arduous restructuring of the banks is almost complete, meaning small and medium-size companies are now getting access to capital which they were not in the past and which ultimately stalled previous recoveries.

He says: “The financial sector is finally sorted, which will help faster-growing small and medium-sized firms get access to capital. Japan is largely an issue of confidence and consumer spending will pick up with people seeing pay rises and bonuses.”

He is not concerned by high oil prices, saying although Japan is a massive importer of oil, it is efficient at producing alternative energy sources. The high oil prices have been a key driver of Russia’s recent growth and the commodities’ story looks set to continue driven by demand from China, with the Beijing Olympics set to maintain or increase the country’s huge construction spend.

“Emerging markets will continue to perform well next year, although not necessarily moving up in a straight line. This is where the growth is and Japan is the major market with the most potential and still a long way off its historic high,” he adds.

Geffen’s balanced fund is maintaining a 40 per cent exposure to emerging markets and 35 per cent Japan, with the balance split between the UK, US and Europe.

New Star multi-manager Mark Harris took an optimistic view on emerging markets last year in his Tactical portfolio, positioning 16 per cent in the sector and 42 per cent in Asia Pacific excluding Japan. He is set to increase exposure to emerging markets, linking performance to a possible US slowdown.

Harris says: “It is evident from our tactical portfolio that we are very positive on the outlook for emerging markets as well as aware of the stunning recent performance and volatility. If the US is to slow, as is likely, commodity prices are likely to come under some pressure which will impact most emerging markets. If such a correction occurs, it is highly likely that we would increase our exposure to both regions.”

Bestinvest business development manager Justin Modray thinks investors who have been wary of Japan and emerging markets may start reinvesting as a result of the recent numbers. As part of a diversified portfolio, Modray recommends up to 10 per cent exposure to Japan and a 5 per cent exposure to emerging markets. Modray’s main concern is preventing investors from getting carried away.

He says: “People are still going to go for their core exposure in the UK, Europe and the US but the figures are good news for those trying to market Japanese and emerging markets funds to investors. The key thing is to make sure investors do not get overexcited and step across the mark.”

Bric funds investing in the more mature emerging markets of Brazil, Russia, India and China are becoming increasingly popular with economists predicting these countries’ stockmarkets will rise massively over the next 15 years.

Allianz Global Investors is hoping to capitalise on enthusiasm for emerging markets by launching the first onshore Bric fund, a UK version of its German Bric fund called the Allianz RCM Bric stars fund, on February 22.

Manager Michael Konstantinov says the fact that the firm is choosing to launch the fund in the UK this year shows it is optimistic about the prospects for these markets over the short term but he is also keen to point out the long-term prospects for the Bric countries.

Konstantinov says: “Most economists agree that in the long term, these countries’ economies are going to be bigger than the existing developed economies of the G6 nations, so there is still a long way to go.”

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