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Fund of the month: Baillie Gifford Japanese

Tokyo-Japan-Asia-Night-700x450.jpgThe third quarter of 2017 saw the Japanese economy grow at an annualised pace of 1.4 per cent, making it the seventh consecutive quarter of growth and the longest run of expansion since 2001.

Abenomics – Prime Minister Shinzo Abe’s set of fiscal, monetary and structural policies designed to take Japan out of its economic quagmire – seems to be bearing fruit. After two decades of stagnant growth, the economy is showing signs of improvement.

However, it has not met the 3 per cent target initially set by Abe in 2012. Inflation remains elusive, inching its way up but still far from its 2 per cent aim. The Bank of Japan maintains the short-term interest rate at -0.1 per cent.

Unemployment is at an all-time low, with a tighter labour market than at the peak of the bubble in 1990 but wage growth stubbornly refuses to rise. Robust growth here seems to be the missing link that could spur consumer spending, thereby pushing inflation levels up. To encourage wage growth-stimulated consumption, Abe is now urging companies to hike salaries by 3 per cent by next year.

Overall, investors appear to be looking on the bright side. Japan’s stockmarkets have been soaring, buoyed by the international market rally, a strong earnings season, a weakening yen and Abe’s landslide victory in the snap election in October.

For investors looking to dip into some of these gains, an active investment strategy is likely to be the most appropriate.

The Baillie Gifford Japanese fund, run by Sarah Whitley and Matthew Brett, comes highly recommended by our research team. However, Whitley is due to retire in April, with Brett assuming full portfolio management responsibilities. We remain confident the portfolio will be run in the same manner, with no changes to the investment process.

The fund’s objective is to produce above-average long-term performance through investments in Japanese equities. It does this by identifying companies that have potential to grow over the long term. The managers typically construct a portfolio of 50 to 60 stocks.

Given that in Japan, growth often commands little or no valuation premium, the managers also invest in leading global businesses which trade on a substantial discount to their peers. Key factors that drive the overall stock selection include a competitive advantage, robust finances and strong management alignment with shareholders.

The fund has consistently outperformed its sector, ranking in the first quartile over one, three, five and 10-year periods.

It performs well when high-growth companies do well, particularly those in the consumer-facing and technological sectors. Picking the right companies within those areas has been crucial and has led to strong outperformance in certain periods, particularly 2010 to 2013. In 2014, the fund began shifting away from some expensive growth stocks and towards more economically sensitive companies. This held it back in terms of performance in 2014 and 2015, but the positioning paid off in 2016.

Looking ahead, the fund is likely to remain most exposed to the technology and consumer industries, and will do better when these parts of the Japanese market do likewise. However, stock selection within these sectors remains of utmost importance. Many of the companies in the portfolio earn revenues from international markets, so the health of the domestic Japanese economy as a whole is not critical for their growth.

This is a high-risk way to access Japan. The fund does not pay attention to how it differs from the market and has moderate allocations to mid- and small-caps, with a tendency to crowd into certain themes or sectors. This means its performance can differ significantly from that of the benchmark. In addition, the poor sell-side coverage in Japan, particularly in mid- and small-caps, provides the fund with more opportunities to generate alpha.

Due to the focus on long-term growth, the average trading activity in the fund is low to benefit from trends the team’s analysis has identified. The fund is a long-term holding and not for the nervous. However, the team has a good track record of making excellent stock picks and finding companies which can grow substantially over the longer term, which makes this an attractive fund to hold for those with a long time horizon and who understand the fund’s stock picks may take years to come to fruition.

It has an OCF of 0.63 per cent and an FE Risk Score of 125 (zero being cash and the FTSE 100 has a FE Risk Score of 100).

Namrata Nanda is institutional marketing manager at FE

Key Facts

Sector: IA Japan

AUM: £2,096m as at 31/10/2017

Launch Date: 08/10/1984

Management: Sarah Whitley, Matthew Brett

FE Alpha Manager rated: No

FE Crown Fund Rating: Four

Source: FE Analytics as at 31/10//2017

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