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In good company?

Japan continues to present a dilemma for potential investors as the country’s public finances may be dire but its businesses are booming. Chris Salih reports

Investing in Japan is never a decision an adviser makes lightly as the sector has flattered to deceive on more than one occasion.

IMA figures for the Japan sector tell a sorry story over the long term, with the average fund making an 11.6 per cent loss over five years and only six making a positive return.

The short-term figures are brighter, however, with the average return for a fund up 15.2 and 13.8 per cent over three and 12-month periods respectively. Could this now be the time for advisers to look to Japan as they continue to move away from bonds and into equities in 2011?

The Japanese economy paints a less than convincing picture for prospective investors. According to the World Economic Forum report, published in September 2010, Japan was ranked 137th of 139 countries for its outstanding balance of government debt – the two that were worse would not release that information – while the budget deficit ranked them 134 out of 139 companies, with only the Ukraine, Jordan, Lebanon, Greece and Iceland worse off.

Japan’s corporates are its stronghold and Neptune Japan fund manager Chris Taylor says it is important that people split the economic situation, where he says a technical default is a possibility, with the prospects for bigger companies in Japan. The same World Economic Forum report that questioned Japan’s debt also ranked its business community as the best in the world.

Taylor says: “Japan is in trouble but the companies spotted this 10 to 15 years ago and have quickly invested outside Japan, with many earnings from non-OECD countries.

“Japanese companies have a lot more cash on their balance sheets than OECD rivals, putting them in an ideal position to move quickly in terms of investment and M&A activity.”

GLG Japan core alpha fund manager Stephen Harker suggests that during the last decade Japan funds have not performed too badly but the odd bad year or two in that timeframe has stung investors.

He says: “Japan had a really terrible time up to 1998 after a 10-year period of retrenchment. Since then, the Japanese market has moved pretty much in line with the UK and the US. It is a really modern economy with good corporates and it has got cheap enough to compete with the West.”

One of the biggest attractions to investing in Japan has been exposure to the currency. The yen has moved in value from around 250 to the pound before the credit crunch to around 130 now.

Harker says: “Our view in 2007 was that the Japanese currency was ridiculously undervalued and the change from 250 to 130 reflects that. Many think it is now overvalued but the long-term run of the Japanese yen means it is still fairly valued and is another diversifying asset.”

Hargreaves Lansdown investment manager Ben Yearsley says: “It has been seen as a safe-haven currency. It was surrounded by a stable country with stable politics despite the changing number of governments.

“I think it is still the case but some will point to the fact that Japan’s public finances have been shot to pieces. The economy is also unsustainable, with Japanese government bonds at 1 per cent.”

Yearsley says those concerns do not put him off investing. He says: “The bottom line is that this is not companies. It is the same as the UK where the public finances are dreadful but we have some good companies. It is still the cheapest market and if you are bullish it would not stop you putting 10 per cent of your profile in Japan.”

Taylor says: “Asset allocation is the deadliest thing of all when it comes to Japan. The companies are the ones that make the money that gets discount-ed into the profits that gets translated into the share price. Ignore that at your peril. No country has better earnings profits.”

Much has also been made of Japan’s ageing population as a concern, with many of the cash-rich at or approaching retirement. Taylor says the savings pool is shrinking and many are spending as Japanese pensions are so poor.

He says: “It has reached the point where the pen-sioner prisoner population in Japan has gone up from 3 per cent to 20 per cent. Chances are you are on your own and can only afford one meal a day. The generation that built Japan after World War II has decided to commit crimes and get banged up as they get three meals a day and have people to talk to.”

Harker says the demo-graphic story has been invented by the bears and Japan has been exploiting 98 per cent of the world’s population in terms of corporate expansion over the past 20 years.

He says: “Japan’s corporate sector is addressing the seven billion population across the world rather than 127 million in its own country. It is not just manufacturers but domestic companies that are moving overseas. The debt problem can be addressed and solved – it is domestic and is therefore a domestic solution. It may mean more tax, which is bad for the economy but the solution is soluble.”

Bestinvest senior investment analyst Adrian Lowcock says: “We raised our exposure to Japan at the end of last year as it does have good valuations and offers an exposure to China but we have been here before and people should not pile in while these overhanging issues of debt and demographics are not tackled.”

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