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Sector focus: Can Japanese equities win back the doubters?

Fundamentals are improving but valuations still sit at historically low levels

Japan-Mount-Fuji-Pagoda-700x450.jpgJapanese equities should pique investors’ interests on a valuations basis, due to their historically and globally low levels. On a P/B basis, the Topix index is trading at a discount to the S&P 500, MSCI Europe and MSCI Emerging Markets indices; on a 12-month forward looking P/E basis, only the MSCI Emerging Markets is cheaper.

With Prime Minister Shinzo Abe and his government continuing to strive to counter the longstanding fears of consistent deflation, limited growth and poor corporate governance, Japanese equities are starting to appear attractive on a fundamental basis too.

Evidence is growing that Abe’s policies are taking effect. The labour market is at its tightest in over 20 years (pointing to wage growth pressure), nominal GDP and corporate profits are at record highs, the level of share buybacks and dividends by Japanese companies has grown significantly, as has the appointment of independent directors on company boards.

Perhaps as a result, in contrast to net redemptions in 2016, Japanese equity funds have benefited from net subscriptions this year (to end of October).

FE’s fund of the month: Baillie Gifford Japanese

Those that invested in Japan small/mid-caps at the beginning of the year were the best rewarded, with the average fund returning 22.7 per cent in sterling terms, against 13.3 per cent and 17.8 per cent for Japan large-cap equity and flex-cap equity funds respectively.

In terms of style, the same period has seen growth outperform at the expense of value. At the sector level, the top three performing were IT, materials and industrials, while financials (banks, in particular), real estate and utilities were the three worst performing.

Investors fared better with active funds than their passive counterparts, however, they also faced a higher level of variability in their return and the risk of choosing a fund that gave a significantly lower return.

 Fund picks

This underlines the importance of robust fund selection. In this respect, here are three fund we like.

Man GLG Japan CoreAlpha holds a Morningstar Analyst rating of Gold. It is managed by one of the most experienced teams in the Japan Large-Cap Equity category, led by Stephen Harker. They employ the same investment approach that Harker has used throughout his investment career, namely value-driven, contrarian bottom-up stock picking. The process uses screens (based on P/B and relative price movements) to identify value opportunities among the largest 300 listed companies in Japan.

Impressively, Harker and the team have successfully delivered strong relative returns despite considerable style headwinds in recent years, illustrating their ability to add value above and beyond the investment style.

Lindsell Train Japanese Equity sits in the Japan Flex-Cap Equity category and holds a Morningstar Analyst rating of Silver. It has been managed since 2004 by Michael Lindsell, who creates a highly concentrated portfolio of stocks that he believes to be high-quality, cash-generative, and have strong and easily understood business franchises.

Using various filters, Lindsell whittles down the universe to a small number of stocks, which are then subject to in-depth fundamental analysis undertaken by Lindsell with the help of two supporting analysts. Lindsell’s deep understanding of company strategies, together with his ability to see through the noise and take a genuinely long-term outlook make this fund a very strong choice for investors seeking exposure to Japanese companies across the market-cap scale.

Schroder Tokyo has a Morningstar Analyst rating of Gold and sits within the Japan Large-Cap Equity category. It is managed from London by the highly experienced Andrew Rose, with the support of Schroder’s sizeable team based in Tokyo.

Rose has adhered to the same process on this fund since 2004 and throughout his career. Style-agnostic and unconstrained in nature, he creates a well-diversified portfolio of companies that he believes have the potential to surprise on the upside over a two- to three-year period but where the market has taken a short-term negative view.

An unconstrained fund can carry a degree of risk in the wrong hands, but Rose has deftly used it to investors’ advantage. His measured approach tends to result in a nicely balanced portfolio, and the focus on valuations and fundamentals has helped keep returns consistently strong over the long term.

Peter Brunt is senior analyst, manager research, at Morningstar

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