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James Burns: Japan is no longer cheap but outlook remains positive

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In recent articles I have looked at alternative income sources but this time I want to focus on a more mainstream area which has seen a huge surge in renewed interest in recent times, namely Japan.

The actions of prime minister Shinzo Abe continue to have a powerful impact on the Japanese economy and his aggressive reflationary policies are starting to bear fruit. However, financial markets remain volatile and daily moves in the equity market of 3 per cent or more became commonplace over the summer.

August’s CPI inflation figures showed prices rising at their fastest pace for five years, suggesting that Abe’s plan to reverse Japan’s deflationary spiral is having an impact. But stripping out energy costs, prices still fell by 0.1 per cent last month and without an increase in wages, it seems unlikely that consumer purchasing power can strengthen. Stimulating wages will be a major policy focus for the Abe regime once the long-planned increase in the rate of sales tax finally goes ahead next year.

The rapid rise in Japanese equities since the end of last year means the market no longer looks particularly cheap. But with monetary policy remaining extremely supportive we remain positive on the outlook for Japanese equities.

We have been overweight Japanese equities in our multi-manager portfolios for some time and continue to be so. Our core exposure to the country has been through the GLG Japan Core Alpha fund run by Stephen Harker. This has a value bias and is very much focused on the larger end of the market. The manager prefers to buy stocks that have underperformed the market for some time and its biggest overweight currently is to banks.

When we first invested in the fund several years ago our outlook was that if the Japanese economy was to improve then the Yen had to weaken. As such we have been invested in the hedged share class of the fund. This initially added no value to us – we would have been better off in the unhedged class, but since the middle of 2012 we have had the full benefit of the market moving strongly upwards without any headwind from the currency depreciation. Overall the decision has worked well for us and we are happy to continue with the hedged position in the anticipation of further Yen weakness.

Our second fund is an investment trust, Prospect Japan. This has been managed by boutique manager Curtis Freeze since inception in December 1994 and it invests at completely the other end of the scale to GLG, in smaller companies with market caps of between $150m-$500m.

The portfolio is highly concentrated (around 25 stocks) and high conviction with a deep value tilt. The manager looks to effect change through corporate action. He takes an active approach with the companies he invests in.

While this is an interesting vehicle, returns will not be in-line with the broader Japanese market and we view it much as a special situations type play. 

Like its entire investment trust peer group the manager at Prospect does not hedge the currency.

James Burns is head of multi-manager at Smith & Williamson

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