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Land of the falling sums

After a year of poor performance in the Japanese market, IFA sentiment on the sector has fallen flat.

No fund invested principally in Japan achieved a positive return over the 12 months to the end of January.

The average Japanese unit trust fell by 28.9 per cent, while the average Japanese smaller companies fund was down by 36.3 per cent.

But unlike the technology sector, where recent heavy losses have begun to see pundits calling the bottom of the market, Japan has an inherent complexity which has continued to leave investors unsure of its fortunes.

Aberdeen Asset Management Japanese fund manager Shahreza Yusof says: “So far this year, the omens are poor. Business sentiment has weakened and although it is too early to suggest a recession, we feel growth will slow since the economy lacks significant growth drivers.

“Consumption has stayed fragile, investment spending is patchy and bad debt is still depressing credit creation.”

Some experts feel Japan&#39s troubles have been exacerbated by its government, which has been slow to react to the economic slowdown while remaining reluctant to take a proactive approach to managing the economy.

The few moves the government has taken have often been seen as destructive rather than helpful. For example, having run a zero interest rate policy for decades, the decision to raise rates last summer was considered by some to have aided the slowdown.

Yusof says: “The wider economy still lacks clear leadership. Consequently, fact-ional infighting and pandering to special interest groups have resulted in enormous structural imbalances.

“These include overinvestment in the wrong industries, banks that are permanently running on empty and poorly mobilised savings. With rising public debt levels, the government is running out of excuses and financial aspirin.”

Another of the recent problems in Japan has been triggered by the large number of equity cross-holdings between the banks and their clients.

For decades, banks have cemented their relationship with companies by each party taking shares in the other. Such cross-holdings still make up around 40 per cent of all Japanese equity.

But more recently, companies have started to unwind these holdings as the Japanese equity culture grows. Companies have realised large gains which they have been able to use to offset poor profits.

However, new accounting practices will be introduced in March to prevent firms waiting for the right moment to realise their gains. Instead, shareholdings will be valued at the end of each tax year, with any gain made over the year being included in that year&#39s profit figures. As a result, many companies are trying to sell off their holdings before March, pushing equity markets down.

Another reason for Japan&#39s troubled year has been its close relationship with the Nasdaq. As a major technology exporter, it has a strong link with the US and the Nasdaq&#39s unstable year has had a negative effect on Japan&#39s fortunes.

But the picture is entirely bleak. It is worth remembering that technology is still only a part of Japan&#39s economy and cannot take the blame for the entire fallout. It would be overly optimistic to rely on further US interest rate cuts by Federal Reserve chairman Alan Greenspan sparking a recovery in the US and a consequent recovery in the Pacific.

But IFAs should bear in mind that although most fund managers are nervous about the short-term prospects for Japan, the sector has clearly not been written off for the longer run.

Continuing corporate restructures and a growing equity culture give Japan the potential to produce high returns in the future, according to fund managers. Only a year ago, the sector was in good favour with many funds sitting on triple-figure annual returns.

Credit Suisse Asset Management Japanese fund manager Nicholas Edwards is optimistic about Japan&#39s prospects. He says: “The current gloom about the Japanese economy appears to us to be misplaced. Japan&#39s economic recovery is not accelerating but continued significant corporate cost-cutting and improvements in productivity should result in further profit gains, which should keep the recovery in place.

“Japan is shifting from a recovery led by business investments and exports to a new stage driven by business investment and consumption.”

IFAs may still need convincing that now is the time to get back into Japan in a big way but most have a keen eye on the sector. Its current unpredictability – both economically and politically – certainly still leaves the possibility of high returns over the coming year.

Plan Invest joint managing director Michael Owen says: “I fail to see what is going to be the stimulus to bring Japan to life at the moment but we are keeping an eye on it.

“In a balanced portfolio, Japan is not a market you should necessarily ignore but it would make up less than 5 per cent for our clients at the moment. We may start looking at it again later in the year.”


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