Japanese funds: What’s inside, key risks & how to choose
Japanese funds have a role to play in many portfolios. They provide investors with diversification and exposure to one of the world’s largest stock markets. In investment terms, Japan is treated as a separate entity rather than as part of Asia because it’s a developed market with a distinct economic and corporate culture. The country has already undergone many corporate reforms over the past decade to make it more shareholder-friendly – and further changes are planned.
Baillie Gifford Japan Trust
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Baillie Gifford Japanese
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Baillie Gifford Japanese Smaller Companies
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Comgest Growth Japan
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JK Japan
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M&G Japan
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M&G Japan Smaller Companies
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Pictet Japanese Equity Selection
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WS Zennor Japan Equity Income
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But how do you know the best Japanese funds to invest in? Here we look at everything you need to know about Japan funds and how to find the best-performing Japanese funds.
- Japanese funds invest primarily in companies listed in Japan and offer exposure to one of the world’s largest and most liquid stock markets.
- Corporate governance reforms have transformed the investment case for Japan, leading to greater transparency, improved shareholder returns, more share buybacks and dividends and better capital allocation.
- Investors should be aware of key risks, including currency fluctuations, Japan’s ageing population, the possibility that reform momentum slows and market volatility driven by sector concentration.
- Japanese funds are often used as portfolio diversifiers or satellite holdings and may suit long-term investors seeking exposure beyond the US and UK.
What are Japanese funds?
They are portfolios that invest in companies listed on the Japanese stock market. Depending on their objectives, these funds can focus on stocks of various sizes in different sectors. The IA Japan sector requires managers to invest at least 80% of their assets in Japanese equities, while the remainder can be allocated elsewhere. Some Japan funds simply track a particular stock market index, while others will be actively managed with the aim of delivering outperformance.
Why UK investors look at Japan
Japan shouldn’t be ignored. It has one of the world’s largest stock markets and is home to multinationals such as Toyota, Hitachi and the SoftBank Group. This makes it attractive as a diversifier, particularly because its economic cycle doesn’t usually mirror that of the United States or the UK. The companies listed in Japan also differ. For example, there are more robotics, automotive and electronics players, with less exposure to large-cap technology names.
The corporate governance reform story
Corporate reforms have been a long-running story in Japan. This has made it a more shareholder-friendly environment, with more transparency. It’s also led to more share buybacks and dividend payouts, while the unwinding of cross-shareholdings has increased foreign investor ownership. While more work is needed, investors have been encouraged by the progress made, which has made many companies more attractive.
Indices and what’s typically inside a Japanese fund
The main stock market index is the TOPIX. This is the largest benchmark and the most commonly referred to by investors. It’s weighted by market capitalisations and includes around 2,000 companies. As a result, it’s regarded as being the most representative bellwether of Japan.
Another popular index is the Nikkei 225. However, this is more limited in scope. It contains 225 large companies and is weighted by price. While individual Japanese investment funds differ, many portfolios will be heavily tilted towards industrials, automotive, and banks, as these sectors dominant the country.
Sub-categories within Japanese funds
It’s possible to break Japanese funds down into different categories.
Core Japanese funds
Some Japan funds are designed to provide broad exposure to the Japanese market and are perfect for investors seeking a one-size-fits-all approach. The hope is that these portfolios will be more stable because they are usually weighted towards large and mid-cap stocks.
Japanese smaller companies funds
This means companies with lower market capitalisations. These include younger innovative businesses that are starting out or those operating in niche areas. The attraction of these stocks is their growth potential. However, would-be investors need to acknowledge that they can be more volatile.
Style-specific Japan funds
Some Japan funds will be run with a particular style in mind. For example, a growth-oriented manager will focus on companies with the potential to rapidly increase earnings. A value-oriented manager, meanwhile, will favour businesses trading below their value, while income funds want exposure to companies paying dividends.
The biggest risks to understand
There are risks with every fund – but what do investors need to consider when it comes to Japan?
Currency risk
Movements in the Japanese yen can influence returns for foreign investors. Some funds offer share classes that enable you to hedge the currency effects. However, this may cost more.
Demographic and structural challenges
One of the biggest problems facing Japan is its ageing demographics. Almost a third of its population is over 65 years old. This can affect age-related spending, such as healthcare and pensions, according to the World Economic Forum. The country is also facing a labour shortage.
Reform execution risk
A tremendous number of reforms have been carried out, but there’s still more to achieve, and progress can be gradual. Of course, political or regulatory changes can influence the pace at which they’re implemented, and the investment case for Japan largely hinges on these reforms continuing.
Volatility and index concentration
The Japanese stock market can fall in response to global shocks or economic factors. That’s why you need to understand where funds are invested. For example, if it’s heavily weighted towards vehicle manufacturers and this sector encounters problems, their performance will take a hit.
How to choose a Japanese fund
Don’t just focus on the best-performing Japanese funds over the past year, as the returns achieved could be short-lived or misleading. Instead, examine several factors.
Define your objective
What do you want to achieve? Do you prefer innovative smaller firms or exposure to more established household names that pay regular dividends? Your investment goals and risk appetite will also influence which fund is most suitable. Finally, you need to factor in existing investments.
Check the benchmark and what it means
Decide which benchmark you prefer. Generally speaking, TOPIX-benchmarked funds offer broad exposure, while Nikkei 225-tracking funds are more concentrated.
Understand the manager’s approach to corporate reform
A manager with experience in Japan and knowledge of how the corporate world operates will be a bonus for any investor. On-the-ground research can be key – as opposed to those who have to manage from the other side of the world – as well as a clear, understandable investment process.
Assess the manager and team
When it comes to actively managed Japanese funds, the fund manager will play a crucial role in selecting the most suitable companies for the portfolio. That’s why it’s important to understand their investment process, the depth of resources in the fund management firm, and how successful they have been in their career. For example, see if they have a strong track record of delivering outperformance in different market conditions and whether they have any risk controls in place.
Review costs and currency policy
Fees are often overlooked, but they can affect your returns. The charges levied by Japanese funds can vary, so you must be clear on what costs apply and how they’re likely to affect your returns. Pay attention to the Ongoing Charge Figure (OCF), which is a percentage representing a fund’s annual operating costs, the entry and exit charges, transaction costs, and any performance fees.
Where Japanese funds fit in a portfolio
It’s fair to say most investors use Japanese funds as a diversifier in a broader portfolio. They are unlikely to be core holdings and often serve as ‘satellite’ positions. Of course, you may already have exposure to Japanese markets if you already have global funds in your portfolio. It doesn’t make sense to double up, so check your existing holdings. Either way, an investment time horizon of at least five years is recommended.
Our process & how we select Japanese funds (Elite Rated)
FundCalibre’s experts help you find the best Japanese funds to invest in. They have been analysing Japanese funds for years, and only the very best are awarded a prestigious Elite Rating. Their process starts with AlphaQuest, our proprietary quantitative screening tool that estimates the likelihood that a fund manager will deliver superior returns. Japan funds passing this test will be quizzed on their investment philosophy and portfolio construction approach. This analysis will be subject to peer review before a decision is made.
FAQs about Japanese funds
What are Japanese funds?
Japanese funds are portfolios that primarily invest in companies listed on Japanese exchanges. They can focus on large, medium-sized or smaller businesses and may be managed actively or passively. Investors typically use them to gain exposure to Japan’s economy and corporate sector through a single country fund.
Should I invest in Japanese funds?
Whether Japanese funds are suitable depends on your investment goals, risk tolerance and existing portfolio. They can provide diversification away from UK and US markets and offer exposure to a developed economy that has its own drivers of growth. However, investors should understand the risks before investing.
Why is Japan treated as a separate fund category from Asia?
It has a different economic and demographic profile. It’s also a developed market (as opposed to an emerging one) and has a large, liquid stock market. Most Asian equity funds focus heavily on emerging markets such as China, India and Taiwan, while Japan has its own distinct investment opportunities and risks.
What’s the difference between TOPIX and the Nikkei 225?
The Nikkei has a more select number of large companies and is weighted by price, whereas the TOPIX tracks around 2,000 Japanese companies and is weighted by market capitalisation, making it a broad representation of the country’s stock market.
What is Japan’s version of the S&P 500?
There is no exact equivalent, but TOPIX is generally considered the closest comparison because it provides broad exposure to Japanese equities.
What is the corporate governance reform story in Japan?
Japan has spent more than a decade encouraging companies to improve governance standards, increase transparency and focus on shareholder returns. These reforms have contributed to higher dividend payments, more share buybacks and greater attention to capital efficiency, making Japanese equities more attractive to many investors.
Are Japanese funds high risk?
Yes, most broad-based Japanese equity portfolio will probably be classed as high risk. One focused on smaller companies, however, may be more volatile. Market conditions, currency movements and economic developments can all influence performance.
Should I hedge yen exposure?
Currency hedging can reduce the impact of fluctuations in the Japanese yen against sterling, but it usually comes at an additional cost. Whether it is worthwhile depends on your investment horizon, risk tolerance and views on future currency movements. Many long-term investors choose to remain unhedged.
What’s the difference between a Japan fund and a Japanese smaller companies fund?
A general Japan fund typically invests across a range of large and medium-sized companies, offering broad market exposure. Japanese smaller companies funds focus on businesses with lower market capitalisations, which may have greater growth potential but can also experience higher volatility and investment risk.
Can I hold a Japanese fund in a Stocks and Shares ISA?
Yes. Most can be held within an ISA. This allows any capital gains and income generated within the account to grow free from UK income tax and capital gains tax, subject to ISA rules.
How much of my portfolio should be in Japanese funds?
There is no universal allocation that suits every investor. The appropriate weighting will depend on your objectives, risk profile and existing holdings. Many investors use Japanese funds as a diversifier alongside global equities, often allocating a modest portion of their overall portfolio to the region.
What does the FundCalibre Elite Rating mean for Japanese funds?
A FundCalibre Elite Rating is awarded to funds that have impressed our research team through detailed qualitative and quantitative analysis. Factors considered include the manager’s track record, investment process, portfolio construction, consistency of approach and the fund’s potential to deliver strong long-term outcomes.