298. Why Japan is due for a review of investor perception
Richard Kaye, manager of Comgest Growth Japan, covers a range of topics relevant to investors tod...
After a dreadful start to the year, Japanese shares spent most of April recovering nicely. All five of our Elite Rated Japan equities funds were among the top 10 Elite Rated performers1. At the last minute, however, the Bank of Japan (BoJ) threw a spanner in the works.
Haruhiko Kuroda, the BoJ’s governor, announced he would keep rates on hold and not provide any further economic stimulus in the coming month. This went against investors’ expectations, given the slew of poorer-than-expected economic data emerging from Japan over the past few weeks. The stock market subsequently tumbled and Japan’s currency, the yen, rose in value.
It isn’t the first time this year updates from the BoJ have resulted in plummeting share prices. At the end of January, the bank introduced negative interest rates for the first time in Japan’s history in a bid to keep growing its economy.
While lowering rates normally helps a country’s currency devalue (which is useful for the large number of Japanese corporates with significant overseas earnings), the move that time round bizarrely boosted the yen and so sent equities 14.7% lower in the two weeks following the cut2. People feared the dream team of Prime Minister Shinzo Abe and Kuroda might finally be out of ammunition.
But that’s Japan in a nutshell really; investors can either be wildly successful or wildly unsuccessful. Politics, the central bank and the currency make or break returns, and the traditional wisdom of taking a long-term view hasn’t necessarily proved profitable.
The stark truth of it is that over the past 20 years UK investors would have been better off keeping their money in cash than the Japanese stock market3.
More recently, however, the case has been promising. I’ve been bullish basically since Abe returned to power at the end of 2012 and the market has recovered by more than 50% from that point, despite this year’s performance4.
Back then, there was a renewed sense of optimism in the land of the rising sun. Abe’s famed three arrows were just being ‘nocked’ (for the archers among you) and if the world’s third largest economy was poised for a comeback, people wanted to be part of it.
Three years on, results are mixed. Japan’s biggest danger is its debt and, try as they might, the Abe–Kuroda dream team just can’t get the economy going in a way that will raise sufficient tax revenues to fund the budget and start to make a dent in those loans.
Deflation hasn’t been vanquished as Abe enthusiasts might have hoped. And the extended period of low to non-existent price growth has done serious damage to the Japanese mentality. Someone who joined the workforce 20 years ago, like I did, has only just seen a small period of sustained inflation for the first time. It’s no wonder employees remain reluctant to splurge and consumer spending isn’t contributing what it ought to the nation’s economy.
On that front, some are now starting to suggest a “new” three arrows. I met with manager of the Legg Mason IF Japan Equity fund this week, Hideo Shiozumi, who now refers to the initial three arrows as the new first arrow.
A second arrow will work to enhance childcare support, with dual aims to raise the birthrate in a battle against Japan’s ageing demographics, and also to get more women back into the workplace. And a third will target a reduction in the number of people forced to leave employment to care for elderly family members.
With this view in mind, the Legg Mason IF Japan Equity fund focuses on what it calls the “new Japan”. Instead of investing heavily in large manufacturers at the top end of the stock market, Hideo believes the future lies in companies like internet distributors, inbound tourism operators, and medical and elderly healthcare providers.
In many ways, it is a persuasive proposition with some interesting ideas. The fund is not Elite Rated, largely because its performance has been inconsistent. Over the past five years, its returns have by far topped the IA Japan sector5. Over the past ten though, it comes in much further down the list6. As always in Japan, different styles of investing find favour at different points – a point I’ll discuss in more detail below.
One of the main challenges when it comes to boosting sustainable economic growth in Japan is that its corporates have extensive exposure to international economies and many of its major companies are in cyclical industries. The fortunes of its economy are heavily dependent on the world’s outlook.
So, if you think China won’t have a hard landing, the U.S. is going to muddle through, and the eurozone will manage to keep it together, you could still build a bull case for Japan.
On the other hand, the idea that the country may eventually have to resort to ‘helicopter money‘ has some people worried. Detailed definitions vary, but this is basically another way of printing money to stimulate the economy – except the central bank won’t ask for it back eventually. If it sounds too good to be true, it probably is and who knows how markets would react.
Will the BoJ go that far? It’s hard to say. At a press conference following the April announcement, Kuroda pretty much ruled it out, saying it would actually be illegal under Japan’s current system. But we have seen back flips from the BoJ before and so we must remain a bit wary.
Another thing that you really need to be cognisant of in Japan is the way currency hedging can affect returns. Rather than adding an extra layer of protection, it is more akin to going in with a ‘double or nothing’ approach.
If the yen strengthens (as it has done) and equities fall, you lose out on the stock market and you don’t get the slight buffer of converting back into sterling. But if the yen falls, your returns are hedged against the exchange rate impact and you get the full potential stock market upside (without currency losses).
So depending on your view of the macro, there are different ways to play the Japanese equities sector. And while over the last 20 years investors might have been better off in cash than a passive market tracker, a few active funds have done pretty well. Plus remember we’re not likely to see the likes 5% cash returns again any time soon.
One of the oldest funds in the sector, the Elite Rated Baillie Gifford Japanese, for example, has returned 180% versus the Nikkei 225’s loss of 18% (in sterling) in the past two decades7. It is a solid growth fund, managed by a team who research sectors across the market and generate fresh ideas.
Another couple of funds I like, although they haven’t been around quite as long, are the Elite Rated Schroder Tokyo and Neptune Japan Opportunities. As a fund that currently has a currency hedge (and has had for some years), Neptune has had a particularly rough start to 2016 but since its launch in 2002 has more than doubled the Nikkei’s returns8. Schroders meanwhile benefits from an 18-strong team on-the-ground in Tokyo and an excellent track record; it has all the right ingredients for a core Japan holding.
1FE Analytics, all Elite Rated funds across all IA sectors, 01/04/2016–26/04/2016 2FE Analytics, Nikkei 225, price in yen, 29/01/2016–12/02/2016 3FE Analytics, Nikkei 225 vs Bank of England Base Rate, TR in GBP, 12/04/1996–14/14/2016 4FE Analytics, Nikkei 225, TR in GBP, 30/11/2012–14/04/2016 5FE Analytics, IA Japan sector all funds, TR in GBP, 27/04/2011–28/04/2016 6FE Analytics, IA Japan sector all funds, TR in GBP, 27/04/2006–28/04/2016 7FE Analytics, Baillie Gifford Japanese vs Nikkei 225, TR in GBP, 15/04/1996–15/04/2016 8FE Analytics, Neptune Japan Opportunities vs Nikkei 225, TR in GBP, 30/09/2002–15/04/2016