Japanese equity markets remain challenging for private investors, warn advisers, as the effects of the 1990 financial crisis linger on.
But despite this, the top-performing UK-based retail fund of 2008 was Neptune’s Japan Opportunities fund, which returned 84 per cent.
The principal reason behind the fund’s impressive result was manager Chris Taylor’s decision to take large short positions on the Topix index using options.
Taylor also maintained strong cash reserves, keeping about 15 to 20 per cent of the fund in sterling and steering clear of financials. And the 71 per cent rise in the value of the yen against the pound over the past 12 months also helped the sterling-denominated fund, which was invested in companies receiving much of their revenue in yen. At the end of last year, £1 bought ¥133 while at the end of 2007, £1 was worth ¥221.
“The rise in the yen’s value proved to be a great salvation for the Japanese market,” says Jamie Jenkins, manager of F&C’s Japanese equities fund.
However, neither F&C’s Jenkins nor Neptune’s Taylor is particularly bullish on Japan’s outlook this year and both claim the prospects for a strong turnround are weak. Analysts have warned that Japan’s $4,300bn (£2,950bn) economy is likely to shrink for the first time since 2001 and Japanese companies will suffer as profits decline and the volume of exports recede. The country’s long-term economic outlook is likely to be constrained by a reduced demand for products and services from a shrinking population, advisers agree.
“It is undoubted that the Japanese economy is deteriorating – the million dollar question is to what extent has the stock market discounted that,” says F&C’s Jenkins.
Only niche sectors such as pet care products and convenience stores whichbenefit from domestic consumer demand are likely to do well, Taylor believes.
Jenkins has cautiously begun buying into cyclical stocks, but he remains pessimistic on sectors such as pharmaceuticals, which depend heavily on exports, as the strengthening yen will penalise them. “The portfolio is still heavily populated with stocks that are likely to be less affected by the economic downturn,” he said. “We tend to look at 20-year earnings models for most of the companies we buy.”
Jenkins has avoided Japanese technology stocks, but will continue to hold his position in Nintendo. “Over the course of the year, it didn’t produce stellar returns, but we continue to have faith in the company,” he says.
Railways, gas stocks and mid-cap healthcare companies such as Sysmex, which specialises in clinical testing of blood and urine, are also favoured. Fanuc, the blue-chip industrial group that makes factory automation equipment, is another pick. “We looked for companies with strong cash flow and balance sheets which were able to pay dividends and reduce their debt,” said Jenkins. “We also sold some commodity-related stocks and bought gas stocks which worked well as a trade.”
Paul Chesson, head of Japanese equities at Invesco Perpetual, agrees that the year is likely to be difficult, but he says valuations in Asia look attractive relative to other markets. “You can’t buy stocks at the discount to break-up value that these stocks are trading on,” he points out.
By the end of last October, Chesson had shifted the portfolio out of defensive stocks such as utilities entirely, purchasing shares in blue-chip car and electronic groups dependent on exports.
“Defensives are far too expensive for what they offer,” is his view.
The yen, he says, is likely to decline somewhat this year. The currency had been cheap for several years, which resulted in a large carry trade, where people borrowed money in yen to take advantage of the low interest rates, and then invested the money overseas in countries offering higher interest on deposits.
But that has since been reversed as other countries have cut their interest rate, reducing the differential between the yen and other currencies.
Japanese investors have also contributed to the yen’s rise by repatriating their funds having sold their overseas equity and currency holdings.
Figures from the Investment Management Association show that Japan funds, which invest at least 80 per cent of their portfolios in Japanese equities, lost 16.4 per cent in the past 12 months. But funds invested mostly in Japanese smaller companies struggled further, losing 21.3 per cent over the same period.
In comparison, the Nikkei 225 fell 42.1 per cent over the period.
