There is more to come from Japan despite a big rally
Japan’s Nikkei 225 stock market index achieved a huge landmark in early 2021 as it returned to levels not seen in three decades.
Japanese stocks have joined the global market recovery rally, rising 76% from March 2020’s 16,552.83 point Covid-inflicted trough to trade at 29,053.97.
This move has been supported by fiscal stimulus and a huge influx of capital into the market from Japan’s central bank.
WHY INVEST IN JAPAN?
Despite its barnstorming equity market comeback, Japan remains overlooked by many UK investors yet it is blessed with a deep stock market that is home to many best-in-class innovative companies growing domestically and overseas.
Japan has contained Covid better than many other nations, its lower infection rates and fatalities helped by strict compliance with masks and social distancing, although a relatively slow vaccine rollout may hamper the domestic recovery in the coming months.
This summer’s rearranged and scaled down Olympics may prove a rather muted affair without foreign visitors, their absence a blow to sectors such as advertising and hotels, but the impact of this has probably been priced in by investors.
The key thing to remember is that the global economy’s vaccine-led recovery is the key driver for Japan’s relatively cyclical stock market, which is the domain of numerous exporters.
Hisashi Arakawa, investment manager of Aberdeen Japan Investment Trust (AJIT), concedes the market had a strong rebound in 2020 and strength has continued this year.
‘A lot of the stock market strength has come from earnings per share revision, so improvement for the outlook for Japanese corporates, rather than the re-rating of stocks,’ he says.
Arakawa insists there is still earnings upside for Japanese companies, many of which are geared into the global supply chain. ‘We are seeing strong recovery or even growth in goods such as cars, smartphones, laptops, semiconductors and machinery.
‘A lot of players have leading positions in these spaces and are well positioned to benefit from the continued cyclical recovery which we see around the world.’
Nicholas Weindling, manager of JPMorgan Japanese Investment Trust (JFJ), is similarly bullish on Japan. It is ‘an incredibly rich and vibrant market with over 4,000 listed companies and many new companies coming to the market each year,’ he says.
SUGA BOOST WELCOMED
Nicholas Price, manager of Fidelity Japan Trust (FJV), stresses that (relatively) new prime minister Yoshihide Suga brought ‘continuity in terms of macroeconomic and foreign policies, but also a focus on domestic issues that raised the possibility of accelerated reform and deregulation’.
One policy that stands out is the modernising of government apparatus by digitalising the public sector, explains Price. ‘Suga’s digitalisation drive is also creating opportunities in the private sector, as the pandemic highlights the need for companies to enhance their digital capabilities after years of underinvestment in their technology infrastructure.’
Many investors perceive Japan to be highly technologically advanced, whereas in many areas it is actually lagging; JPMorgan’s Weindling explains that Japan is only just starting to embrace electronic signatures and cashless payments, for example.
Fidelity Japan expert Price also highlights Suga’s commitment to reduce the country’s overall greenhouse gas emissions to zero by 2050, which could generate opportunities in areas such as renewables and infrastructure.
CORPORATE GOVERNANCE ‘SEA CHANGE’
Weindling flags a sea change in attitudes towards corporate governance.
‘We still think it is at a very early stage and this is the single most important thing to understand when thinking about what kind of valuations investors might ascribe to Japanese companies in three or five years’ time.’
More than half of Japanese firms have net cash on their balance sheets. In the past, companies would hoard cash out of an abundance of caution, but attitudes are changing with dividends and buybacks increasing each year in Japan.
At the height of the crisis, markets such as the UK saw a lot of dividends being paused or buybacks being halted, but this wasn’t the case in increasingly shareholder-friendly Japan.
JOURNEY TO JAPAN VIA FUNDS
Rather than picking individual stocks, UK investors might be better served by tapping into the expertise of professional fund managers with experience of investing in Japan and/or with support from research teams with boots on the ground.
In the investment trust Japan sector, the three best 10-year total return performers are Baillie Gifford Japan Trust (BGFD), which has returned 480% according to Fe Fundinfo, followed by the aforementioned JPMorgan Japanese with a 341% return.
Fidelity Japan has returned 323% whose portfolio includes online freelancers’ market Coconala, diversified chemicals company NOF and Mitsui High-Tec, which comprises almost 70% of the global motor-core market, an essential component of power-train motors in electric and hybrid vehicles.
According to FE Fundinfo, the top-performing open-ended fund over the past decade by some stretch is Legg Mason IF Japan Equity (B8JYLC7), with a return approaching 730%, for ahead of open-ended Japan funds from the JPMorgan, Baillie Gifford, T. Rowe Price and Axa Framlington stables.
Investors who prefer lower cost passive funds should note that the iShares Nikkei 225 UCITS ETF JPY (CNKY) has generated 207% in sterling terms over 10 years.
Three Japan-focused funds and trusts to buy
JPMORGAN JAPANESE INVESTMENT TRUST
Discount to NAV: 2.8% Yield: 0.78%
A year-to-date pullback at JPMorgan Japanese (JFJ) presents a fresh buying opportunity in this capital growth-focused country specialist with a five-star Morningstar rating and strong long-run record. The net asset value discount has narrowed from a 12-month average of 6% to 2.8%, with investors increasingly recognising the trust’s merits and sentiment towards Japan turning more positive. We remain confident managers Nicholas Weindling and Miyako Urabe will continue to find the most attractively valued Japanese investment themes and companies in an under-researched market. They focus on market leaders with high levels of profitability, strong free cash flow and excellent balance sheets. The portfolio includes factory automation business Keyence, gaming giant Nintendo, Uniqlo clothing brand owner Fast Retailing and Hoya, which has a 100% market share in the glass substrate used in hard disk drives for data centres.
ABERDEEN JAPAN INVESTMENT TRUST
Discount to NAV: 9.4% Yield: 1.5%
Investors seeking a less well-known trust with potential for a valuation uplift might consider Aberdeen Japan Investment Trust (AJIT), which trades on the second widest NAV discount across the Association of Investment Companies’ Japan and Japanese Smaller Companies sectors. An all-cap strategy with a capital growth focus, we like Aberdeen Japan’s emphasis on quality companies with differentiated business models, wide economic moats, strong balance sheets and good ESG and stewardship. 2020 proved a strong year for performance with quality growth names in vogue, but the trust has lagged the benchmark year-to-date amid the rotation towards value stocks and profit taking in names that did well during the pandemic last year. Among the high conviction portfolio’s holdings are the likes of Toyota Motor, electronics giant Sony, Nippon Paint, furniture retailer Nitori and a relatively new addition in beer maker Asahi.
LEGG MASON IF JAPAN EQUITY
Managed by experienced Japanese equity investor Hideo Shiozumi, Legg Mason IF Japan Equity (B8JYLC7) is the stand-out performer in the IA Japan sector. It has generated total returns of 726.6% and 100.4% over the past 10 and five years respectively, according to FE Fundinfo. The £1.3 billion fund’s manager Shiozumi Investments seeks to exploit structural changes in Japan. The focus of the investment process is to identify high growth companies by looking at attractively managed businesses with annual earnings growth in excess of 20%. Relatively concentrated with 44 holdings at last count, the fund offers investors exposure to the likes of online medical-related services company M3, consoles giant Nintendo, digital cameras-to-x-ray imaging systems developer Fujifilm and GMO Payment Gateway, an online payment platform.