Investing in Japan could be a resounding success

Japan will dominate headlines around the world for the next three weeks as the Olympics begin next Friday. In normal times, such buzz can give a nice economic boost to the host country of the Games. But if the eyes of the world are on Japan, should investor interest be heading in that direction too?

WHY JAPAN STILL HAS A WINNING FORMULA

Unfortunately, Japan may not get a boost from the Games. After all, the pandemic has thwarted all hopes of a tourism boom. Meanwhile, a lack of enthusiasm for the event at home means there’s little chance of turning Games’ excitement into profit.

Taeko Setaishi is an investment advisor to the Atlantis Japan Growth Fund. He says: ‘The Olympics are very unpopular with the general public, making it difficult for a company associated with the event to make money.’

Winners: Japanese stocks can overshoot even without an Olympics boost

But while the Olympics may be an economic downer, there are plenty of other reasons to suggest that Japan has a winning formula for investors looking to grow their wealth.

CHANCE TO FIND A BARGAIN BEFORE STOCKS RETURN

The value of Japanese companies rose steadily until March this year, when investors became nervous about Japan’s response to the pandemic. Japan had the spread so well under control that it has been complacently slow to roll out a vaccine program. Only ten percent of the population is currently fully vaccinated.

As a result, the value growth of Japanese companies lagged behind that of other countries. Some experts think this means there are Japanese bargains to be had. After all, not all companies will be affected by a slow rollout of vaccines, especially those selling abroad.

Darius McDermott is general manager at investment controller FundCalibre. He points out that Japanese companies kept pace with the rapid growth in the US from December 2012 to March this year. At that point, however, investors lost confidence.

“As a result, the stock market in Japan is up just four percent since January this year, compared to eight percent in the UK and almost 18 percent in the US,” he says.

Japan is home to many brands with huge international appeal, ready to take advantage of pent-up demand around the world – even if Japan’s own economy takes a while to recover. Among these are Sony, Nintendo, Toyota, SoftBank, and Asahi.

Chern-Yeh Kwok, manager of the Aberdeen Japan Investment Trust, says: “Exports have recovered. Sectors such as technology, cars and those linked to China are already seeing increasing demand.’

He adds: ‘We see Japan as a market full of opportunities, especially in the areas of digitization, robotics and electric cars.’

BARRIERS TO GROWTH COMING DOWN

For years, the Japanese economy had three characteristics that held it back. First, it has been slow to embrace modern technology. We may think of Japan as a country of fast trains and robotic convenience, but it’s also a country that still relies on fax machines and only eight percent of purchases are made online. Second, corporate structures have been rather unusual in the past, resulting in huge amounts of cash hoarding on balance sheets and strange shareholder structures where unrelated companies have shares in each other. Experts think this has held back their potential.

Third, the population is aging rapidly. Construction workers, for example, are 55 years old on average, which may have slowed progress. However, those three limiting characteristics are quickly addressed.

Nicholas Weindling is lead portfolio manager for the JPMorgan Japanese Investment Trust. He believes the pandemic and an aging population have forced companies to innovate. They have been busy building software systems to enable working from home. A pivot towards home delivery has given online store sales a huge boost.

“There are good opportunities for investors in companies concerned with Japanese work practices and consumer culture,” he says. “I have 40 percent of my portfolio in Internet companies such as GMO Payment Gateway and BASE, which are helping Japan transition to e-commerce.”

Corporate structures are also changing. Former Prime Minister Shinzo A is being brought in corporate governance reforms that free up liquidity from balance sheets. Current Prime Minister Yoshihide Suga has made the digitization of the economy a central part of his policy.

A VOLATILE MARKET BUT FUNDS CAN HELP

If you own a global equity fund, you probably already have investments in Japanese companies. For many investors, that may be enough. However, if you think Japan may outperform other markets, you may choose to invest in a specialized Japanese fund as well.

However, because investments in Japan can be volatile, a Japanese fund should only make up a small part of your portfolio. There are many inexpensive passive funds available, as well as active funds overseen by a specialist fund manager.

James Carthew, at investment research firm QuotedData, likes JPMorgan Japanese Investment Trust, which he says “supports the companies at the forefront of technological change.” The fund has significantly outperformed its competitors over the past three years, turning an investment of £1,000 into £1,446.

He also mentions AVI Japan Opportunity, which has yielded 8.6 percent this year. The fund was only launched in October 2018, so it is not possible to assess its long-term performance.

Carthew admires how the fund is “trying to find growth companies that also have corporate governance flaws that make them undervalued, sometimes ridiculous.”

Dzmitry Lipski, head of fund research at investment platform Interactive Investor, likes Lindsell Train Japanese Equity. The fund is managed by Michael Lindsell, who has been hedging Japanese equities since 1985. It’s only gone up 4 percent over three years, but 50 percent over five years.

He also likes Legg Mason IF Japan Equity Fund for investors looking to invest in smaller and mid-sized Japanese companies. The fund is managed by veteran investor Hideo Shiozumi who has been investing in Japanese companies since 1970. However, Lipski warns that the fund is “significantly volatile.” It invests in companies that benefit from Japan’s aging population, increasing use of the Internet and changing consumer lifestyles.

Jason Hollands is director of asset manager Tilney. He likes Baillie Gifford Japanese and LF Morant Wright Nippon Yield. “These have a very different approach to investing in Japan and will therefore work well in different environments,” he says.

The Baillie Gifford fund has converted an investment from £1,000 to £1,240 in three years and is mainly focused on larger companies. The Morant fund focuses on companies that pay an income and that appear cheap. An investment of £1,000 three years ago would now be worth £1,022.

For those seeking income from their investment, McDermott Baillie Gifford suggests Japanese Income Growth, which returns just under two percent.

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