Where managers are poles apart
Managers of Japan portfolios tend to have sharply polarised views on issues such as the attractiveness of the financial sector, the economy’s dependence on a US recovery and the importance of currency hedging. This makes it vitally important to understand exactly what you are getting with you chosen fund manager. Investment style and currency orientation can be crucial in this context.
The polarity of opinion amongst the experts is a reflection of the fact that Japan has confounded successive generations of international fund managers, many of whom have managed to create exceptionally good performance at times, but at other times have suffered for their exposure to this serial boom and bust economy.
The long term charts for Japan show a long painful decline since 1990, but in the intervening period, there have been mini booms and busts, all built in seemingly plausible reasons. It’s important to recognise this when investing in Japan. Were those fund managers who raised their exposure in 1999 and 2000 doing so because they believed that Japan had turned some sort of corner (it was different this time) or because they were concerned that peer group funds with higher exposure to the market would outperform?
All of which would suggest that a less mainstream approach might be most suitable. Within the range of funds in this article, there are a few following a long/short strategy. One such, the Jardine Fleming Macro Absolute Return, has investment returns which run counter to the prevailing market conditions, suggesting it is most suited to those who want to short the market. There are also, within the wider Japan funds universe, several funds available in Europe which concentrate on the fixed income opportunities in Japan.
Mainstream Japanese equity funds remain fairly cautiously positioned, heavily biased towards domestics and away from exporters, given continued concerns over the weak US economy and Yen strength. Portfolios currently tend to emphasise companies with earnings visibility and those undertaking extensive restructuring stories.
Investors with benchmark considerations and an obligation to maintain a presence in Japan, might be best served by the relative value managers such as Schroder and Polar Capital. Those with index driven focus might care to consider the Martin Currie Japan Fund and the Goldman Sachs port-folios.Here follows a selection of funds worthy of your consideration, and immediate dismissal in some cases.
Whitney New Japan Fund -
With the backing of one of the biggest US private equity firms, Whitney’s Japan long/short fund is one of the most successful in the sector. The fund’s Tokyo-based managers have a combined 37 years experience in the Japanese equity markets. A Tokyo address makes it easier for them to conduct extensive company visits and execute the fund’s ethos of being driven by fundamentals as well as market anomalies. Launched in October 2000, the $500 million fund has achieved an annualized return of 14.6%, just under its stated annual target of 15% risk-adjusted.
The Close Finsbury Japan Fund, was the strongest performing fund during the review period, moving 14% higher in US dollar terms. The fund was outsourced to Jade Absolute Fund Managers and is managed by former Perpetual head of Asian funds Scott McGlashan with support from Dominic McGowen (formerly a Japanese equity broker and fund manager with Bonfield). The bottom-up investment approach targets attractively valued quality companies for which the team can highlight a catalyst for growth to enable a re-rating over the next 12 months. The investment process has a judgmental asset allocation approach linked to thematic stock selection process. The team favours companies able to generate sustainable growth of 10% to 15% per annum, with strong cash flows and balance sheet strength.
ABN Amro runs a Japan fund that seeks to profit from what it refers to as ‘investor irrationality’. The Behavioural Finance Japan Fund works on the premise that markets are inefficient measures of stock value in the short term, but reflect a company’s fundamentals over the long term. The fund management team judges when investors have over-reacted to news and pick up stock opportunities as they arise from the resultant mis-pricing. ABN Amro has developed a quantitative model to examine the psychological factors that influence investor decision-making. This is not entirely a new idea since around $70bn (E72bn) is invested in this way in the US. With no set core holding strategy, the fund offers diversification in terms of style from other funds. Its stated aim is to outperform its benchmark by 5% annually. Unfortunately, performance has been less than impressive so far.
Asako Kibe pursues a growth orientated stock-picking approach for Fidelity Funds Japan Smaller Companies. She is one of five manager/analysts dedicated to Japanese small caps. According to Standard & Poor’s, her style is more conservative than her peers in the S&P sector review, highlighted by a well-diversified portfolio of around 100 holdings with no more than 3% in an individual position. The manager’s rigid adherence to this disciplined process tends to deliver less extreme performance than competitor funds, but this has resulted in a steady long term record. Relative performance has recovered after a difficult 2000, on the back of good stock selection.
Sirius Fund Management, through its Japan Opportunities Fund (one of a range of Japanese portfolios) offers a fund using an opportunistic approach to optimise absolute return in a long/short portfolio aimed at Swiss Franc investors. The fund aims to maximise its return over the long term through investments in Japanese equities. To do so, it is free to move at will between the various markets (1st Section, 2nd Section, regional markets and the OTC market) and from time to time to be under-invested. Japan is now in the middle of a transition period which is reflected by a volatile and uncertain stock market according to the manager who believe that this difficult phase will come to an end soon and that actual levels offer some unique investment opportunities.
Mellon GF Japan Equity Fund manager Miki Sugimoto took over as lead manager of the fund a year ago, from colleague Martin Batty. Her strategy is driven by the opportunity to invest in truly global market players with companies looked at not only in the context of their own market but also against their peers on a global basis. Although blue chips are the main focus of the portfolio, the manager will invest in some small caps in the emerging areas of the economy.
Marc Desmidt, manager of the Merrill Lynch IIF Japan Fund, runs the portfolio on the belief that the Japanese recovery will be export-led rather than pushed by domestic demand, as he believes overseas economies are likely to grow faster than the domestic economy. He is therefore positioned in companies whose earnings are generated abroad, such as Nissan, Honda, Canon and Ricoh. The portfolio’s concentrated exposure in exporters hurt fund performance as the yen firmed against the dollar. However, the manager stresses that he is not overly concerned on the assumption that short-term movements in the yen do not have an enormous impact. Overall, Desmidt is moving from a defensive to a cyclical growth bias, although he stresses that he remains cautious.
Paul Chesson, manager of the Invesco Japanese Equity Core Fund maintains a great deal of operational freedom. He tends to apply rigid valuation criteria to stock selection and will often be aggressively positioned compared with the index in terms of stocks and sectors.
Chesson feels the cyclical recovery should benefit Japan’s exporters, a number of which remain global leaders – being highly competitive in sectors such as autos and electronics. Chesson has moved the fund’s export weighting higher, avoiding the largest IT stocks on valuation grounds in favour of mid-cap stocks such as Maruwa, a ceramic component maker.
According Fumiko Roberts, manager of the Schroder ISF Japanese Equity Fund, the Japanese banking system continues to face problems. She argues that the absolute level of provisions for non-performing loans peaked last year but that banks are still providing for them. She feels that one cannot believe what the management of banks say and therefore prefers to play the financial sector through consumer finance companies and a credit card company. The average PE for the market has come down to approximately 18x with forecasts indicating a recovery for the next two to three years. The manager believes that current valuations offer a good entry point.
The Goldman Sachs Japan Portfolio, run by Shogo Maeda operates a risk-controlled investment process, focused on inexpensive stocks with strong or improving earnings. Disciplined valuation techniques are implemented, based on absolute as well as relative valuation levels with an emphasis on cash flow. Sector weightings can only deviate from the benchmark by +/-5%, whilst stock positions must be within +/-300 basis points of the index weight. The group’s smaller companies fund is not covered by the leading fund rating agencies but its performance is much better than the Japan Portfolio.
The investment style of the Polar Capital Japan Fund, run by James Salter, focuses on value at the right price, exploiting market inefficiencies across the market-cap spectrum. The manager expects the portfolio to hold a greater number of defensives and a higher weighting of attractively valued names, which he believes are more likely to hold up should we see recession. Salter and his team are also questioning the portfolio’s financial exposure which remains in the broker and insurance sector, whilst underweight the banking names.
Other funds worthy of investigation include:
AIG Japan Smaller Companies
Axa Rosenberg Japan Smaller Companies
Invesco GT Japan OTC Stock
GAM Japan Hedge (Euro class)
New Star Japan Hedge Fund
Sinopia AF Japan Long Short