Japanese equities should pique investors’ interests due to their historical and global low valuations. On a price to book basis, the Topix index is trading at a discount to the S&P 500, MSCI Europe and MSCI Emerging Markets indices.
With Prime Minister Shinzo Abe and his government continuing to strive to counter the longstanding fears of consistent deflation, limited growth and poor corporate governance, it can be argued that Japanese equities are starting to appear attractive on a fundamental basis too.
Evidence is growing that Abe’s policies are taking effect – the labour market is at its tightest in over 20 years, nominal GDP and corporate profits are at record highs, the level of share buybacks and dividends by Japanese companies has grown significantly, as has the appointment of independent directors on company boards, better representing shareholder interests.
Perhaps as a result, in contrast to the net redemptions in 2016, European domiciled open-ended Japanese equity funds benefited from net subscriptions in 2017 to the end of October. While the asset-flow trends this year has been positive, the subscription levels have varied across each of our three Japanese equity categories.
Japan Large-Cap funds took the lion’s share of net inflows, with subscriptions of EUR 4.5bn taking overall assets under management to €73 billion. Japan Small and Mid-Cap funds saw the next highest level of net inflows with €1.2 billion and Japan Flex-Cap funds took in €753 million. Using the category average fund as a proxy, those that invested in Japan Small and Mid-Caps at the beginning of the year were the best rewarded – the average fund returned 22.7% in Sterling terms, against 13.3% and 17.8% for Large-Cap Equity and Flex-Cap Equity funds respectively.
This extended a long run of outperformance for Japan Small and Mid-Caps, with the category average fund outpacing that of Japan Large-Cap and Japan Flex-Cap funds in the preceding eight calendar years. In terms of style, the first ten months of 2017 have seen growth outperform at the expense of value. At the sector level, the top three performing sectors were IT, materials and industrials, while financials – in particular banks, real estate, and utilities were the three-worst performing.
Of the overall €5.5 billion net inflows, €1 billion was heading into index tracker funds, the large majority of which were found in the Japan Large-Cap category, with the balance heading to actively managed funds. In Sterling terms, the Large-Cap category average, excluding-index trackers, returned 13.7% in the first 10 months of 2017, while the average return of Large-Cap index tracker funds stood at 11.1%.
With the Topix returning 13.3% over the same period, this suggests that on average, investors fared better with active funds than their passive counterparts. Over five years, the average Large-Cap fund returned 16.4%, while the average Large-Cap index tracker returned 16% and the Topix index 17.6%.
Overall, while the average actively managed fund returned marginally more than the average index-tracking fund, investors also faced a higher level of variability in their return and the risk of selecting a fund that gave a significantly lower return. This underlines the importance of selection when considering investment in funds, both actively managed and index-tracking.
3 Funds that Analysts View Positively
Man GLG Japan CoreAlpha holds a Morningstar Analyst rating of Gold. It is managed by one of the most experienced teams in the Japan Large-Cap Equity category, led by Stephen Harker. They employ the same investment approach that Harker has used throughout his investment career, namely value-driven, contrarian bottom-up stock picking. The process uses screens to identify value opportunities among the largest 300 listed companies in Japan.
Impressively, Harker and the team have successfully delivered strong relative returns despite considerable style headwinds in recent years, illustrating their ability to add value above and beyond the investment style.
Lindsell Train Japanese Equity sits in the Japan Flex-Cap Equity category and holds a Morningstar Analyst rating of Silver. It has been managed since 2004 by Michael Lindsell, who creates a highly concentrated portfolio of stocks that he believes to be high-quality, cash-generative, and have strong and easily understood business franchises. Using various filters, Lindsell whittles down the universe to a small number of stocks, which are then subject to in-depth fundamental analysis undertaken by Lindsell with the help of two supporting analysts.
We consider Lindsell’s deep understanding of company strategies, together with his ability to see through the noise and take a genuinely long-term outlook make this fund a very strong choice for investors seeking exposure to Japanese companies across the market-cap scale.
Schroder Tokyo has a Morningstar Analyst rating of Gold and sits within the Japan Large-Cap Equity category. It is managed from London by the highly experienced Andrew Rose, with the support of Schroder’s sizeable team based in Tokyo. Rose has adhered to the same process on this fund since 2004 and throughout his career. Style-agnostic and unconstrained in nature, he creates a well-diversified portfolio of companies that he believes have the potential to surprise on the upside over a two- to three-year period but where the market has taken a short-term negative view.
An unconstrained fund can carry a degree of risk in the wrong hands, but Rose has deftly used it to investors' advantage. His measured approach tends to result in a nicely balanced portfolio, and the focus on valuations and fundamentals has helped keep returns consistently strong over the long term.
