Abenomics: the not so dismal science

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Abenomics: the not so dismal science

The land of the rising sun has had more false dawns than most investors can remember, but the election of Prime Minister Shinzo Abe in December 2012 could go down in history as the point when it all changed. His radical policies that have come to be known as Abenomics are designed to breathe new life into the economy and have helped the Nikkei 225 to more than double in value since he took office.

There are plenty of ways to take advantage of the resurgence of the Japanese stock market as there are more than 60 open-ended funds operating in the sector, as well as numerous ETFs and a handful of investment trusts.

According to FE Trustnet, the average Japanese OEIC and unit trust has returned 51.2% in the last three years. Only three of them have got anywhere near the 137% increase in the main stock market index, the Nikkei 225, with the rest producing gains of between 24.8% and 73.2%.

The top performer over the period was Lindsell Train Japanese Equity Hedged with a return of 132.7%. This Dublin registered OEIC has £56.5m in assets under management and holds a highly concentrated portfolio of between 20 and 35 stocks with very little turnover.

I have a high regard for Lindsell Train, but the main reason for the outperformance was the currency hedging, as the unhedged A shares were only up 50.4% over the three years. During this time the yen has depreciated from around 125 to the pound to 190, which represents a fall of about 34%.

The main reason for the massive decline in the value of the currency is the programme of Quantitative Easing that is one of the main elements of Abenomics. This has been a major benefit to Japan’s large export industry because it makes it more competitive, but the government is now trying to stabilise the exchange rate as it is afraid of the impact of higher import prices on its domestic businesses.

In second place on the list is Legg Mason Japan Equity with a three-year return of 126.1%. It is another concentrated fund with the £283m of assets under management being divided between 36 different holdings. The portfolio is highly skewed in favour of Health Care and Information Technology with these two sectors accounting for 60% of the exposure.

Hideo Shiozumi, the fund manager, is a growth orientated stock-picker and he has put together a highly idiosyncratic portfolio that has proved to be extremely successful. There is also a separate hedged share class for those that want it.

The other noteworthy performance came from Neptune Japan Opportunities with a gain of 103.3% over three years. It is a bit more diversified than the Lindsell Train and Legg Mason funds and has a different emphasis with the main sector weighting being the 30.7% exposure to Industrial companies.

Chris Taylor, the manager, has a bias towards large- and mid-cap stocks and currently favours the multi-nationals that earn the majority of their revenues overseas. He is able to hedge the currency back to sterling whenever he thinks it would be appropriate and has kept the hedge in place since 2009, which will have contributed to the positive performance. He also has the freedom to use derivatives to limit the downside risk.

Smaller companies funds

The Japanese smaller company funds have done even better than their large-cap equivalents, with an average three-year return of 60.2%. This is quite normal in a bull market, although they would be more vulnerable whenever conditions deteriorate.

There are only five open-ended funds in the sector with the top performer being Baillie Gifford Japanese Smaller Companies with a gain of 90.1% over the last three years. It is managed by John MacDougall, who invests in attractively valued small companies that offer decent growth opportunities.

A good example is Cookpad, which operates a popular recipe website. This has been one of the fund’s strongest performers due to the increased marketing by food producers and supermarkets. The fund has also benefited from its holding in the blood testing company, Sysmex, whose latest machines have been selling well in countries such as the US and China.

MacDougall invests for the long-term and there is very little turnover in the portfolio, although he has recently bought into the biotech companies Peptidream and Nanocarrier. These are typical of the smaller, innovative businesses that he likes to target.

Max Godwin, the manager of the M&G Japan Smaller Companies fund, is a value investor and targets businesses that are out of favour with the market. He has recently topped up his holding in Cocokara Fine, which is one of the five largest nationwide drugstore chains in the country. The business is currently undergoing a restructuring to try to address various inefficiencies and appears to be undervalued.

Another recent purchase is the regional bank, Tokyo TY Financial Group. The company is struggling due to the low interest rates, but Godwin believes that the shares are cheap relative to the expected earnings and that it has a well-diversified loan book. His fund has a total of 50 holdings and has returned 66.4% in the last three years.

A passive alternative

FE Trustnet lists 48 passively managed ETFs in the sector. The majority of them track the MSCI Japan index and have produced returns of between 40% and 50% over the last three years, with the two standout performers both hedging the currency.

Leading the way is iShares Japan Fundamental Index CAD Hedged with a gain of 143.7%. It is managed by BlackRock and is a really unusual fund with the index having a value tilt and the currency hedged back into Canadian dollars.

In second place is iShares MSCI Japan EUR Hedged UCITS ETF, with a three-year return of 105.1%. This uses physical replication and is fully hedged back into euros. It has assets under management of €4bn, 314 underlying holdings and a Total Expense Ratio of 0.64%.

The other top performer is a leveraged ETF called ProShares Ultra MSCI Japan. It is designed to pay twice the daily return of the MSCI Japan index and would obviously be a lot more vulnerable than the others in the event of any market weakness.

There are also three small cap ETFs, although the performance has not been that impressive with an average three-year return of 48.7%. If you want exposure to this part of the market an actively managed fund would be the better option as the managers have plenty of scope to add value.

Investment trusts

There are only four investment trusts that provide exposure to large cap Japanese equities, but they have an excellent track record with an average 3-year return of 121.1%. One of the main reasons that the investment trusts have outperformed their open-ended counterparts is because the discounts to NAV have narrowed as the sector has come back into fashion. There is much less scope for this to play a role going forwards as the discounts are now all less than 10%.

The best performer over the last three years is the Baillie Gifford Japan Trust with an impressive return of 137.8%. This invests mainly in small- and mid-sized companies with the two most significant sector exposures being commerce & services and manufacturing & machinery.

Sarah Whitley, the manager, invests in between 40 and 70 individual stocks that she believes offer long-term growth potential on a three- to five-year time horizon. She also has the scope to hedge the currency if she thinks that it is appropriate.

Another fund with a decent track record is the JP Morgan Japanese Investment Trust, yet despite this it has the largest discount to NAV in the sector of 9.7%. The manager has positioned the portfolio to benefit from the increasing number of tourists visiting the country due to the weaker currency and the rising income levels across the rest of Asia.

The five smaller company investment trusts have lagged behind their large-cap peers, although once again it is the Baillie Gifford product, Shin Nippon, which tops the table. It is managed by John MacDougall, who also runs their open-ended small cap fund.

MacDougall holds a portfolio of 40 to 75 attractively valued smaller companies that offer good growth prospects on a 3 to 5 year view. Many of the top holdings are the same in both of his funds, but it is the investment trust that has the best three-year record with a return of 131.2% versus the 90.1% from Baillie Gifford Japanese Smaller Companies, although part of this is due to the narrowing discount.


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