Investment in Japan has fallen to 9% of MSCI World index, from 45% in 1980
Investors in Japan have been scarred over the last two decades as a result of the fall of stock markets in both absolute terms and in relative terms to other equity markets. Japan once represented over 45% of the MSCI World index in 1980, but today represents just 9%.
However, this looks set to change. With Japan benefitting from exports to fast-growing Asian economies as well as attempting to change its internal demographic problems through tax breaks for children, wider stock market views are becoming more positive. Testament to this is the analysis of the exposure that global equity funds have in Japan relative to the MSCI World index weight of 9%. Of the 15 representative groups examined, the majority were found to be overweight Japan in their global equity portfolios.
The S&P Fund Services 2010 survey of Japanese equity funds covered 29 vehicles. The review, which was undertaken in April and May 2010, showed Japanese equity fund managers were much more positive about the sector compared to the same time last year, when there was a general lack of visibility in companies. Compared to the 12 months to the end of March 2009 (stated in yen), when fund performance dropped on average 38%, this year saw gains of around 30% over the same time period.
In 2009, successful strategies included a cyclical stance, especially to companies that export to Asia, overweight positions in technology, glass & ceramics, precision instruments and transportation equipment, an underweight position in financials (especially banks) and an overweight to small caps, especially micro caps.
This quantitative improvement was reflected by the overwhelming majority of managers becoming more positive about the Japanese market. During manager interviews, several key factors expected to drive the stock market forward were noted.
The first is that earnings increased substantially. Nomura, for example, forecasted earnings growth in the 12 months to March 2010 of around 60% (released in the summer). Fund managers also noted Japan’s attractiveness relative to other equity markets, both on a price-to-book and an earnings basis. Additionally, Japan had its banking crisis over 10 years ago and, unlike many US and European banks that need to recapitalise after the credit crunch, Japanese banks are relatively strong. Small caps were also seen as attractive to fund managers, with further relative gains by small-cap stocks to be expected.
In future, Yutaka Uda, the manager of the Nippon Growth fund, believes the earnings growth forecast by Nomura is actually underestimated and expects company earnings to come in at +80%-90%. Uda also believes small caps are likely to do better in an economic recovery but liquidity is still a problem down the market capitalisation scale.
Akihide Kinugawa, who works for T&D Asset Management and manages the Metzler Japanese Equity fund, feels there is a greater possibility of alpha from mid and small caps than from large caps. Stephen Harker and Neil Edwards, managers of the GLG Japan CoreAlpha fund, believe Japan has only just rebounded from a 40-year record low if one looks at the price-to-book ratio, which fell below 1x. They feel at 1.4x price-to-book level, the market remains cheap.
Akihiro Sekiya at Pinebridge believes Japan can decouple from other markets. He believes Japanese domestic stocks have not performed as well in the past due to the well-known demographic issues. He expects exporters to benefit from a global recovery and is therefore overweight IT and industrial stocks, especially those that will benefit from growth out
of China.
A different view is taken by Allan Gray and Brett Moshal at Orbis, who agree domestic stocks have little growth but believe this is fully reflected in valuations, and their funds are therefore overexposed to them. They like drugstores (9%), which are set to benefit from an ageing population, and Rakuten, an online shopping mall, which they consider to be cheap compared to Amazon.
Lesley Kaye, manager of the GAM Star Japan Equity fund, has found it difficult to identify new themes and has continued to focus on technology stocks and those benefitting from exposure to China. She feels Japan and the global economy are intertwined and does not believe the country can act independently. As a result, she has only marginally increased domestic plays.
Risk factors over the period were studied by analysing holdings – the number of holdings gives an indication of the stock-specific risk within a fund. Typically, the lower the number of holdings, the higher the stock-specific risk. However, modern portfolio theory suggests a portfolio of around 20 holdings is sufficient to adequately reduce stock-specific risk. Within the 29 rated funds in the sector, the number of holdings ranged from 24 to 381.
On a sector level, the funds significantly overweight financials and real estate were Invesco Japan Core and Invesco Perpetual Far Eastern Japan, which both have 43% in financials and real estate, Orbis (28%) and Jupiter Japan Income (24%). Paul Chesson at Invesco Perpetual particularly favours real estate companies in the expectation occupancy rates in Tokyo will normalise over the next couple of years while share prices are felt to be at distressed levels.
GLG’s heavy overweight to the electrical appliances sector represents another large bet. Stephen Harker and his team felt companies such as the telecommunication equipment manufacturer Rohn were unlikely to go bankrupt in 2009. As a result, they heavily overweighted the stock and sold once it reached their fair-value threshold.
S&P Fund Services looked at several return characteristics when analysing the funds in Japan’s equity funds sector, including monthly volatility, which is measured by examining the standard deviation of the funds. The Orbis Japan Equity fund (US$) is the most volatile with a standard deviation of 8.6. Another measure, beta, looks at a fund’s sensitivity to the S&P Fund Services mainstream Japanese equity sector. A beta above 1 indicates the volatility of that fund is higher than average for the sector, and vice versa for betas below 1. In broad terms, a beta of 1.2 implies a fund will perform 20% better than the sector on the upside, but 20% worse on the downside. The lower betas were found in the portfolios of JOHCM Japan (which was defensive in the downturn), Jupiter Income (where the focus is on cashflow), Orbis Japan and Polar Capital Japan (both value managers).
During our 2010 review, three funds were placed under review while two funds were downgraded. Those funds under review included three AXA Rosenberg funds after the manager discovered significant error in its risk modelling, which has since been rectified. AXA Rosenberg has brought in external consultants to investigate the impact on all its funds, and they will be reassessed pending the outcome. The rating downgrades included the Metzler Japanese Equity fund, which fell from AAA to AA, and the Pictet funds – Japanese Equity Selection, which was downgraded from A to Not Rated.
Guy Boden is a fund analyst at Standard & Poor’s
