DAVID VARLEY, manager of the Royal London Japan Growth fund on Japan
Japan may well be the cheapest equity market in the developed world. At just 1x the book value of its assets, it seems a bargain compared to the US (2.4x), UK (1.7x) or Germany (1.4x).
The average for the last 15 years in Japan is 1.7x, and we are close to the 40-year low of 0.85x reached at the height of the credit crisis. In theory the risk/reward trade-off looks compelling. So why are investors not buying Japanese stocks?
Firstly, it might be noted Japan has, in recent times, generated lower profits from its assets than other markets (averaging return on equity of 6.4% in the 2000s, when the US and Europe returned more than 10%), and so should trade on a lower valuation.
It is, however, equally possible to say Japanese corporations are changing; the cost-cutting has been such that aggregate operating profit margins in the most recent quarter are very close to those of June 2007, despite a 15% dip in sales. This stands Japan Inc in excellent stead to produce better returns on capital in future up-cycles.
It is not, however, so easy to rebut other arguments against investing in the Japanese market. At the forefront of minds currently is the strength of the yen. The Japanese currency has strengthened from ¥110 to ¥85 to the dollar since the onset of the financial crisis.
Japan remains an export-led economy and, as is often said, its best companies are generally to be found in the outward-facing sectors of the market. The progress on operating profits noted above has come in the face of this currency problem, but it is still hard to imagine investors returning to buy their favourite Japanese shares until this yen strength, which stems largely from the intransigence of the Bank of Japan relative to other central banks, abates.
So what can we buy while we are waiting for the currency to turn around? In our opinion, several years of fund manager indifference towards the domestic segment of the Japanese market has left some very interesting opportunities for the patient investor.
For example, games company Namco Bandai has underperformed the market by 30% since its high, has nearly half of its market cap in cash on the balance sheet, and trades on approximately half of its former price to book.
Or Tokyu Corp, a railway operator that has fallen by 60% since the heady days of 2006, to trade close to its lowest price-to-book multiple for at least two decades. We are confident researching overlooked companies such as these will, over time, bring rewards, whether the currency remains strong or not.
David Varley is manager of the Royal London Japan Growth fund
