Exploit Japan's growth opportunity with Baillie Gifford Japanese Smaller Companies

IC TIP RATING

Tip style: GROWTH

Risk rating: HIGH

Timescale: LONG TERM

"Japan still benefits from a reform-minded government and a degree of political and social cohesion of which Europeans can only dream," says Brian Dennehy, managing director of research and dealing website FundExpert.co.uk. "Their policy initiatives are about three times greater than those taken by the US, relative to the size of their economies. The Japanese domestic economy can still tick along even if exporters continue to take a hit from a slowing global economy."

The move to cut rates might in any case have a positive effect on Japanese equities if it keeps the yen weaker and benefits Japanese exports by making them cheaper.

Mr Dennehy continues: "A significant number of companies are reporting earnings that beat forecasts, and earnings forecasts continue to rise. They also hold record amounts of cash, so can keep growing dividends, attracting investors enduring nil or negative interest rates, and still have cash left for capital investment."

But despite this Japanese equities remain relatively cheap compared with other developed markets.

If you already hold a core large-cap Japan fund and want to increase your exposure, Baillie Gifford Japanese Smaller Companies (GB0006014921) is a good option.

"At a company level Japan appears to have a growing pool of quality companies, often overlooked and under-researched," says Mr Dennehy. "Those with the greatest potential, and most overlooked, will inevitably sit amongst the smaller companies. Baillie Gifford Japanese Smaller Companies has exploited this rich seam with extraordinary consistency."

This fund's managers target what they consider to be attractively valued smaller companies that offer good growth opportunities. These companies may derive their growth from innovative business models that disrupt traditional Japanese business practises, or market opportunities such as growth outside Japan.

Baillie Gifford Japanese Smaller Companies has already delivered strong returns, beating MSCI Japan Small Cap Index over one, three, five and 10 years, as well as the Investment Association (IA) Japanese Smaller Companies sector average - and by quite a margin over longer periods.

The fund can also be bought for a very reasonable charge of 0.63 per cent from fund platforms.

But Baillie Gifford Japanese Smaller Companies's strong historic record has largely been achieved under the tenure of a previous manager, John MacDougall, who left in December. He has been replaced by Praveen Kumar and it remains to be seen if he can replicate Mr MacDougall's record.

However, Baillie Gifford takes a team-based approach to stock picking and says Mr Kumar is supported by the company's Japanese equities team. Mr Kumar has also worked closely with Mr MacDougall over the past year, and been part of Baillie Gifford's Japanese equity team since 2011 after joining the company in 2008, meaning he has prior experience of Japanese equities.

If you have a high risk appetite and long-term time horizon, Japan might be a good area to find growth as it has a good outlook and offers ample investment opportunities among its smaller listed companies. And Baillie Gifford Japanese Smaller Companies Fund looks like a reasonably priced way to exploit this opportunity via a strong investment team. Buy.

Performance

Source: Morningstar, as at 3 February 2016

Top 10 holdings, as at 31 December 2015 (%)

Sector breakdown (%)