Sun rises on Baillie Gifford Japan

It may seem a leap of faith to buy into a stock market that has been losing investors money for over 20 years, and at a time when Japan remains mired in a constant battle with deflation and faces a massive demographic obstacle to economic growth in the form of its ageing population. So why buy shares in an investment trust specialising in Japan?

While Japan has had a horrible two decades, it remains the world's third biggest economy and is home to many world-leading exporters. Crucially, it also neighbours some of the world's fastest growing economies - in particular, China - and that's proving fruitful for many Japanese companies.

And there is a new argument that favours the bulls of Japan - good value. Following its horrendous run, the Japanese stock market is now valued at no more than book value (the value of the net assets of all listed companies). That compares with a peak of over five times book value back in the 1980s. So maybe the long-term de-rating process has run its course.

Although a catalyst may still be needed to get share prices moving. One possibility is that Japanese companies have done a good job at recovering from the effects of the global downturn and, according to Baillie Gifford, profit growth of around 20 per cent is estimated for the current fiscal year ending 31 March 2011. With dividends rising by about 18 per cent, too, that could have the desired effect.

But what politicians are doing is really attracting the attention of investors. Given the reliance of Japan's economy on exports, the value of the yen is a key determinant of which way the stock market moves, with a weakening yen meaning a rising market. The currency recently reached an all-time high, which in September prompted the government to intervene in currency markets for the first time in five years. While there has been international disquiet about this, it clearly demonstrates a renewed political will. And more stimulus for the domestic economy is planned. Note, however, that Japanese politicians have a poor record of economic intervention. Nevertheless, the events are of real note.

Baillie Gifford Japan looks a particularly good way to play the bull case. The investment trust has both a good reputation and a good track record. It also holds a reasonable amount of mid-market and smaller stocks, so its portfolio is focused on growth. That said, the trust does not hedge its yen exposure, so local currency gains could be eroded when translated into sterling. But it could always change that policy.

The trust's shares also trade 15 per cent below net asset value currently. So, if the bull case for Japan gains traction, the discount on the trust's shares should narrow, giving performance an extra boost. Discounts can widen as well as narrow, though. The trust is also geared, which means it has borrowed to buy shares. This would also boost portfolio performance in a rising market.