A contrarian way into Japan

Japan's economy has been hit hard by the global recession, but for a contrarian play two experts are recommending Melchior Japan Investment Trust.

Japan has been a difficult market for a number of years and the short-term outlook remains poor. Japanese investment trusts had a tough year in 2008 with all funds under-performing their respective benchmarks and lagging the equivalent open-ended peer group. Reasons for this included the use of gearing and being overweight in cyclical stocks while underweight in utilities.

However, investors prepared to take a contrarian view will take comfort from the fact that Japan is the only major market in the world that is now trading below book value.

Researchers at WINS Investment Trusts believe that investment trusts are an attractive way to play any recovery primarily because the average discount is now wider than 20 per cent, the widest level for a decade. Discounts have traditionally reflected investor interest: when the market has strengthened, they have tightened significantly.

To some extent, this is true for all investment trusts but in the case of the Japanese sector the effect is magnified partly because none of the funds has an active discount control policy. In addition, investment trusts have tended to be higher beta plays (exaggerating the overall movement of the market) with a number deploying gearing and, consequently, WINS believes that the sector is well placed to outperform when the market turns.

As a recovery play, WINS highlights Melchior Japan, whose performance has picked up following a review of the company's investment strategy last June.

Mark Dampier, head of research at Hargreaves Lansdown, also recommends Melchior Japan. He says: "I am sure plenty of people will be sending the men in white coats to pick me up in recommending Melchior Japan Investment Trust. The performance of the fund hasn't been great since its launch in 2006, either in absolute or relative terms.

"However, since the change and review of investment policy in 2008, performance has begun to improve. Top-10 holdings count for 47 per cent of the portfolio which means it is sharply focused with major sector weightings in technology and consumer discretionary. Certainly, this is one for the brave, but on a 30 per cent discount, if the trust was wound up there is money to be made."

The manager of Melchior Japan is Dalton Capital (Guernsey) Limited, which delegates investment management to Dalton Strategic Partnership LLP. The manager and investment manager have appointed FuNNeX Asset Management, a Tokyo-based investment management firm founded in 2000.

The fund's chief investment officer (CIO) Ken Nishizawa is the president and CIO of FunNNeX Asset Management. He has worked at Nikko Securities, and Merrill Lynch Investment Management in Tokyo as a fund manger, subsequently becoming the managing director in charge of the Japanese equity fund management team.

Following a bottom up, fundamental stock selection process, the fund has a bias towards mid-cap and small-cap stocks using a combination of longer-term strategic positions and shorter-term opportunistic positions.

The manager's latest report says: "The earning prospects in the near-term are grim and visibility is poor. However, market expectations have come down a long way, and the overall Japanese market is trading below book value."

In an uncertain environment, they are looking for companies with strong core competence, strong cash-generative business models, strong balance sheets, good management and, most importantly, a focus on shareholder value.

Key fund data:

Source: Dalton Strategic Partnership LLP, the Association of Investment Companies and Datastream

TOP 10 HOLDINGS

SECTOR BREAKDOWN