Capture Japan's domestic potential with Legg Mason IF Japan Equity

This means an allocation to this country's stock market could be a useful component in a growth portfolio. And a good way to get it looks like Legg Mason IF Japan Equity (GB00B8JYLC77). This is the top-performing Japan fund over one, three and five years, having made more than double the returns of the Topix index and Investment Association (IA) Japan sector average over those periods. 

Hideo Shiozumi has run the fund since launch in 1996 and is Tokyo-based. He prefers to invest in smaller, Japan-focused companies, rather than the large global companies and exporters that feature prominently in the holdings of many other Japan equity funds. So almost two-thirds of the fund is invested in medium-sized stocks, which tend to be more Japan-focused, compared with a sector average of only 18 per cent. 

Mr Shiozumi invests in themes such as the country's ageing population, which he accesses via the fund's significant allocation to healthcare, which accounted for 27 per cent of assets at the end of January. Examples of holdings in this area include two of the fund's largest holdings, PeptiDream (Jap:4587) and M3 (Jap:2413). Outsourcing (Jap:2427), the fund's fourth-largest holding which accounts for about 5 per cent of assets, offers business process management, a function larger companies are increasingly outsourcing.

However, while the fund is likely to outperform the main country indices and its peers when Japanese equities are in favour, such as just now, its manager's investment style comes with a number of risks. Mr Shiozumi takes large bets on a small number of stocks, with the fund's top 10 holdings accounting for nearly half of its assets. For example, Nihon M&A Center (Jap:2127), a company that supports business mergers and acquisitions, and was its best-performing stock in 2017, accounts for over 9 per cent of assets. So while only a few holdings need to do well for the fund to outperform its peers and the market, the fund could also considerably underperform if only a few holdings don't do well.

This, combined with the exposure to smaller companies, means the fund can be highly volatile over shorter periods. For example, over the first six months of 2016 the fund rose 48 per cent, but in the second half fell 12 per cent. As a result, investors can face worse returns than the IA Japan sector average depending on when they buy and sell the fund. 

However, over the long term these fluctuations have resulted in strong cumulative returns. And the fund seems well positioned to capture the further gains that Japan's domestic economy seems set to make.

So, if you have a long-term investment horizon, and a high enough risk appetite to tolerate considerable volatility along the way, then Legg Mason IF Japan Equity and its experienced manager could be a good way to capture strong growth. Buy. TL