Unwelcome as they have been, the big shifts in markets in recent months are at least consistent with received wisdom. Growth stocks and bonds should be expected to struggle in the face of higher interest rates, while commodities seem like an obvious winner as inflation soars. That adds a small sense of order amid the market havoc of the last year.
Not all assets have behaved as we might assume, however. The Japanese yen is widely viewed as a safe haven currency and tends to strengthen in times of uncertainty. It rocketed versus sterling in February and March 2020 as concerns about lockdown measures helped tip global markets briefly into a tailspin, for instance. At the time, that would have boosted a sterling investor’s returns from Japanese equities and offset some of the pain in a global portfolio.
But fast forward to the sell-off that began late last year and the yen has failed to live up to its usual reputation, tumbling versus both sterling and the US dollar. That in turn has lessened the appeal of Japanese shares for UK investors: to cite one of the better-known indices, the Topix is down by 3.1 per cent for the year to 28 July in sterling terms – a stark contrast to the 3.6 per cent gain it has made in local currency terms.
Japanese equities remain a niche allocation for many, and issues such as the nation’s vulnerability to rising energy prices and global trade hiccups have posed real challenges. But Japanese assets have begun to look notably cheap once again, and the prospect of challenges abating could lead to better times for the market.
An outlier among nations
The yen's weakness which has abtaed slightly in recent days, largely relates to the fact that Japan has diverged from other developed nations when it comes to monetary policy. As Peter Dalgliesh, managing director at Parmenion Investment Management, comments, inflation remains “largely absent” in Japan despite its status as the world’s second largest net importer of fossil fuels. “This has allowed the Bank of Japan to retain their ultra-low interest rate policy and yield curve control, leading to widening interest rate differentials with other G7 countries as they raised interest rates,” he says. “The outcome has been a material weakening in the yen, especially versus the US dollar of over 15 per cent year to date.”
There are silver linings to be drawn here. A recent note from Dina Ting, global head of index portfolio management at Franklin Templeton, highlights the fact that around 82 per cent of Japan’s population has now received Covid-19 vaccinations, one of the highest inoculation rates among G7 nations. “With the yen now at a fresh 24-year low against the US dollar, this export-driven market may be posed for a boost not only from its manufacturing sector, but also from rebounding tourism,” she adds. “The attractive exchange rate should help encourage back to Japan mainland Chinese visitors, which made up the largest single group of travellers pre-pandemic.”
Other external factors also play a part in the case for Japan. Dalgliesh notes that industrials and consumer discretionary stocks, two prominent sectors in the Japanese market, have struggled because of supply constraints and falling disposable income among consumers. But he adds that a pick-up in semiconductor supply, an easing of global supply side constraints and Chinese policy support boosting retail and car sales could spur an improvement in the outlook for Japanese companies. The big macroeconomic themes of the day also play a big role: if oil prices have peaked and the Federal Reserve begins slowing the pace of monetary tightening, that would also prove a boost. But these will be big ifs for some.
Finally, a long established investment case for the region is still bearing fruit, albeit slowly. The assassination of former prime minister Shinzo Abe shocked the nation, but the corporate reforms he set in train several years ago still appear to have momentum. They include a focus on attracting more foreign investment and improving corporate governance. Importantly, they also involve a push for Japanese companies to adopt more shareholder-friendly approaches, including better dividend payouts. But this is an iterative process, and dividends in Japan are not so eye-catching as in some other markets.
In the funds universe abrdn Japan Investment Trust (AJIT), LF Morant Wright Nippon Yield (GB00B2R83B20) and CC Japan Income & Growth Trust (CCJI) recently stood out with yields of between 3.4 and 3.6 per cent, while other funds in both the open and closed-ended space are yet to breach the 3 per cent threshold. Funds investing in Asia and the UK continue to sand out for having much higher yields – although Japan can offer some diversification alongside those offerings.
Investment trusts in particular have moved to especially 'cheap' valuations: names such as the activist-minded AVI Japan Opportunity (AJOT) recently made it into our Alpha team's monthly investment trust report, which identifies funds with attractive valuations relative to their own history and recent share price momentum.
Fund options
As in other regions, investors can combine funds with differing styles to build in some diversification. Japan has certainly witnessed the same style divergence evident in other markets: Man GLG Japan CoreAlpha (GB00B0119B50), a well-known value option whose team recently had a chunky allocation to transportation equipment stocks, has returned nearly 11 per cent in sterling terms over a year, making it a relative standout. Other sector overweight positions at the end of June included real estate and banks. Income funds have also fared well, including LF Morant Wright Nippon Yield and CC Japan Income & Growth Trust. But abrdn Japan Investment Trust is down by nearly 17 per cent over a year, which may explain its relatively high dividend yield.
On the growth front Baillie Gifford has a decent presence here: the Baillie Gifford Japanese Fund (GB0006011133), focuses on “high quality companies capable of delivering attractive and sustainable earnings growth for shareholders”. Its investment team notes that, unlike in other markets, the growth style often commands little or no valuation premium in Japan, which allows them to seek out global leaders at decent prices. The fund, which holds names such as Softbank Group (JP:9984) and robotics business Fanuc (JP:6954), has been caught out by recent market rotations, and is down by around 12 per cent over a year.
It’s worth noting that one well-known Japanese equity fund, FTF Martin Currie Japan Equity (GB00B8JYLC77), is due a change of the guard. Hideo Shiozumi, its longstanding manager, will step back from portfolio management duties in September, with a new team taking over. This has long been a popular fund for investors with a good stomach for risk: targeting high-growth companies that play a part in big structural changes in Japan, it comes with excellent long-term returns but hideous levels of volatility. To illustrate this, the fund has returned nearly 370 per cent in sterling terms over the last decade, but is down by more than 30 per cent over the past year.
Japanese exposure can also come via funds with a broader remit. As Matthew Bird, managing director of Falco Financial Planning, notes, Lindsell Train Global Equity (IE00BJSPMJ28) has a chunky allocation to Japan via holdings such as Nintendo (JP:7974), while the popular Stewart Investors Asia Pacific Leaders Sustainability Fund (GB0033874768) had an allocation of around 10 per cent at the end of May.
