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Japan could still give an upside surprise
I have held about 5% of my porfolio in Japan for the past three years. Until last year, it was a lousy investment in terms of stockmarket performance, but the rise in the yen meant I made almost as much as I did in UK equities.
That all changed with the monster rally that followed the election of Shinzo Abe and the invention of Abenomics. Not many UK investors bought into the rally — they had seen too many such rallies fail over the past decade — and most probably think of Japan only in terms of an ageing society with far too much government debt. This is to confuse a nation and a stockmarket — world exposure means most of the FTSE 100 stocks bear no relation to the UK, and the same is true of a large proportion of Japan’s top businesses. Abenomics could start a multi-year bull market.
For two decades Japan has been an investment graveyard. Periodic bouts of optimism and market rallies have been followed by further declines. The market as measured by the Nikkei 225 Index peaked at 38,000 in December 1989 and eventually hit bottom at 7,800 in April 2003, with one more rally and a final brief lurch down to 7,500 in January 2009 in the wake of the global financial crisis.
After a period of short-lived and ineffective governments, the Liberal Democratic Party leader Shinzo Abe regained power in December 2012 on the basis of a 3-pronged recovery plan: a fiscal boost (about $100 billion of spending), a monetary boost through quantitative easing and a reform agenda to tackle a rigid employment market. His party now controls both the lower and upper houses of the legislature.
One of the reasons for being bullish on Japan is quantitative easing. Japan’s monetary expansion (known as QQE) is the most aggressive such programme yet implemented — several times as large in relation to the size of the Japanese economy as that adopted by the Federal Reserve in the US. So far, the yen has only declined about 20% against the US$, but even this has seen corporate profits rising sharply. Provided QQE continues as planned, it is likely to send the yen lower.
Though Japan’s corporate profits are rising faster than those in Europe or the US — an annual rate of nearly 30% — company valuations are low, with price-earnings ratios around 12.5 as compared with 15 in Europe and 17.5 in the US. The average dividend yield is higher than that for the US at 2.6%.
Many commentators regard the “Abenomics” plan as the last chance saloon for Japan, since its ratio of debt to GDP is already over 200%, more than double what economists consider viable in the long term. By Japanese standards, the plan is very bold and Abe has pushed through a rise in the consumption tax as a first step to eliminating the budget deficit. If the plan works,a return to economic growth will result in a steady reduction in the debt ratio.
According to analysis by investment managers Neptune, the Yen needs to decline by between 50% and 65% in order to balance the budget. These may sound high figures but even this would only take the yen back to levels of the 1990s. A currency decline of half as much as this would have a big positive effect on the profits of Japanese companies operating overseas or exporting.
The announcement of the Abe plan saw the stock market rise by a half to 15,627 in May 2013. It retreated to about 14,500 but in recent weeks has risen to its highest level since 2007. There is still uncertainty about the third arrow” of the plan — reforms to liberalise the economy — but already the government has joined the Trans Pacific Partnership, which involves the abolition of protectionist agricultural tariffs, and has struck a deal with the US to import shale gas to improve energy security and lower costs.
In essence, Japan’s stock market is cheap compared with those of the UK, Europe and the US, yet it includes many first-class businesses whose profits will soar if the yen declines. If you want to buy into Japan, the key issue is currency. Some fund managers now offer two share classes for their funds, hedged and unhedged. Given QQE, I would only buy the hedged share class in funds that offer the option. But most funds still leave the manager to decide whether and how much to hedge, and you may — like me — prefer to leave currency decisions to the manager. Right now, I would want to know that the manager is fully hedging the portfolio, as with all the funds listed below.
Big potential in mid and small caps
Neptune Japan Opportunities fund is managed by Chris Taylor, Neptune’s Head of Research. He has positioned his portfolio to benefit from a fall in the currency, with large holdings in industrial companies. He is also hedging the currency so that investors benefit from any rise in the stock market without losing from a decline in the currency. Given his very specific views, I would expect the performance of this fund to be quite volatile: in the past it has done much better than its peer group over some periods and much worse over others.
GLG Core Alpha follows a value/contrarian style in Japanese large-cap stocks. This should benefit from the currency effect — large-cap exporters are big winners from a yen decline. But it will miss out on the domestic, mainly small and midcap, beneficiaries of labour market reforms.
Baillie Gifford Shin Nippon investment trust invests mainly in mid and small cap stocks. The long term record is excellent. Many of its domestic consumer stocks will be big winners if and when wage growth lifts discretionary spending. Baillie Gifford Japanese Smaller Companies OEIC is run by the same management team.
Already QQE has started to generate inflation. It will be mid-2014 before we know if wages are rising across the economy. By then, the currency may have taken another dip. Domestic investors are just beginning to switch from bonds to equities, encouraged by a new taxsheltered plan modelled on the UK’s ISA. I can see potential for at least a 30-40% return over the next 18 months and have increased my Japan holdings to 10% of my portfolio. Who knows, in a few years’ time Japan may even become — as it was in the 1980s — a core ingredient in global portfolios. In which case the market is going a lot higher.
Chris Gilchrist, December 2013
Woodford: stay or go?
The news that Neil Woodford is set to leave Invesco Perpetual next April to set up his own fund management group poses a £33 billion question for investors. That is the total amount Mr Woodford now manages using his Buffett-style, long-termist value methods that he has applied for the past 25 years. And boy, has it worked.
The teenage scribblers of the press can carp about recent results, but short-term data is meaningless in value investing. Instead check out the chart below which compares Invesco Perpetual Income with the FTSE 100 over 20 years. IP income has returned £9,000 for an initial £1,000 investment as compared with £4,260 for the Footsie.
It’s common knowledge that Woodford achieved this by taking big contrarian positions, most notably in tobacco back in the late 1990s when he bought BAT and the like on PERs of about 6. He made more than 10 times his money. Most recently, his big call has been “big pharma”, with large stakes in GlaxoSmithKline, AstraZeneca, Roche and other giants.
Woodford has got ever more impatient with short-termism. I don’t blame him. Many of the advisers asked about his funds are lukewarm. Genuinely long-term value investing will always be an uncomfortable style and is ill suited to most financial advisers, who have little real understanding of investment and are much too trigger-happy.
So the issue is: stay or go? I have met Woodford’s successor as manager of the two big equity income funds (Income and High Income) and as Head of UK Equities, Mark Barnett. He is very different from Woodford, who is aloof and arrogant. Barnett appears more pragmatic and cautious, but is still a long-term value investor like Woodford. Over the past five years, the fund he manages (UK Strategic Income) has actually done better than Woodford’s, partly because Barnett never allows a stock to account for over 5% of his fund.
I personally own IP Income and intend to hold it to give Barnett a chance.
Chris Gilchrist, November 2013