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Managers stick by Japan despite failed outperformance predictions

Japanese equity funds were a favourite pick among fund selectors at the start of 2018, yet performance tables published at the end of the year showed it had been one of the worst-performing sectors.

On average, Japanese equity funds across the FCA Recognised and Offshore Mutual sectors lost 12.2% and 12.5% respectively. No funds available to continental European investors delivered a return.

Last Word Research found renewed optimism for the asset class towards the end of last year due to economic growth and societal shifts.

What went wrong?

Ryan Hughes, head of active portfolios at AJ Bell, said investors were positive on Japan’s export-led economy at the start of 2018 due to expectations of synchronised global growth.

“However, as we now know, it didn’t quite pan out like that and in the fourth quarter, growth expectations completely changed which saw a very sharp falls in Japanese markets on the back of slowing global demand,” he says.

Trade tariffs are to blame, according to Chelsea Financial Services managing director Darius McDermott.

“What we didn’t know is how quickly and severe some of these trade tariffs were going to come, especially as Japan has a big steel industry and a big car industry,” McDermott said.

“Cars are mostly made from aluminium so if your input cost is going up, your profit margin is going down and then you’ve got a potential trade tariff when China sell Japanese cars in the states anyway – that really is the first reason that Japan underperformed.”

A strong yen also hurt international investors. “If you’re a UK unit holder and yen is strong, it affects your unit price, relatively,” McDermott says.

Emma Saunders, senior research analyst at Rathbones, argues much of the poor performance in 2018 stemmed from Q4 alone amid rising concerns surrounding Japan’s vulnerability to a US-China trade war, and the lack of meaningful wage growth and inflation.

No funds deliver

No funds available to continental Europe made a return in 2018 unless the investor was betting against Japanese equities.

The Boost Topix 1x Short Daily exchange traded product made a return of 22.8% for the year to 31 December 2018. However, the fund provides the inverse daily performance of the Topix index.

Top-5 Japan funds in 2018

Fund Return one year to 31
December 2018 (%)
Boost TOPIX 1x Short Daily ETP 22.8
SPARX Japan A Institutional JP -1.4
Comgest Growth Japan Z
Accumulation EUR
Candriam Equities L Japan N JPY -4.6
Invesco Japanese Equity Advantage A
Accumulation JPY

Source: FE Analytics

While the Lindsell Train Japanese Equity B Sterling Quoted fund made a return of 0.55% during the same time period, it was not available to continental European investors.

In a reflection of 2018 published in the new year, fund manager Michael Lindsell said the market peaked in mid-January and had been declining ever since losing 21% in the intervening period. Lindsell reckoned investors counted on cyclical earnings taking a hit, highlighting shipping, machinery, commodity cyclicals and electronics were among the worst-performing sectors for the year, alongside banks and securities companies.

In contrast, pharmaceuticals, utilities and retailers were the best performers.

Hughes says: “Within the market, large companies were the most resilient which meant that many managers who were positioned away from this area suffered more than the market”.

Meanwhile, Saunders says: “In terms of funds, we would argue that, broadly speaking, active Japan managers, while suffering negative performance in absolute terms, have provided downside protection relative to the market. All things considered, we still see Japan an opportunity”.

She adds: “Although the Japanese stock markets remains supported by domestic shareholders, we have seen outflows from foreign investors. We believe this dynamic is a result of sentiment rather than any fundamental deficiencies related to the market”.

Lindsell Train Japan is focusing on defensive companies insulated from what’s affecting the market as a whole, Lindsell says. He pinned his hopes on the likes of portfolio holdings Nintendo, Kao, Shiseido and Obic Business Consultants “ploughing their own furrow”.

Cyclical market

However, fund managers still see value in the region. Hughes says AJ Bell remain reasonably positive on Japan but are “careful on what type of positioning we have”.

“We see significant opportunity in the large cap value space as valuation discounts have reached extreme levels,” he said.

Saunders says: “We remain bullish on domestic Japan owing to a radical improvement in return on equity as a result of improving corporate governance, and increasing shareholder focus as companies return cash on the balance sheet to shareholders by way of dividends and buybacks”.

“Japan is also one of the most politically stable nations in the region, with Shinzo Abe surpassing his predecessors this year to become Japan’s longest ever serving post war prime minister,” she said.

McDermott, who is neutral to slightly overweight Japan across funds, adds: “The cyclical part and the value part of the Japanese market is as cheap relative to the growth part as it has ever been”.


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Sonia Rach

Sonia joined Last Word Media and the investment industry in 2017 as a reporter, having spent 3 years in HR journalism. While her role consisted of writing about HR related topics such as employee benefits,...

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