Follow the optimists into Japan

Fund managers are optimistic about Japan and for good reason, says Max King. Investors should follow their lead.


Abe: waking up to the new Japan
(Image credit: © Aflo Co. Ltd. / Alamy Stock Photo)

When Japan's prime minister, Shinzo Abe, launched his "three arrows" programme in 2012, hopes were high that he would kick-start the stagnant Japanese economy. As the Bank of Japan swung into action on quantitative easing, the yen dropped by a third, the equity market doubled and continuing falls in bond yields laid to rest widespread fears of a debt crisis.

Four years on, growth is stuttering, the yen has recovered half its losses and the stockmarket has retreated 20%. UK investors are happy because a huge drop in the yen-sterling exchange rate has boosted sterling returns, but elsewhere, investors are disillusioned.

No such mood is apparent in the Japanese team at Baillie Gifford, which continues to produce excellent performance by focusing on stocks rather than politics and economics. Sarah Whitley, manager of Baillie Gifford's Japan Trust (LSE: BGFD), was an early "Abenomics" sceptic, pointing out that it represented a government waking up to a process of gradual change in the country that had been under way for 15 years and would continue.

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She points to rising female participation in the workforce, a huge jump in inbound tourism and steadily improving corporate governance as examples of positive change and thinks that others focus too much on short-term economic data.

Baillie Gifford is generally regarded as a growth rather than a value investor, but Whitley believes that Japan is a market where you don't have to choose. The portfolio of nearly 70 stocks bears little resemblance to the market indices, so you won't find the dinosaurs of old Japan in it. One of the largest holdings is SoftBank, which recently and opportunistically acquired UK-listed ARM Holdings, following a sharp drop in sterling.

About 50% of the portfolio is in mid-caps and 20% in small caps, but the overlap with sister Baillie Gifford fund Shin Nippon Trust (LSE: BGS), which focuses more on small caps, is only about 25%. It is a mark of the team's optimism that gearing (the ratio of borrowings to net assets) is more than 15%, though the firms in the portfolio have low debt-to-equity ratios. In line with the Baillie Gifford style, investments are made with a long time horizon and so portfolio turnover is low just 7% annualised when last measured.

Shin Nippon, managed by Praveen Kumar, also has an outstanding record (disclosure: our editor-in-chief is a director at Shin Nippon). Gearing, at 10%, is a little lower than at its sister trust; its portfolio turnover, at 15%, a little higher, and the growth orientation stronger with 23% of the portfolio in information technology and 15% in health care. The portfolio overlap with the benchmark index is just 6%; the team's view is that the key to performance is to pick the stocks that represent "new" rather than "old" Japan.

Both trusts have out-performed their benchmarks and competitors over one, three and five years. The Japan Trust has returned 214% in sterling over five years, 116% ahead of the index, while Shin Nippon has returned 272%, 157% ahead of the small-cap benchmark. Both trusts trade close to net asset value, though the historic performance justifies the premium at which they normally trade.

Neither pays a dividend, as income is mostly absorbed by ongoing charges (0.9% at Japan Trust, a little higher at Shin Nippon) and by costs of borrowing. Which to choose? The Japan Trust, with a market value of more than £400m, is nearly twice the size of Shin Nippon and a bit more mainstream, but Shin Nippon looks better value. Still, with the mass of investors disillusioned but the managers optimistic and Japanese companies coping well with a rising yen, buying both could make sense.

Max King
Investment Writer

Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.

After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.