DFMs stick by Japan following failed predictions of outperformance

Lindsell Train was the only fund in the sector to deliver positive returns in 2018

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, funds across the Investment Association Japan sector lost 11.3% over the course of the year, making it the fifth worst performer, beaten only by European Smaller Companies and Europe ex-UK, China and UK Smaller Companies. In fact, only one fund in the sector delivered positive returns.

Last Word Research highlights the positivity among European fund selectors towards the country at the beginning of last year with net sentiment positive at 10% in January and climbing to 30% by April. Inflows were also strong in January nearing €300m, although gradually tapering off over the course of the year.


Source: Last Word Research

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. 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.

Lindsell Train delivers – but only just

Lindsell Train Japan fund was the only fund with a positive return on 2018, according to figures from FE Analytics, delivering a meagre 2.1%. McDermott attributed that to low turnover and quality compounding companies.

Top-10 Japan funds in 2018

Lindsell Train Japanese Equity2.10
Comgest Growth Japan-1.07
Nomura Japan High Conviction-5.57
Baillie Gifford Japanese Income Growth-6.38
Oldfield Overstone UCITS Japanese Equity-6.41
Fidelity Index Japan-7.46
Aberdeen Japan Equity Enhanced Index-7.54
Vanguard Japan Stock Index-7.65
T. Rowe Price Japanese Equity-7.77
LF Canlife Japan-7.90
Source: FE Analytics

In a reflection of 2018 published in the new year, fund manager Michael Lindsell (pictured) 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

DFMs 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.”

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.”

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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