Funds to play a region that’s got its mojo back

Investors have been waiting a long time, but earlier this year it finally happened. Japan’s stock market climbed above its previous peak, set in December 1989.

Naturally, when a stock market has a good run of short-term performance many investors are inclined to look down rather than up. In the case of Japan, our recent long-read feature examined both sides.

Overall, while there are concerns over valuations becoming pricier and the prospect of a stronger yen hitting Japanese exporters, most commentators are adopting a glass half-full stance.

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Reasons to be optimistic on Japan include growth in domestic investors due to the recent expansion of the annual investment limits on the Nippon Individual Savings Account, which was modelled on the UK’s ISA system. 

In addition, another big positive are ongoing corporate governance reforms. The aim is to make Japanese companies better for shareholders, such as by returning more cash to them in the form of dividends. In time, it is hoped these reforms will encourage both domestic and international investors to put more money into the region, thereby boosting share prices.

Another major plus point is that Japan seems to be winning its long-running deflation battle.  

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But, for fund and investment trust investors considering Japan, which one of the approximately 100 options should they consider? Below we round up ideas from experts.  

For Nick Kelsall, a fund manager in Premier Miton’s multi-manager team, Japan’s new record high does not represent another stock market bubble, which was the case in 1989.  

Kelsall says: “While the stock market has indeed had a strong rally and reached a level which could understandably make some investors jittery, there is a case for why this time could be different given the current macro backdrop and structural changes that are afoot.

“Since the policies of Abenomics were introduced in 2012, there has been a gradual acceptance for change, which has evolved with subsequent administrations and led to a more open mindset at a company board level. As a result, there has been a shift in focus that previously solely looked at business interests to one that now values shareholder returns more favourably.”

One of his favoured funds for the region is Man GLG Japan Core Alpha. The fund, which is one of interactive investor’s Super 60 investment ideas, has a contrarian approach. This means the managers tend to buy unloved stocks and increase their weighting as the stock price falls further,  remaining patient until the value is realised.

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Kelsall says: “The fund is well placed to take advantage of the valuation angle given its contrarian approach to investing. The manager holds a core portfolio of attractively valued, good-quality large cap stocks combined with stocks that have a significant potential to improve.”

For Josef Licsauer, an investment trust research analyst at Kepler Partners, Japan remains cheaper than many developed markets, including the US, Europe and UK. He says AVI Japan Opportunity (LSE:AJOT)and CC Japan Income & Growth (LSE:CCJI) are well placed to benefit from the cheapest areas of Japan’s stock market - the small and mid-cap companies.

Licsauer says AVI Japan Opportunity seeks “to take advantage of the corporate governance reform programme and its potential to unlock value in deeply discounted Japanese companies”.  

Meanwhile, CC Japan Income & Growth is tapping into the “continuous surge in dividends from Japanese companies, alongside expanding share buyback plans”.

Another income option, in our Super 60 list is Jupiter Japan Income. The fund focuses on well-managed companies that demonstrate strong cash flows above cost of capital, good growth prospects and management aligned with shareholders’ interests.

Best and worst performers over five years

Over five years, there is little to separate the fund and investment trust Japan sectors, according to figures from FE Analytics.

The average fund is up 38.4%, while the average investment trust has produced a share price total return of 36%. However, bear in mind that the investment trust sector has only five members.

For the investment trust Japanese smaller companies sector, returns are lacklustre with an average gain of 4.6%. It is also a small sector, with just four constituents.

For funds, of which there are around 100 in the Japan sector, the top three performers over the past five years are New Capital Japan Equity, Nomura Japan Strategic Value and GS Japan Equity, up 136.1%, 134.8% and 120.2% respectively.

At the other end of the table with losses of -38.1%, -30.7% and -15.6% are Baillie Gifford Shin Nippon (LSE:BGS), Baillie Gifford Japan Small Companies and Lindsell Train Japanese Equity.

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Baillie Gifford Shin Nippon’s performance makes for uncomfortable reading, but our analysts have been keeping the faith, and the investment trust is one of our Super 60 investments. If performance does not improve, investors will be offered an escape route.

The board announced in its annual results (at the end of March) that it will commit to a one-off tender offer (of 15% of the issued share capital) if the performance of its underlying investments (the net asset value or NAV) fails to beat the MSCI Japan Small Cap Index over three years to 31 January 2027.

For investors considering “buying the market” through a passive strategy – an index fund or exchange-traded fund (ETF) – there are not many options to gain exposure to Japan’s most well-known market, the Nikkei 225.

This is because the Nikkei 225 is a price-weighted and not a market-capitalisation weighted index. In a price-weighted index, the trading prices of stocks determine how much of the index they comprise. Whereas, indices using market-cap weightings rank companies by their size. This is the most common approach, used by the S&P 500 and FTSE 100.

Options for tracking Japan’s most famous stock market are iShares Nikkei 225 ETF and Xtrackers Nikkei 225 ETF. However, bear in mind that the former has much higher yearly ongoing costs of 0.48% versus 0.11% for the latter.

It is more common for index funds and ETFs to track the MSCI Japan and FTSE Japan indices. The number of holdings differ at 217 versus 504. The FTSE Japan index can be tracked via HSBC Japan Index, a member of our Super 60 list. For a yearly fee of 0.12%, this fund tracks a diversified basket of  large and mid-cap Japanese companies.