Ian Cowie: the bargain basement country Warren Buffett is backing

Our columnist has drawn comfort from Warren Buffett’s contrarian bet.

Warren Buffett’s $6 bilion contrarian bet on Japan’s five biggest trading houses gives good reason for international investors to reconsider bad news from the Land of the Rising Sun. Better still, you can buy shares in investment trusts focused there for a double-digit discount to their net asset value (NAV) and receive inflation-busting income.

Last week’s surprise resignation of Japanese prime minister Shinzo Abe on ill-health grounds hurt hopes of economic reform and recovery. During nearly eight years at the helm, Abe boosted the money supply and tackled inefficient working practices from agriculture to retail, in a bid to reverse decades of deflation and low or no investment returns.

• As Japan’s prime minister quits, time to rethink Japan exposure?
• Global fund managers boost exposure to tech giants
• Income hunters can find great funds on ii’s Super 60 recommended list of investments

Despite all that, the Nikkei 225 index of the Tokyo stock exchange continues to trade not much higher than half the peak it briefly hit in 1989. Back then, the land occupied by the Imperial Palace in that city was said to be worth more than all the real estate in California.

Now Buffett, the long-term investor sometimes described as the ‘Sage of Omaha’, has leapt a similar valuation gap; albeit the other way round, from soaring American prices to bargain basement Japan. His investment company Berkshire Hathaway (NYSE:BRK.B) disclosed this week that it has become one of the biggest shareholders in Mitsubishi Corp and four other ‘sogo shosha’ or general trading houses.

Buffett is swimming against a tide of pessimism that has seen an estimated $132 billion of foreign investors’ capital flow out of Japan in less than three years. But his timing looks shrewd with this country filling two of the five top-performing global fund sectors last month, according to the Investment Association.

This analysis showed Japanese smaller companies leading the worldwide recovery with an average return in August of 5.7%, followed by Japan in fifth place with 4.6%. Interestingly, independent statisticians at Bloomberg report the Nikkei 225 index has risen by 14% over the last year, beating the Dow’s 10% but lagging far behind the American technology NASDAQ benchmark’s stratospheric 59%.

Coming down from the clouds, I have been a shareholder in Baillie Gifford Shin Nippon (LSE:BGS) for many years and this Japanese smaller companies specialist still ranks among my top 10 holdings by value. Last December, rankled by tepid growth and the absence of any income at BGS, I added a modest stake in JPMorgan Japan Smaller Companies (LSE:JPS).

In the short term, my impatience looks like a mistake with BGS delivering total returns of more than 14% over the last year, with JPS just below that figure. However, I believe these two trusts - which are respectively the top and second-best performers among five trusts in their sector over the last one year, five years and decade - make a complementary pair; not least because JPS yields 4.2%.

• Explore interactive investor podcasts here
• Take control of your retirement planning with our award-winning, low-cost Self-Invested Personal Pension (SIPP)
• Coming soon: more fund manager videos. Click here to subscribe

With one eye on retirement - which I hope to fund with income from investments - JPS looks marginally more attractive for top-up investments, not least because its shares are priced nearly 13% below their NAV while the discount at BGS is just 2.1%, according to independent statisticians Morningstar.

Drilling down to try to assess the reliability of those dividends, I am encouraged by JPMorgan Asset Management’s analysis. This found that Japanese companies of all sizes now typically yield 2.3% after growing dividends by an annual average of 11% over the last five years to give a current payout ratio of 51%. These figures look preferable to their American alternatives.

So investors should not be surprised to find Buffett buying into Tokyo’s bargain basement. Political uncertainty about who will succeed Abe may even allow more time for those who have yet to obtain exposure to the world’s third-largest economy to consider doing so.

In the short term, expect to hear plenty of colourful chatter about the only two credible candidates. These are Yoshihide Suga, 71, Mr Abe’s chief cabinet secretary, and Shigeru Ishiba, 63, who used to be defence minister.

The former has been described as a “ruthless enforcer” while the latter rang alarm bells by musing that Japan might one day need its own nuclear weapons. Whichever wins, I draw comfort from Buffett increasing his exposure to this country and continue to believe that - at least as far as the stock market is concerned - economics should trump politics.

Ian Cowie is a shareholder in Baillie Gifford Shin Nippon (LSE: BGS) and JPMorgan Japan Smaller Companies (LSE: JPS).

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.