The current strength of the Japanese stock market is not “just another false dawn” and investors still have time allocate to the world’s third largest economy to make the most of its bull run, according to T. Rowe Price’s Archibald Ciganer.
Japanese equities went through a long period of underperformance on the back of a long-lasting deflationary spiral and lacklustre economic growth. Investors also remained nervous on the country because of memories of the Japanese asset price bubble, which collapsed in the early 1990s.
More recent years have seen the country’s stock market surge, however; as the chart below shows, over the past five years it has been one of the best performing equity markets, beaten only by the US. The reasons for this are well known and come down to the ambitious stimulus package launched by prime minister Shinzō Abe.
Performance of equity markets over 5yrs
Source: FE Analytics
This strong rise in Japanese equities has led some to question whether now is too late to buy into the country but Ciganer – who manages the top-performing T. Rowe Price Japanese Equity fund – believes this opportunity has much further to run.
“Certainly the Japanese market contains many expensive stocks, but it is also a broad, deep market, and valuations are not rich overall,” he said.
“We continue to find attractively valued opportunities among the circa 1,200 stocks in our investment universe. It’s not too late to invest. We believe the improvements will continue because the changes are still taking place slowly.”
The closely watched BofA Merrill Lynch Global Fund Manager Survey shows that asset allocators continue to overweight Japan. The latest edition of the survey found that fund managers are running a net 17 per cent overweight to Japanese equities; this compares with a net 1 per cent overweight to the US and a net 21 per cent underweight to the UK.
Of course, there have been a number of ‘false dawns’ for Japan over the past few decades. The chart below, which shows the performance of the Topix in yen and without dividends reinvested, highlights how Japan has witnessed several periods where stocks have climbed rapidly only to crash back down.
But Ciganer added: “We believe that this time so many factors are pushing Japan along that there is no turning back. Previously, when things got bad Japanese companies would temporarily raise their game – and then return to their old ways when things were better. This time, you have new governance and stewardship legislation, increased foreign investment and growing competition from China preventing Japan from going backward.
“There are risks, of course. Not every company is getting better, and some are resisting change. The Japanese market is slowly becoming more diverse, less cyclical and less dependent on exporters. But it remains very exposed to the global macroeconomic cycle. If there’s a global downturn, particularly if it starts in the United States, Japanese profits will be hit – there’s no avoiding that.”
Performance of Topix since Mar 1980
Source: FE Analytics
When managing T. Rowe Price Japanese Equity, Ciganer focuses on companies that are benefitting from long-term social or technological change. This means the strategy aims to be positioned on “the right side” of major trends affecting Japan, such as its ageing population, the rising purchasing power of emerging market consumers and stricter environmental regulations.
In terms of how the fund is positioned, the manager like services companies as a way to benefit from Japan’s strong economy, rising demand and structural labour shortage. One holding in this space is staffing company Recruit, which offers many services to small- and medium-sized businesses and produces consumer-oriented media.
Another preferred area in the portfolio is automation-related companies given how this is an area of important technological change where Japan has a strong position. The fund holds companies such as Keyence – a consultant that designs plants for better use of automation and supplies the components – and industrial robot manufacturer FANUC.
However, the manager is avoiding banks owing to his view that Japan has “far too many” lending institutions, leading to the country having “a virtually unlimited supply of credit”. This has led to very compressed net interest margins and thin yield spreads, meaning Japanese banks find it difficult to generate attractive profits.
Old-style manufacturers such as steelmakers are also being avoided in the fund as they face direct competition from China and other low-cost producers.
On the whole, though, Ciganer maintains his argument that Japan remains an appealing area for long-term investors: “Now may be the time to invest in Japan. We think it’s a quality market that is improving, and its risk/reward balance is really attractive.
“Japan has the attributes of a developed market, but it also has the advantage of having a lot of room for improvement. It could be a 20-year process, so I see considerable potential for gains.”
Performance of fund vs sector and index under Ciganer
Source: FE Analytics
Ciganer has managed the £331m T. Rowe Price Japanese Equity fund since December 2013, over which time it has generated a total return of 104.07 per cent. This ranks it sixth out of 60 funds in the IA Japan sector and ahead of its Topix benchmark by a significant margin.
FE Analytics also shows that the fund is in the sector’s top quartile over one and three years, as well as over one, three and six months.
T. Rowe Price Japanese Equity has an ongoing charges figure (OCF) of 0.90 per cent and holds five FE Crowns.