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James Carthew: is the Japanese glass half full, empty, or illusory?

James Carthew: is the Japanese glass half full, empty, or illusory?

Shinzo Abe, who has just become an internet meme by doing a backward roll into a golf bunker while hanging out with Donald Trump, has pulled off what Theresa May could not: calling a snap election and increasing his majority.

Japan’s prime minister (pictured) first secured the position in 2006 but it was his re-election on 16 December 2012 that ushered in the period of Abenomics and the renaissance of Japan’s stock market.

A 118% return from the Topix index since then (to 31 October 2017) has helped dim memories of Japan’s lost decades when the country became a byword for deflation and weak stock market performance (the Topix index returned just 15% over the period from 1 November 1997 to 16 December 2012).

I must take my hat off to the fund managers that navigated their way through the wilderness years in Japan. Especially to those that made money for investors regardless.

Top of that list for me is Sarah Whitely, manager of Baillie Gifford Japan (BGFD), who recently announced her retirement from the end of April next year.

The baton will pass to Matthew Brett, who has been working alongside Sarah since 2003. He will be assisted by Praveen Kumar who manages the more small cap focused Baillie Gifford Shin Nippon (BGS) and has been with Baillie Gifford since 2008.

I have a soft spot for BGFD as it has been one of my most profitable investments over the years and it is a constant source of regret that I have trimmed the holding from time to time only to see it go on to hit new highs.

I suppose the only other regret is that I do not have any exposure to BGS, which has done even better. To illustrate this, since the 2012 election, BGFD has returned 293% and BGS 321% and through the period from 1 December 2012 to 16 November 2017, BGFD returned 109% and BGS 188%. If ever there was a need for an argument in favour of active investing, this is it.

It would be fair to say that the Japanese economy is not exactly firing on all cylinders. Although it is true that Japan has been experiencing the second longest recovery in its history (58 consecutive months of GDP growth – running from the introduction of Abenomics), within that, consumers have seen barely any growth in their disposable income. After years of targeting inflation, in the hope of kickstarting the economy, it remains anaemic at about 0.7%.

The government has done what it can to try to address the problem. Corporate governance reforms are removing some of the strangleholds on economic growth but Japan’s aging population and the march of technology act as severe deflationary brakes on the economy that are hard to shift. This is a factor in most Western economies as well and we must adapt to it.

Japanese companies have learned to live with the situation. On the negative side they did things like hoarding cash, but why wouldn’t you when its real value was rising?

However, some of the policies introduced by the government have sought to discourage this and this is being reflected in rising dividend pay-out ratios and share buy backs.

This has provided the sort of environment where CC Japan Income & Growth could be launched and provide investors with a modest yield that is not manufactured from capital. Remarkably, this fund has just pipped BGFD to the post in terms of producing the best NAV returns over the past year for the peer group of large cap Japanese funds.

How can these managers deliver, consistently, benchmark beating returns? The answer is simple, good stock selection. The managers will tell you that Japan is full of dynamic, innovative companies – you just have to find them.

It is easy to become fixated on the macroeconomic picture.

Regional politics (especially North Korea and the territorial disputes over the South China Sea) played a large part in Abe’s re-election and there are any number of other existential threats to rising stock markets.

However, the chair statement from BGFD’s recently published annual report contains a glowing report for the country: ‘The board visited Japan in May with the managers, meeting CEOs and senior management of many current and potential investments.

‘We returned home with an even more positive outlook for your trust given the impressive entrepreneurial spirit we found that many fail to give Japan credit for, a real commitment to the social fabric of the country through profitable progress and investment, allied to new technologies that will blossom in this evolving technological age.’ 

James Carthew is a director at Marten & Co and head of its investment trust research


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