Confidence in Japan begins to wane

Exposure to Japanese equities was reduced in all three Adviser Fund Indices in the November rebalancing as panellists switched their attention to other parts of the Asia Pacific region.

Short-term confidence in the Japanese economic recovery appears to be waning among some of the Adviser Fund Index panellists. The first AFI mid-season questionnaire (see Fund Strategy, August 21, pages 16-20), showed them in bullish mood, with six out of 14 respondents predicting that Japan would outperform the other major equity market regions over the next one and three-year periods. However, exposure to Japan fell across all three indices in the November rebalancing.

The Aggressive, Balanced and Cautious AFI allocations to the Investment Management Association’s Japan sector fell by 1.3, 0.7 and 0.1 percentage points respectively. The Aggressive and Balanced weightings to IMA Asia Pacific including Japan also decreased, by 1.8 and 1.2 percentage points. But, to dispel any thoughts that this was a sign of bearishness on Asia as a whole, the panellists increased their exposure to IMA Asia Pacific excluding Japan in all three AFIs.

Schroder Japan Alpha Plus and Fidelity Japan Special Situations, selected by one adviser each in the May rebalancing, left the AFI completely. As reported in Fund Strategy on March 27, Jun Tano took over the £180m Fidelity fund from Asako Kibe on April 1. Kibe remains with the firm, in a mentoring role for the Tokyo investment team. Two other funds – JP Morgan Japan and Schroder Tokyo – remain in the Aggressive AFI only, following ejection from the Balanced and Cautious indices.

Hilary Coghill, investment director at City Asset Management and an AFI panellist, says she is positive on a long-term Japanese recovery. However, several factors are causing her to tread carefully. She says: “I was not bullish on Japan over the summer, but I was at the beginning of the year, and I was wrong. We brought our exposure to Japan down and have kept it down.”

Coghill’s first area of concern is the impact of the weak yen on foreign investors, and she points to suggestions that the currency has been kept artificially low to help exports. Coghill sees continuedJapanese dependence on a successful American economy as an additional problem. She highlights recent comments by Stephen Roach, chief economist at Morgan Stanley.

In a report entitled “Unprepared in Beijing”, published on the investment bank’s Global Economic Forum on December 1, Roach argued that large, externally-dependent Asian economies may be hit by a “double-whammy” in the event of slower American economic growth. Not only could countries like Japan directly suffer from reduced exports to America, he said, but also from a cutback in Chinese demand for components.

Roach also warned of the impact of American protectionism, and claimed that Congress had introduced 27 pieces of anti-China trade legislation since early 2005. He said last week’s talks between Chinese and American officials were akin to China negotiating with “lame ducks”, following the Republicans’ loss of control in both houses of Congress. Roach added that the chances of one of these pieces of legislation becoming law next year were rising.

In response to these concerns, Coghill is holding just 4-5% of her Aggressive AFI allocation in Japan – underweight the index. She sold out of JP Morgan’s £370m Japan portfolio in November, because of its high level of exposure to small and mid-cap stocks. According to JP Morgan, the fund held more than a third of its assets in 10 stocks on October 31, seven of which were financial companies. Overall, the portfolio, run by David Mitchinson, was overweight financials by 24%, with its largest underweight in consumer goods.

Not all of the panellists are as cautious on Japan. Three funds from the Japan sector were added to the AFI in November, with Jupiter Japan Income and Old Mutual Japanese Select appearing in all three indices. The £70m Jupiter portfolio was launched in September last year and is run by Simon Somerville. It invests in a combination of equities, convertible bonds, cash, deposits and money-market instruments. Somerville looks for undervalued growth stocks offering solid earnings potential and strong track records.

Old Mutual Asset Management’s Japanese Select fund is run by Leslie Jones, who joined OMAM in 2001. The £60m portfolio held 61 stocks at the end of October, with its largest positions in Mitsubishi Tokyo Financial, Toyota and Nissan. Returns are slightly below the IMA Japan sector average for the year ending December 13, according to data from Financial Express. However, long-term performance is impressive, with a 10-year return of 42% against an average of just 15%.

Société Générale Asset Management’s Japan CoreAlpha fund has also been added to the Aggressive and Balanced indices. The £120m portfolio changed its name from SG Japan at the start of this year, a move designed to coincide with a change in manager. As reported in Fund Strategy on January 23, Stephen Harker took over from Neiloy Ghosh, adopting a more concentrated style by holding 40-80 large-cap stocks.

However, retail investor interest in Japan has undoubtedly fallen away since last year, according to statistics from the IMA. The Japan sector received £260m in net retail inflows during August, September and October 2005, representing 36% of retail equity fund sales. However, just £85m in retail money flowed into the sector in the same period this year, despite total net retail equity sales topping £2.6trn.

The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/adviser_fund_index.html).