Finding ‘hidden gems’ in Japan’s coverage gap

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Investors have flocked to Japan in recent months but with almost half of the Japanese equity market largely untapped due to a massive coverage gap, managers are still finding plenty of “hidden gems”.

The Japanese equity market has experienced a strong rally since the election of new prime minister Shinzo Abe at the end of 2012, leading to the dawn of Abenomics and a massive stimulus package from the Bank of Japan.

Even after experiencing a period of increased volatility in recent months, Japan was the only market to perform positively on the S&P Global Broad Market Index in June.

According to the latest retail sales figures from the IMA, Japan was also one of the top 10 best selling sectors in June with net retail sales totalling £68m.

However a number of fund managers and advisers point to a significant analyst coverage cap in Japan which could mean that the market is missing emerging opportunities outwith popular stocks.

Chelsea Financial Services managing director Darius McDermott tipped Japan as a contrarian investment for 2013. He argues that Japan’s history as an unloved market has lead to poorer coverage.

He says: “The Japanese equity market has been so unloved for so long that analyst coverage of the region is a lot lower than it once was, which means there are indeed hidden ideas to be found by those who do research the market.”

JP Morgan Japan investment trust manager Nicholas Weindling notes that around 50 per cent of the Japanese equity market is only covered by one analyst or even none at all.

McDermott highlights a number of funds with a “history of finding hidden gems” including the £188.8m Legg Mason Japan Equity, £1.2bn GLG Japan Core Alpha and the £639.3m Jupiter Japan Income funds.

Weindling believes that being part of a team based on the ground in Japan allows the JP Morgan Japan and Japan Smaller Companies trusts to discover opportunities missed by the market.

He says: “Having our team in Tokyo really helps our process because we are very bottom-up, very fundamental. Everything is based around our company meetings. Our team had 2,400 meetings with companies last year.

“There is a general information and coverage gap in Japan. There is very little coverage if you compare it to other markets. We are able to find hidden stories that are being the missed by the market.”

Further down the market cap scale the lack of coverage gets “even more extreme”, says Weindling, such as online B2B e-commerce company MontaRO. He says: “It has steadily sales growth between 20-25 per cent per year.

“It is also expanding into the US and Korea. MonotaRO has a very strong management team, yet no analyst coverage at all. This is the kind of stock that we see as very exciting.”

JO Hambro Japan equity manager Ruth Nash “struggles to find value” amidst Japan’s top 100 stocks, looking instead to companies with little or no coverage for real value.

She says: “Generally on the top 100 stocks you could find an idea that wasn’t discounted, for example, and the stock might go up by 10 to 20 per cent.

“But with these smaller and less covered names are incredibly cheap, even with the rest of the Japanese market looking generally quite cheap. I would argue this is where the real value is.”

The co-manager of the £473.3m JO Hambro Japan Equity fund does acknowledge that these stocks are more of a long-term play on the recovery in Japan, often taking time to re-rate. However she adds that these re-ratings are often significant when they happen.

Engineering company Aida was bought for the fund a couple of years ago with no analyst coverage, says Nash, but has since seen its share price treble. She adds: “Aida is still cheap at its current levels.

“It continues to have a very strong balance sheet, delivering on earnings and increasing dividends. It is a great story but it is one that the market hasn’t bothered to look at it.”

Artemis global fund manager Simon Edelsten says that approaching Japan from a global perspective can also give access to opportunities that are often overlooked by the domestic Japanese market.

The manager of the £33.9m Artemis Global Select fund gives the example of Japanese crisp producer Calbee, which only had two analysts covering it at the time of purchase. However Edelsten spotted an opportunity in the company’s recent deal to sell to emerging markets.

“Local fund managers would quite often miss something like this, thinking it expensive. This might be the case if all you think about is domestic sales in Japan but we thought it would get cheap quickly if they started selling in emerging markets. This is exactly what happened,” he says.

“Most investors on Calbee’s shareholder list were not Japan experts but emerging market consumer fans like us and very often they came to Calbee from a similar global understanding.”