Professional Adviser – Japan Sector Review
Hindsight in investment markets is a wonderful thing – and Japan is the latest example of this.
During 2013 one of the best developed equity markets for investors was Japan driven on largely by the economic reforms of Prime Minister Abe, but it’s easy to see that in retrospect.
For a lot of advisers they had been hearing the story from fund managers that Japanese equities were about to recover since the turn of the century.
There have been a number of false dawns and short term rallies in that period but the main benchmark index, the Nikkei 225, is still less than half its peak level of over 39,000 in November 1989, so it is understandable why professional investors remain sceptical.
But a look at the three year performance figures from PureResearch shows why investors are being drawn back to the sector, but the question is will some of the top performing funds over the last three years perform well going forward?
The table of top performers makes fascinating reading because the top fund, by pure performance, over the three years to the end of December last year was the Legg Mason Japan Equity fund, which is unique for the being the top performing fund in two of the three previous discrete years as well as the top fund over an annualised three year period.
This is unusual because in most sectors the three year best performing fund is not always the same as the fund which is the best performer in each of the three preceding individual years.
The question for investors already invested in the Legg Mason fund, or looking at it based on its strong past performance is can it replicate that going forward?
Advisers can look at the Morningstar rating for the fund, which is based on quantitative criteria, and like many of the other rating models is largely retrospective.
Or they can combine this view with a ‘forward’ looking view which can be based on their own research, which may include an interview with the fund’s manager, or they can consider the PureResearch Forward Perspective Rating, which provides a 12 month view, based on statistical and economic data.
In this instance the Legg Mason fund is rated a 5 by PureResearch, meaning it is likely to a top quartile performer, because in a momentum driven market, which Japan currently is, it performs well.
Contrast this with the second best performing fund over three years to the end of December, the iShares Nikkei 225 ETF, where you see the difference between an actively managed and passive product.
The iShares ETF returned just over half what the Legg Mason product did over the three years, but according to the PureResearch analysis is rated only a 2 for the coming 12 months indicating that while it may be cheaper than actively managed funds it could disappoint in performance terms.
The difference between ratings and analyses systems is most obvious when analysing the top 20 funds using Morningstar’s own methodology and comparing it with other research organisation or services such as PureResearch and looking for funds which appear in more than one table.
The Baillie Gifford Japan investment trust is rated highly by Morningstar’s research team based on its performance and the qualitative assessment of the fund manager, and it also achieves the highest rating at 5 from PureResearch. Similarly Schroder Japan Growth is another fund rated highly by both groups, using different analysis systems.
When constructing an allocation to Japan as a sector it could be an approach to consider some of the funds which have struggled over the last few years but using a forward looking perspective are likely to perform well in the coming 6-12 months.
In addition, some of the most popular Japanese equity funds are close to capacity so it could be prudent for advisers to consider funds they are less familiar with but which have strong forward looking potential.
The Neptune Japan Opportunities Fund has had periods where its performance has matched that of the Legg Mason Japan Equity fund, but unfortunately for Neptune investors that has not been the case in recent years and the fund has struggled.
But in such a strong momentum driven market the PureResearch analysis would suggest the Neptune fund is worth reconsidering because it is rated 5 as a top quintile pick for the forthcoming 12 months.
Other funds in the sector which advisers may not be immediately familiar with but the PureResearch analysis suggest are worth considering are those run by Capital Group and Polar Capital. Capital International Japan Equity improved its solid rating of a 3 up to a 5 over the course of 2013 and looks set to retain this for 2014, while the Polar Capital Japan Fund which is in the table of bottom 20 funds as ranked by Morningstar, is ranked 4 using PureResearch Forward Perspective methodology.
The universe of Japanese funds – opened ended, closed ended, and exchange traded – is relatively small at only 72 funds with 238 share classes – the challenge of selecting the best ones going forward is difficult.
But Japanese equities is clearly an asset class where a mixture of all 3 fund structures will provide the best balance between risk and return and cost going forward.