Both the high-octane Legg Mason IF Japan Equity and quality-focused Lindsell Train Japanese Equity funds boast attractive qualities, according to several investment professionals, although both come with caveats that investors should consider carefully.
This comes following growing confidence in Japanese equities from many industry commentators, as prime minister Shinzo Abe’s economic reforms are expected to benefit shareholders in the years ahead.
While the Topix has indeed overtaken the global indices over recent months, many believe the market still has much further to run.
In an article published last month, Shore Financial Planning’s Ben Yearsley told FE Trustnet that Japanese equities are cheap from a price-earnings ratio perspective and also have a far higher dividend cover than many of their equivalents listed elsewhere.
“I think Abe’s reforms are promising,” he said. “There appears to be some inflation coming through into the system – they’re not going to hit their target but it’s still better than nothing.
“They’ve realised the negative yields on the Japanese government bonds are basically bonkers and actually I think it’s a really exciting time.”
Given the wide variety of investing styles within the IA Japan sector, we decided to pit two highly-rated and top-performing Japanese equity funds – with diametrically opposed investing styles – against each other and ask the opinions of investment professionals.
The first fund we chose was Hideo Shiozumi’s five crown-rated Legg Mason IF Japan Equity, which is £746m in size and has a concentrated portfolio of 43 stocks. These holdings are typically further down the cap spectrum and have been chosen based on the manager’s belief that they will benefit from the ongoing economic reforms in Japan.
Shiozumi adopts an aggressive, high-growth approach to investing. Over the last decade, the fund has significantly outperformed all other funds in the sector with gains of 424.3 per cent.
Performance of funds vs sector and index over 10yrs
Source: FE Analytics
However, it has done so with a maximum drawdown – which measures the most money lost if bought and sold at the worst possible times – of 42.1 per cent, compared to its average peer’s drawdown of 22.68 per cent. Its worst year over the last decade was 2007, when it fell 34.27 per cent compared to the Topix’s loss of 8.04 per cent.
We compared this fund to Michael Lindsell’s five crown-rated Lindsell Train Japanese Equity fund, which has £170m under management and also has a concentrated portfolio of stocks.
However, the manager adopts an entirely different investment process from Shiozumi, in that he has a focus on high-quality and well-known large-caps with strong branding power and well-established competitive advantages.
As such, the fund has not quite shot the lights out in the same way as Legg Mason IF Japan Equity over the last decade with gains of 168.13 per cent. However, it has comfortably outperformed its average peer and benchmark and has done so with a maximum drawdown of 23.62 per cent.
performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
For investors who are looking to increase their exposure to Japanese equities, which of these investment vehicles and styles do industry commentators find favourable?
Rob Morgan, pension and investment analyst at Charles Stanley Direct, said one commonality between the vehicles is that both managers operate a ‘buy and hold’ approach rather than being traders of stocks. In terms of investing in Japan generally, he said a weak yen, corporate reform and relatively low ratings on Japanese shares could mean further gains.
“The high level of tech and biotech and healthcare stocks in Legg Mason Japan means the fund is significantly influenced by sentiment towards these sectors. It can be particularly volatile as a result and often close to the top or bottom of its peer group over a given time period,” he pointed out.
“Both funds have very particular styles and would actually work well blended together as there would be no overlap in the portfolios. I like both funds but if I had to pick one I’d go for Legg Mason Japan.
“It requires patience and a tolerance for high volatility but the manager has shown he is able to successfully identify high-growth companies and generate very strong returns in a market not noted for its growth characteristics.”
Adrian Lowcock, investment director at Architas, is also positive on Japanese equities as corporate earnings in the country are being driven by top-line sales growth, the consumer is spending again and corporate guidance remains conservative.
In terms of the funds in question, he said investors should expect greater volatility from Legg Mason IF Japan Equity fund given its smaller cap bias.
“The Legg Mason fund tends to be very volatile - when it does well it does exceptionally well, but it also can lose investors a lot of money when it underperforms,” he warned. “Both are fairly concentrated with Legg Mason at up 40 stocks and Lindsell train closer to 20.
“I would go with the Lindsell Train: the fund is less volatile and capital preservation is an important driver of long-term returns. The fund is just not as risky whereas the Legg Mason fund is too risky to promote to investors.”
Jason Hollands, managing director at Tilney Group, said Japan is a market that is under-researched by investment banks and consequently provides real opportunities for active managers.
While Japanese value-focused funds have tended to outperform over the long term, he said growth funds – particularly those that invest further down the cap spectrum – have led the way over recent years.
“The Legg Mason IF Japan Equity and Lindsell Train Japanese Equity funds are very much chalk and cheese,” he said. “The former takes a high-octane approach with significant exposure to small and mid-cap companies and a focus on ‘New Japan’ sectors such as healthcare and technology.
“In contrast, the Lindsell Train fund, in common with other Lindsell Train funds, targets high quality growth companies and has a low turnover approach. These are often strong consumer brands, which make up 45 per cent of the portfolio, which includes the likes of cosmetics firm Shiseido and games giant Nintendo.
“Both funds have their merits and are likely to appeal to different types of investors depending on their risk appetite. Personally, I prefer alternatives such as Baillie Gifford Japanese Equity and CF Morant Wright Nippon Yield.”