Investors that have shunned Japan have, to some extent, been justified over the last 20 years but there are opportunities to be had, according to veteran fund manager Michael Lindsell. 
The manager of the five FE Crown-rated Lindsell Train Japanese Equity fund said that, on average, companies in the US and other developed markets are better than those in Japan.
“On an economy-wide base if you look at the returns on capital from the Topix index they are about half that of the rest of the world minus Japan,” Lindsell (pictured) said.
Indeed, over the last 20 years, the FTSE World ex Japan index has returned 338.82 per cent, while the Topix has made investors 157.24 per cent.
Performance of indices over 20yrs
Source: FE Analytics
“On the basis that over the very long term the return you expect to get from a company is going to roughly equate to the internal rates of return on capital, then there is very good reason why you might orientate your assets to somewhere where returns might be higher,” he said.
He points to countries such as the US, where the stock market is much larger, the country bigger and where returns on capital tend to be higher, as proving extremely popular with investors over the period.
“Some of that is because the economy grows a bit faster but a lot of it is because the companies are better in aggregate,” he said.
“If you want to go and look in Japan to find some great companies then you will find some but you might just find a lot more in the United States.”
“[However] that doesn’t mean to say that there isn’t a selection of companies in the Japanese market that might earn you far higher returns and it is our job to identify those.”
The manager said he is focused on finding great companies capable of delivering high returns on capital for long periods of time.
“They can generally do that because they have got a competitive moat around their business that others can’t readily break down,” he said.
While many of these companies are consumer franchises, the most common factor between the 22 holdings of the Lindsell Train Japanese Equity fund is their ownership of valuable intellectual property.
The manager added: “That could be a brand which lies behind the success of many of the consumer franchises that we have, it could be some media content or IP of that vein or it could be some software.
“The great thing about content or intellectual property is that it doesn’t cost an enormous amount of expenditure to create – just quite a lot of imagination – and if it can be protected it is generally unique and can earn very high returns on capital for very long periods of time.”
Intellectual property can be found in many sectors though one that may not be too much of a surprise to investors is healthcare, which makes up 21.2 per cent of Lindsell’s fund.
“In healthcare you will find companies that have systems that are unique to the company that people rely upon and provide repeat returns,” the manager said.
“If you are investing in a pharmaceutical company, clearly there is intellectual property that is patented that can earn very high returns for the period of time that the patent exists and those high returns can generate huge cash flows that can be reinvested to invent new products.”
One example is Hogy Medical, which provides surgical kits needed for operations to hospitals in Japan and makes up 5 per cent of the portfolio.
Performance of stock since launch
Source: Google Finance
Even the most basic operations require a number of instruments as well as gloves, gowns etc. that have to be sterilised and delivered to hospitals, he explained.
While this used to be done in-house by the hospitals themselves, employing staff to sterilise equipment was expensive to do on an individual basis.
“Instead of duplicating all that Hogy does this all in its own plant. It organises all these kits and sets up contracts with the hospital so all it has to do is order the kit for the operations. There is a logistics element to it,” Lindsell said.
“It is the leader in that industry and is signing up more and more hospitals and proving more utility to hospitals with the service behind the provision of those kits.”
The share price has responded with the stock up 84.77 per cent over the last five years, having struggled in the first five years of existence following its launch in 2006.
An area that may surprise investors, however, is media including software, which make up more than a quarter of the fund.
“Nintendo is the best example we have of a media company. What makes Nintendo unique is the franchises that it has built up over 30 or 40 years based upon cartoon characters it has invented like Mario, Pokemon, Zelda,” he said.
“There have been billions of interactions with consumers over time who have bought games and been entertained with the software.
“They have some association with the software that generally confers good feeling from them to buying the software again at some point in the future.”
This, he said makes the characters created by Nintendo some of the most valuable entertainment intellectual property in the world. “We think of the Nintendo characters as the Disney characters of the 21st Century.”
Performance of fund vs index over 20yrs
Source: FE Analytics
By using this approach of identifying companies with strong intellectual property, the manager has managed to outperform the index over the last 20 years, as the above chart shows.
The £187m Lindsell Train Japanese Equity fund has a clean ongoing charges figure (OCF) of 0.86 per cent.