The sun could at last be rising on Japan this year

The market could be a wise investment but is not without its risks

JAPAN could be this year’s comeback kid for investors. The fundamentals are coming together: shares are soaring (the Nikkei notched up 19 per cent gains between January and March, and topped 13,000 for the first time since 2008), household spending saw a year-on-year increase of 5.2 per cent in March, and the authorities are enacting a huge monetary and fiscal stimulus package. Together with new Bank of Japan governor Haruhiko Kuroda, Prime Minister Shinzo Abe is trying to kick-start Japan’s economy through a brazen combination of fiscal spending and a massive quantitative easing (QE) programme to try and achieve a target of 2 per cent inflation.

Investors have been negative on Japan for years and with good reason. Aside from a few spurts of good performance, the market has had a torrid time for the last 30 years. But Abe’s aggressive economic stimulus has sparked an equity rally, leading Fidelity’s Trevor Greetham to name the country his favourite market. “Signs of a recovery in confidence are already evident,” he says. So if you’re among those feeling confident, where should you turn?

There are three main avenues open to investors looking to gain exposure to Japan: individual shares, a passively managed or tracker fund, or an actively-managed fund. The first presents a number issues for UK investors, in terms of accessing foreign markets, the cost of doing so, and the research involved. Tracker funds – which mirror stock market indices – have become more popular among investors since the beginning of the year, and remove most concerns over cost or research. But Darius McDermott of Chelsea Financial Services views them negatively, saying that “in all markets, tracker funds are structurally obliged to under-perform, even if only by a small amount. Investors should think, when buying a market, that they’re buying the good and the bad, the value, the growth and the cyclicals in one package.”

McDermott favours the third option, and more specifically the Legg Mason Japan Equity Fund – a mid and small cap growth fund that is up 77 per cent over one year, and 123 per cent over three years. “If you look at the average fund – which is up 15 per cent – it is massively ahead.” Before investors jump in at the deep end, however, it is important to remember that if a fund has the potential for huge gains, the market turning against it will incur huge losses.

And while smaller growth-oriented companies have performed better than the larger and medium-sized value stock, Richard Troue of Hargreaves Lansdown thinks those larger businesses, which have been left behind so far in the rally, “could start to catch up as time goes on”. For that reason, he recommends GLG Japan Core Alpha, which focuses on those larger-sized companies. Its growth over the past year has been 25.86 per cent, which Troue thinks is set to increase. McDermott likes the Jupiter Japan Income fund, which is “not specifically an income fund (as Japan is not the biggest yielding market). But it’s got a value tilt and its managers are looking for stocks that either yield or will have a prospective yield.” Another option is the Invesco Perpetual Japanese Smaller Income Fund, which returned 35.6 per cent in the first quarter of 2013. But whatever your approach, it is important to ensure Japan only forms part of a much wider, diversified portfolio.

Why, beyond the obvious importance of diversification? Because scepticism still surrounds the market, and Japan has experienced a number of false dawns. At 13,861 yesterday, the Nikkei is still far from its December 1989 peak. While the experts don’t anticipate any change in direction in the next three months, Japan’s upper house elections in the summer could rock the boat if the incumbent party performs badly. And, says Troue, “there is a fear that, after such a strong run in the market – in the region of 40 per cent in currency terms – some investors might start to take some profits.”

The potential for high gains and is high risk means now could be a good time for people to dip their toe back in the market by “adding a couple of per cent to their portfolio,” says McDermott. And Troue believes the more confident, risk tolerant investor could add as much as 10 per cent. But this is far from the 20 per cent investors may have held in Japan 30 years ago. To mitigate risk, Troue offers two approaches. The first is to avoid rushing in and committing too much capital early; the second is to drip money into the market over a period of, for example, six months. “If you have £6,000, invest £1,000 per month over the next six months, to smooth our any shorter term volatility.”

But there may be more exciting opportunities elsewhere. McDermott says he always advises clients to consider investments that either have strong momentum, or are cheap. European equities are still good value, with the market performing well over the past six to 12 months. Meanwhile, US equities have such momentum that McDermott thinks investors should take another look.