Japanese equity managers at JO Hambro Capital Management (JOHCM) and Invesco Perpetual are struggling to balance their portfolios, citing expensive defensives as a key concern.
Tony Roberts, who manages the Invesco Perpetual Japan fund alongside Paul Chesson, said market valuations in the country had made it difficult to adjust to a changing economy.
He said: “We have been getting more cautious on the outlook and are slightly more negative on the economy and stockmarket.
“It is difficult to find defensive sectors because of value.”
Japan’s economy contracted by an annualised 1.2 per cent in the second quarter, and further falls are anticipated for the rest of this year, leading to calls for a ramping up of both fiscal and monetary stimuli.
The country’s equity market had enjoyed a strong start to the year but this has tailed off in recent weeks.
Ruth Nash, manager of the JOHCM Japan Dividend Growth fund, suggested it was defensive stocks that had been driving performance at the start of 2015.
Like Mr Roberts, Ms Nash said elevated valuations had meant she had been unable to buy into defensive areas earlier this year.
Instead, she had been buying cyclical stocks, a decision she acknowledged had affected her fund’s relative short-term performance. But she added that valuations of riskier companies looked too attractive to ignore.
“We think cyclical valuations are so extreme that something has to give and share prices should start to move up,” Ms Nash said.
This represented a point of divergence for the managers as Mr Roberts claimed it was “too early to go back into cyclicals”.
Their belief that defensives have become too expensive has proved a painful one in recent months as valuations on these stocks continue to appreciate.
In the 12 months to the end of August, Ms Nash’s fund returned 9.1 per cent, while the Topix 100 index rose 12.9 per cent, the portfolio’s latest update shows.
Mr Roberts’ fund delivered 15 per cent in the period, ahead of its Investment Association Japan sector benchmark’s average return of 13%, though performance has dipped in the past quarter.
He said the £316m fund had struggled in 2015 due to overexposure to steel, but he was confident long-term conviction positions in stocks such as Nintendo would prove fruitful.
Mr Roberts identified Japanese utility firm Chubu Electric Power as an example of a defensive play that was trading at a reasonable value.
The manager said the gradual switch back to nuclear power in the country, as well as falling oil and gas prices, would help the company’s earnings and dividends.
His fund has 5 per cent allocated to electricity supply stocks, but he remains concerned over value in comparable areas.
Ms Nash has none of her fund in either the food or transportation sectors, making these defensive areas underweights of 3.8 and 4 per cent respectively. But she is more confident in her cyclical plays, in part because of her dividend focus.
The manager said that on average the food sector was yielding just 1.6 per cent, while iron and steel – in which she has a 3.7 per cent overweight – has yielded 4.9 per cent.
Mr Roberts continues to hold carmaker Honda, in spite of his general concerns over such stocks. He swapped rival Toyota for Honda in 2014, but the firm has since been marred by manufacturing defects and car recalls and is trading at a discount to Toyota.
