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Fund Review: Investors eyeing smaller prospects in Japan

Fund Review: Investors eyeing smaller prospects in Japan
Monthly net retail sales into the IA Japanese Smaller Companies sector

Japan may not yet be out of the woods in terms of its bid to restore inflation and economic growth, but the latest tenure of prime minister Shinzo Abe has certainly seen the country’s prospects improve

The main driver has been Mr Abe’s willingness to embrace reform in the shape of ‘Abenomics’, and with a recent rule change by his political party allowing a leader to serve up to three consecutive three-year terms instead of two, this could potentially see Mr Abe remain as Japan’s leader until 2021. 

The question is whether this stability could help Japanese smaller companies, which have endured a volatile 12 months. 

Naoki Kamiyama, chief strategist at Nikko Asset Management, points out: “The situation in Japan has changed following the Trump rally of last November. Investors are more interested in Japan as a beneficiary of global growth. A stronger US dollar is expected, not because of the Bank of Japan [and the weak Japanese yen], but more because of interest rate hikes in the US.

“The small-cap space is still preferred [by] some investors concerned about protectionism from the US, but many so far are optimistic about the Trump administration, which seems to have moderated its protectionist policy measures.”

Mr Kamiyama continues: “The country as well as style choices [large or small caps in this case] are unclear now as many investors are still on the sidelines awaiting a firming up of US policy sets. I believe the less protectionism that we see, the more large caps will benefit in 2017.”

Alex Blake, client manager on the Shin Nippon investment trust, notes the Bank of Japan’s decision at the start of 2016 to increase purchases of exchange-traded funds linked to mid- and large-cap indices led to a rotation away from small-cap companies. This was then followed by the Brexit vote, which saw Japanese small caps “hit particularly hard as investors sought refuge in ‘safe’ stocks”. 

He adds: “High yielding stocks with dull growth prospects did quite well in this environment. The result of the US election in the latter half of last year arguably had the biggest negative impact on the share price of high-growth, small-cap stocks. [But] we believe [these] companies have the ability to grow at high rates irrespective of macro headwinds or sluggishness in the domestic economy. This is because these firms typically target large domestic profit pools, have a disruptive business model and generally compete with traditional slow-moving incumbents.”

Meanwhile, Nicholas Weindling, portfolio manager on the JPMorgan Japan Smaller Companies Investment Trust, highlights that earnings forecasts for Japanese companies have been revised up sharply, backed by a pick-up in the global economy and a weaker Japanese yen versus a few months ago. 

He says: “The interest rate environment has also improved for Japanese banks. The outlook for inflation is gradually improving, driven by a tight labour market and rising commodity prices. Corporate governance continues to be a major focus in Japan, [and] in 2016 share buybacks totalled a record high of ¥5.2trn [£37.4bn].”