Japan Inc. is back in business, but a careful approach is needed if you plan to buy in now.
Japan's Nikkei 225 stock index is up about 35 per cent this year, making it one of the strongest markets in the world. Think the TSX has been strong lately? Its 5-per-cent gain in the past month is impressive enough, but the Nikkei was up more than 8 per cent over the same period.
Foreign investors have helped push the Nikkei higher, but there are signs that the market is being driven by more than just global hot money. Japan's own citizens are pitching in, too, in a reversal of their past preference for more conservative investments. A recent report in the International Herald Tribune said holdings in domestic Japanese equity mutual funds have jumped by 30 per cent this year to the highest level since 1991.
The Canadian stock market may have a bit more juice in it after three consecutive bang-up years, but smart investors have to be looking for the next big thing. Is it Japan?
Maybe, but jumping on this bandwagon now is a risky manoeuvre because of how far the Japanese market has come, because of its volatile recent history and because there are still concerns about the economic rebound that has fuelled the Nikkei rally.
For all these reasons, the best approach is to forgo the many mutual funds, closed-end funds and exchange-traded funds that focus exclusively on Japan and instead look at either a broadly diversified global equity fund with a strong presence in Japan or an international index fund with a heavy Japan weighting.
The risks involved in the Japanese market were on display this past Thursday, when the country's stock market fell a stiff 301 points, or almost 2 per cent, as a result of profit-taking. Of course, sharp declines are nothing new to Japan's stock market. It was back in December, 1989, that the Nikkei hit its record high of 38,916, which is a scary number when you realize that the index is now trading around the 15,200 mark. That's right -- the Nikkei has risen by more than one-third this year and it's still nowhere near its level of a decade and a half ago.
Something else to consider is that the Nikkei has shown a tendency to rally strongly since 1989 and then fall back further than it rose. This is the type of pattern that can make suckers out of unwary small investors who buy after a big run-up like the one we've seen this year.
Neil Murray, an investment adviser with BMO Nesbitt Burns who has a special interest in Japan, said he first recommended investing in the country back in June, 2003, when it was utterly out of favour. Since then, the Nikkei is up about 66 per cent, compared with 28 per cent for the S&P 500 and 59 per cent for the S&P/TSX composite index.
"I would have preferred that investors take a position in Japan two years ago," Mr. Murray said in an e-mail. "There is probably further upside ahead, however investors should expect a consolidation at some point, which may make for a more attractive entry point."
If you're comfortable keeping an eye on the Japanese market and waiting for a pullback, then that's probably the way to go. But if you want to get in now to capitalize on the momentum that is clearly still present in Japanese stocks, then check out the handful of global equity funds that currently emphasize Japan while offering risk-reducing diversification into other parts of the world.
Using the ProStation fund and stock-screening tool on the Globeadvisor.com website, I was able to find nine global equity funds with at least 20 per cent of their assets in Japan.
Oddly, the fund with the biggest weighting in Japan is also the fund on the list that is most appealing in a general sense because of its all-around steadiness. It's Mackenzie Cundill Value (version C) and as of Nov. 30 it had 39.2 per cent of its assets invested in Japanese stocks.
To be upfront, I'm a happy unitholder of this fund. Lots of other people like it, too, including Mr. Murray and Ranga Chand, an economist and fund analyst who twins Cundill Value with the Trimark Fund in the prepackaged fund portfolios he has designed for clients of the on-line broker BMO InvestorLine.
Mr. Chand praises Cundill Value's emphasis on bargain-priced, overlooked stocks and its strong performance in down markets. While the past five years have left the average global equity fund with a compound average annual loss of 3.2 per cent, Cundill Value gained 9.7 per cent a year. In the past 12 months, its 16.2-per-cent return beats the average fund's 9.4 per cent.
Another virtue, according to Mr. Chand, is that Cundill Value provides significant exposure to the Japanese market with less risk than a dedicated Japan fund.
"Japan certainly is doing well now and it seems to have its act together in terms of its economy," he said. "But from a longer-term perspective, it still has some problems. It has a very large fiscal deficit, it has a very large debt-to-GDP ratio and it has a rapidly aging population.
"So what I would say to investors is that Japan definitely has a role to play in your portfolio, but the smartest thing really is a global equity fund."
A few other funds have parlayed big Japan weightings into top returns in the past while, notably Dynamic Power Global Growth Class. With almost one-third of its assets in Japan, this fund has returned 19.3 per cent in the past 12 months and 14 per cent in the past three years (the fund lacks a longer track record). AGF Aggressive Global Stock is the strongest of the Japan-focused global equity funds in the past 12 months with a return of 22.9 per cent, but it lost money over the past five years.
An alternative to a global equity fund for Japan exposure would be an exchange-traded fund that tracks the Morgan Stanley Capital International Europe Australasia Far East (EAFE) Index, in which Japan has a weighting of just over 20 per cent.
There are two such ETFs, the TSX-listed iUnits International Equity C$ Index Fund (XIN) and the iShares MSCI-EAFE Fund (EFA), which trades on the American Stock Exchange. The iUnits fund offers currency hedging so your returns aren't undermined when the Canadian dollar rises against foreign currencies, but its management expense ratio of 0.5 per cent is higher than the 0.35 per cent of the iShares fund.
International equity mutual funds do the same thing as the EAFE index in providing exposure to stock markets outside North America, and they typically have weightings in Japan of 20 to 30 per cent. The problem with these funds is that returns tend to be worse than those from the global equity category, which include varying amounts of U.S. stocks. International equity funds have also shown a tendency to underperform the EAFE index on average.
If you insist on jumping directly into the Japanese market, then two easy choices are Japanese equity mutual funds or ETFs. Japanese equity funds haven't attracted much in the way of assets, but the top Japan ETF is on fire these days.
The NYSE-listed iShares MSCI Japan Index fund (EWJ) now generates daily trading volumes of between 20 million and 40 million units, which makes it one of the three or four most popular of the 230 ETFs available to North American investors.
Looks like Japan Inc. is indeed back in business.
Big in Japan
Here are eight global equity funds that offer a heavy weighting of Japanese stocks along with diversification across the world.
Dec 29, 1989:
Nikkei closes at a record high
38,915.87
Sept. 21, 2001:
Japanese stocks continue to plummet on concern terrorist attacks of 9/11 will devastate U.S. demand for overseas goods.
9,554.99
April 25, 2003:
Nikkei falls to 20 year low as Sony reports a fourth quarter loss that is triple some analysts' estimates.
7,699.50
| Rank | Fund names | MER% | % of assets in Japan* | Year to date% | 3 year % | 5 year % |
| 1 | AGF Aggressive Global Stock | 3.12 | 21.3 | 21.67 | 11.64 | -8.96 |
| 2 | Dynamic Power Global Growth Class | 3.69 | 31.5 | 12.45 | 13.99 | |
| 3 | HSBC Global Equity-1 | 2.54 | 24.0 | 6.21 | 1.82 | -8.19 |
| 4 | imaxx Global Equity Growth | 2.87 | 24.1 | 10.54 | 5.68 | |
| 5 | Mackenzie Cundill Value C | 2.52 | 39.2 | 11.20 | 16.65 | 9.65 |
| 6 | Mackenzie Select Managers | 2.54 | 21.3 | 10.21 | 7.79 | -5.71 |
| 7 | Northwest EAFE | 2.90 | 20.0 | -0.71 | 3.38 | -8.37 |
| 8 | Renaissance Global Growth | 2.77 | 35.1 | 11.01 | 5.03 | -9.50 |
SOURCE: GLOVEADVISOR.COM
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