Ian Cowie: this region is being heavily tipped. Time to buy or another false dawn?

Now the Japanese stock market is exploring 34-year highs, and bankers at Goldman Sachs trumpet a “transformational year” for Tokyo, investment trust shareholders should cautiously consider some exposure to the world’s second-largest equities exchange. But more than three decades after its main benchmark the Nikkei 225 index plunged from its all-time high, are things really looking up in the Land of the Rising Sun or is it all hype?

Fidelity International, the pooled funds giant, added its voice to the Nippon dawn chorus this week, when it claimed: “Japan is set to become the world’s economic bright spot in 2024.”

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Analyst Gita Bal explained: “Expectations for revenue and earnings growth are higher for Japan than for any other region. 

“Japan leads the pack when it comes to forecasts for capital expenditure, returns on capital, dividend increases, ability to pass on costs to consumers, and whether or not its companies will be in an expansionary phase of the business cycle by this time next year.”

Phew! Sad to say, this small shareholder cannot claim to detect any trickle-down effect yet from all this macroeconomic optimism via my modest stake in Baillie Gifford Shin Nippon Ord (LSE:BGS).

This £535 million investment trust has the dubious distinction of being the biggest and the worst performer in its Association of Investment Companies (AIC) ‘Japan Smaller Companies’ sector over the last year, five years and 10-year periods. Negative “returns” of  -22%, -26% and a positive 93% respectively earn BGS that unhappy hat-trick, when compared to sector averages of -7% and -10%, with too few participants to produce a meaningful figure over the decade.

Underlying holdings in the specialist engineer Nakanishi; the sports clothing brand Descente; and the motorcycle helmet-maker Shoei, seem plausible enough. But I fear BGS is suffering from the double-trouble of being an out-of-favour fund manager in what was until very recently an out-of-favour sector.

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It’s more than a decade since I bought these shares and I can remember happier times when BGS featured among my top 10 holdings by value. Here and now, I am grateful I took profits by selling parcels of stock worth much more than my current holding at 248p and 238p in February and July 2021, because they cost just 127p today. 

This illustrates an important truth for investors; it’s never too soon to turn paper profits into real ones. On a brighter note, Nippon Active Value Ord (LSE:NAVF) fund is the top performer in this AIC sector over the last year with an eye-stretching return of 23%.

Unfortunately, because NAVF was launched in February 2020, it lacks a track record over either of the other standard periods for comparison and its underlying portfolio could be described as inscrutable. Assets listed as “investments at fair value through profit or loss” account for 80% of the total, with “cash and cash equivalents” accounting for the other 20%.

Fortunately, underlying holdings are easier to assess at AVI Japan Opportunity (LSE:AJOT), the top performer in its sector over the more meaningful five-year period, with a total return of 31% and a one-year return of 5%. Launched in October 2018, it also lacks a 10-year track record.

The electrocardiogram maker Nihon Kohden accounts for nearly 10% of assets; followed by the clothing company TSI, then the boiler-maker Takuma, and the chemicals company Konishi; each with nearly 9% of the fund.

AJOT fund manager, Joe Bauernfreund, views the Tokyo market in a long-term perspective and points out: “Until now, the valuations and earnings potential of Japanese companies had been held back for decades by practices designed to maintain stability in the wake of the 1990s bust.

“This changed with the introduction of Abenomics in 2012, which ushered in an era of structural reforms, shareholder engagement and a focus on improving corporate value.

 “There are a plethora of wonderful small companies operating in niche markets with enormous barriers to entry. Being smaller, they have greater growth opportunities, both overseas and domestically as industries consolidate.”

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Against all that, it’s only fair to add that Shinzo Abe, Japan’s longest-serving prime minister, who introduced the economic reforms that bear his name, was assassinated in July 2022. Like so many before him, he did not live long enough to see the Nikkei index revisit the peak of 38,195  that it briefly touched in December 1989.

Part of the problem is longevity among the general population, with more than one in 10 Japanese now aged 80 or older and 29% of them aged 65 or older. That’s bad for economic output and consumption. But optimists may disregard jibes about another false dawn in the Land of the Rising Sun and hope that it really will be different this time.

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

Ian Cowie is a long-suffering shareholder in Baillie Gifford Shin Nippon (BGS) as part of a diversified global portfolio of investment trusts and other shares.