Japanese equities are back in the headlines.
The substantial market gains in recent years have drawn attention. So too did the unprecedented market volatility in early August 2024. Yen weakness has been a substantial influence, alongside ongoing corporate governance reforms (for our two-part analysis of Japanese boardroom activity and Japanese corporate culture overall, click here and here).
We see evidence that these reforms are well and truly taking hold, but we think there is more to do. This story has not yet fully played out and is expected to be one of the major drivers of Japan equity performance in the coming five to 10 years. Shareholder returns are being prioritised. Company boards are being improved. Non-productive assets are being sold. Special situations abound.
Elsewhere, a return to inflation is hugely significant, and in time may prompt a long-awaited return to a virtuous cycle of consumption and economic growth. Naturally, there are risks, so it it would be naive to think recent change will lift all boats. Changes in the economy and corporate governance landscape are not impacting all companies equally.
We are cognisant, therefore, that fractious markets might cause trepidation for prospective investors. As long-term investors, such bouts of volatility leave us unphased, however. Broadly speaking, fundamentals remain strong. There are causes for long-term optimism, and particularly for active fund managers.
We think there are strong reasons to consider Japan a stock-picker’s market. Good active management should position portfolios away from stocks that are adapting more slowly to ongoing governance reforms. Nevertheless, investment styles and related factor premiums are important. This supports the case for a more balanced approach to Japanese equities: a blend of a growth- and value-biased fund, or an all-in-one, more core-like approach. Below we present a handful of compelling Japan equity funds.
MAN GLG Japan CoreAlpha
In the large-cap value space, we draw attention to Man GLG’s Japan CoreAlpha fund. We see positives stemming from the combination of a well-structured, contrarian value investment process and the continuity provided by veteran portfolio manager Jeff Atherton, who took the mantel in January 2021. Since he took over as lead portfolio manager, he has made some important process enhancements, which have been applied to good effect. There is now a greater appreciation of catalysts that help drive rerating, including metrics such as return on equity and earnings quality, as well as corporate governance changes. These changes play directly into many of the themes discussed in this article.
Key Morningstar Metrics for Man GLG Japan CoreAlpha
• Morningstar Medalist Rating: Bronze
• Morningstar Star Rating: ★★★
• Fund Size: £2.2 billion
• Morningstar Category: Japan Large-Cap Equity
• Ongoing Charge: 1.65%
J.P. Morgan Asset Management Japan Equity
For large-cap Japanese growth equities, there are a number of strong options. We acknowledge many funds that invest in this area of the market have suffered from weak relative returns in recent years given the extreme market dynamics previously discussed. We stay long-term, but, where appropriate, have updated our views. On a forward-looking basis, we see optimism from many secular growth opportunities, which persist in areas relating to Asian premiumisation, automation, and online companies. We think growth-biased funds continue to serve a role for those looking to offset the style biases from a pure value fund. Here, we highlight J.P. Morgan Asset Management’s Japan Equity fund.
This fund benefits from a top-notch lead portfolio manager, a well-resourced supporting team, and a time-tested investment approach. The well-codified, quality-growth investment approach is long-established and has also been employed successfully across related JPM Asia-Pacific and JPM Emerging Markets equity strategies. Lead portfolio manager Nicholas Weindling has managed this strategy since 2007. He adheres to the strategy’s long-standing growth-oriented approach through various market environments and is unfazed by shorter-term headwinds. He has an impressive track record across multiple market cycles. This is one of the most well-resourced Japan-dedicated equity teams under our coverage, and the manager fully uses his best ideas and is often willing to pay high multiples for them.
As such, the portfolio’s average expected growth and return on equity, as well as its valuation, have consistently been markedly higher than the Topix. The approach has delivered solid long-term results, although it may also result in lumpy and volatile results at times, amplified by the strategy’s salient growth tilt. Indeed, the strategy faced severe stylistic headwinds since 2021, which put a dent in medium-term results. We remain confident it can add value over the long run for investors who can stomach recent setbacks.
Key Morningstar Metrics for J.P. Morgan Japan Equity
• Morningstar Medalist Rating: Silver
• Morningstar Star Rating: ★★
• Fund Size: £1.9 billion
• Morningstar Category: Japan Large-Cap Equity
• Ongoing Charge: 1.76%
M&G Japan Equity
For a more core-like option, there are a few funds we cover actively. The most popular of these in recent years is the M&G Japan Equity fund. Managed by Carl Vine, this fund takes a blended approach to investing in Japan. Both Vine and deputy manager David Perrett joined in 2019 after M&G acquired Port Meadow Capital Management, a pan-Asian long-short equity-focused hedge fund they founded in 2014. Almost the entirety of their experience has been in the pan-Asian long-short space, and so this Japan long-only mandate represents something of a change in tack.
However, the amassed research catalog and experience working to tighter risk budgets remain highly relevant and advantageous. The supporting team is large, and a unique element is Dr Ryohei Yanagi, the team’s corporate engagement consultant. As a drafting member of the Ito Review, Yanagi is inextricably linked with reform in the region. A “core universe” of around 700 names has been curated across Asia, and Japan represents roughly 250 of these. The team understands these businesses operationally, but, more importantly, has assessed these businesses on an ex-ante basis very effectively. Its unique valuation framework is built on mental modeling, rather than financial modeling, deriving expected value from scenario and probability analysis, rather than a hypothetical fair value from discounted cash flows.
Unlike many peers in the space, the team also isn’t wedded to any style, and aggregate portfolio positioning derives from bottom-up opportunities. We expect the portfolio to sit within the large-cap-blend portion of the Morningstar Style Box. The team’s engagement playbook is thoughtful, and its desire to be the “shareholder of choice” is amply evidenced. Performance has met expectations. We do, however, note that it has attracted vast inflows in recent years, and capacity is something we keep an eye on.
Key Morningstar Metrics for M&G Japan Equity
• Morningstar Medalist Rating: Bronze
• Morningstar Star Rating: ★★★★★
• Fund Size: £3.5 billion
• Morningstar Category: Japan Large-Cap Equity
• Ongoing Charge: 0.51%
IUP Zennor Japan
We also point to Zennor Japan as a potentially highly compelling equity proposition in Japan large caps, though with a mid-cap bias. We have followed this fund since its launch in 2021.
While not under active coverage currently, it rightly retains a spot on our prospects list. The fund is managed by two veteran investors in James Salter and David Mitchinson. They bring complementary skill sets. Salter is a renowned Japan value investor and was a co-founder of Polar Capital and longtime manager of the Polar Japan Equity fund. Meanwhile, Mitchinson is a growth investor, with experience spanning several reputable shops, including many years at JP Morgan. This duo makes for a strong pairing. Their accumulated acumen is a big part of the appeal, and alignment of interests here is strong. In a sense, it might best be explained as a special situations approach, investing across three “buckets”: overlooked assets, mispriced cash flows, and underearners. It plays directly into many of the themes discussed in this paper, while value-growth biases are kept in check. Performance has been strong to date, despite a bias to domestic earners and mid-caps. The duo also runs the Zennor Japan Income fund (launched in 2023), which we also have on our radar.
Key Morningstar Metrics for IUP Zennor Japan
• Morningstar Medalist Rating: Neutral
• Morningstar Star Rating: ★★★★★
• Fund Size: £509 million
• Morningstar Category: Japan Large-Cap Equity
• Ongoing Charge: 0.75%
AVI Japanese Opportunity
Finally, an investment strategy we are beginning to explore is the closed-ended AVI Japanese Opportunity trust (AJOT), which launched in 2018, and its open-ended UCITS sibling, the AVI Japan Special Situations fund, which launched in April 2024. This strategy invests only in small- and mid-cap Japan equities, and it takes an activist approach. This is a punchy portfolio of 25-35 stocks that sits firmly in the lower end of the market-cap spectrum. These are asset-backed opportunities where value can be unlocked via active engagement. Chief executive and chief investment officer Joe Bauernfreund is lead manager with support from a dedicated research team of six. Performance since the trust launched in 2018 has been strong, and the portfolio manager is in charge of his own destiny via his activist approach and significant margin of safety on valuations.
Key Morningstar Metrics for AVI Japanese Opportunity
• Morningstar Medalist Rating: N/A
• Morningstar Star Rating: N/A
• Fund Size: 197.7 million
• Morningstar Category: Japan Small/Mid-Cap Equity
• Ongoing Charge: 1.51%