By David Randall
NEW YORK Jan 11 Institutional investors have
been increasing their holdings in Japan's surging stock market,
yet investors might want to keep a narrow focus when adding
exposure to Japan.
That's because the more than 25 percent jump in the Nikkei
index since mid-October is largely the result of new Prime
Minister Shinzo Abe's intense pressure on the Bank of Japan to
double its inflation target to 2 percent. The move, aimed at
breaking Japan's long cycle of deflation, would weaken the value
of the yen and could help make Japanese exports more
Markets have begun pricing in the policy, similar to the
U.S. Federal Reserve's rounds of quantitative easing. That has
sent the dollar up more than 12 percent against the yen since
November, hitting a 2-1/2-year high. A Reuters poll of currency
strategists conducted last week, meanwhile, suggested the yen is
expected to fall further throughout 2013. A falling yen makes
Japan trickier for dollar-based U.S. investors. Even as stock
prices go up, a falling yen eats into returns.
"It's a Catch-22 over there: The market only does well when
the yen is weakening and ... that's not great because it hurts
the currency translation," said Alec Young, a global equity
strategist at S&P Capital IQ.
What's more, Japan has yet to tackle the structural problems
of an aging population and massive debt that have sidelined the
Japanese stock market and economy for nearly a generation, fund
managers and analysts say. That will likely put a limit on any
Japan approved a $117 billion economic stimulus package on
Friday, pushing the Nikkei up 1.4 percent. For those who do want
to chase the market, a two-pronged strategy of targeted buying
of exporters, such as automakers, that might see their earnings
rise in real terms while simultaneously shorting the yen could
provide a way around Japan's Catch-22, analysts say.
STOCK FOCUS, WITH HEDGES
The difficulty of simply investing in a Japanese-focused
stock mutual fund is reflected in their returns. The
top-performing, dollar-based Japan funds returned between 10
percent and 12 percent last year - underperforming the benchmark
S&P index return of 13.4 percent - even though the Nikkei itself
gained about 25 percent, according to Lipper data.
Investors should look instead for funds that take a broader
bet on Asia or have currency hedges in place. One option: The
$437 million Matthews Asia Growth fund, which charges
$1.19 per $100 invested and whose annualized returns of 4.2
percent over the last five years put it 6.6 percentage points
ahead of its category average. It returned 17.4 percent over the
Fund manager Taizo Ishida recently increased his stake in
automakers such as Honda Motor Co Ltd and Toyota Motor
Corp. These companies will likely see their earnings
rise, even after accounting for the depreciating yen, as a
result of the monetary policy changes and increasing exports to
countries such as India and the Philippines, he said. Honda,
which he added to the portfolio in the most recent quarter, has
lagged its competitors, which he believes makes it the most
likely to outperform over the next year.
Honda is up nearly 6 percent so far in 2013, trades at a
price to earnings ratio of 18 and offers a dividend yield of 2
Other investors are looking at exporters of consumer
staples. While he remains skeptical about Japan's long-term
outlook, Brett Gallagher, deputy CIO for Artio Global Investors,
recently increased his allocation to Japanese stocks by 3
percentage points because of the expected monetary policy
changes. He likes Unicharm Corp, a company that gets
about 27 percent of its revenues from selling diapers and
feminine care products to China and other Asian countries. The
company is up 20 percent over the last year and trades at a P/E
"This is one of those companies that is in Japan, but
doesn't depend on Japan to be successful," he said.
Select banks may be another option for investors hoping to
benefit from the monetary stimulus, said Andrew Sleeman,
portfolio manager of Franklin Templeton's $38 million Mutual
International Fund, which hedges for currency risk.
One of his largest positions is in Aozora Bank Ltd,
which fell 10 percent on Jan. 7 after reports that private
equity firm Cereberus planned to reduce its stake in the
company. The company will likely benefit from rising real estate
prices that come as a result of the falling yen, which could in
turn generate new rounds of lending, he said.
Some investors who have been short the yen see no reason to
change their strategy.
Brian Hess, a fixed income manager at Brandywine Global, has
been shorting the yen for more than a year.
"The only way forward we see is a very aggressive, Fed-style
policy of quantitative easing," he said.
He's also shying away from Japanese corporate and bonds
because of their relatively low yields.
Investors who want to take a bet on the direction of the yen
could also opt for the WisdomTree Japan Hedged Equity ETF
, a $1.4 billion fund that costs 48 cents per $100
invested. The fund, whose returns are listed after the currency
conversion, is up 19.3 percent over the last year.