Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Archie Ciganer, Manager of T. Rowe Price Japanese Equity Fund.
Hello, Archie.
Archibald Ciganer: Hi, Emma.
Wall: So, firstly, I should congratulate you on the 2016 performance of the fund, up 32% and ask what were the tailwinds to that performance.
Ciganer: Thank you very much. Yes, I do think 2016 was extremely good year for the fund. We had a number of tailwinds obviously. In particular, in the beginning of the year, the Bank of Japan introduced negative interest rates which really surprised markets and shocked, I would say, shareholders of financial companies. And thankfully, we did not own any banks, have very little exposure in financials for various reasons. But this was definitely a tailwind because that sector underperformed a lot.
After that, in general, quality stocks had good performance until right after Brexit and the fund is always overweight quality effectively. On top of that, we had a number of individual stock picks that went really well. Then even after Brexit when the growth tailwind kind of faded away and we had a rotation into value, our performance actually continued to be adequate mostly because of individual stock picking. And so, that's why we were able to end the year with a fairly good number, yes.
Wall: For investors trying to follow the Japanese story, it's very difficult to get a handle on what drives this market, partly because of the negative economic news that comes out of Japan. Now, we're always taught as investors that economies and markets do not necessarily have any kind of correlation, but it's particularly true in Japan. You've got very low GDP growth, GDP per capita falling, population size is falling, very little inflation and yet, the stock market goes seemingly from strength to strength. So, why is there this disconnect in Japan?
Ciganer: Well, first of all, I think you make a very good point that is, our fund underestimated by most investors, I think, maybe because Japan is far away and not as well-known. There's a tendency to think that the economy and the market are going to go hand-in-hand together. That's not the case as you said. And actually, if you look at the composition of the market, it's fairly easy to understand why.
One example, Toyota is the biggest index weight with about 4 or 5 points of the market. Toyota is a global company. It really doesn't matter how many cars they sell in Japan in terms of stock performance. And I could go down the list, but essentially, the market is heavily weighted towards multinational companies and that is why there is very little influence there.
Actually, the economy that impacts the Japanese market the most is the U.S. economy. So, I do spend time following macro developments in the U.S. And effectively, what happened last year was that the outlook for the U.S. did improve. There was more optimism and that's one reason why the Japanese stock market did well last year.
Wall: Looking forward then, perhaps in the U.S. in order to give some indication of what to expect in Japanese stock market, there's a lot of uncertainty there with a new President at the helm. What can shareholders of Japanese equities expect the next sort of 12, 24 months?
Ciganer: I think there are two factors here at play or two different timeframes. Right now, the outlook for Japan is very positive or at least sentiment towards Japanese equities is very positive, because both the cyclical aspect, which is, effectively the strength of the global economy and the U.S. economy, the indicators are green and the structural aspect, which is the improvement in the quality of the Japanese market, is also pointing in the right direction. Now, we need to be a bit prudent, especially with regard to the enthusiasm about global macroeconomic growth. So, that's one area where I'm a bit cautious and I'm not so certain that in the very short term Japanese equities can continue to perform just because there's so much enthusiasm right now.
That being said, the second aspect, which is the structural aspect, I think is very interesting and still pointing in the same direction. And by that, I mean that the quality of the market and the quality of the governance for Japanese companies, the level of returns delivered by Japanese companies, all of that is sort of in a catchup phase compared to the U.S. and Europe. And for some of these improvements, there's effectively no coming back.
Shareholder returns are improving, the level of returns is improving. Even on a cyclically adjusted basis, Japanese companies are run better than they used to be and this improving trend will continue I think over the next two years. So, barring – there might be a short-term blip, it might be a nice entry point for people who haven't looked at Japanese equities before. But over the medium-term, I remain fairly constructive on the Japanese market.
Wall: Archie, thank you very much.
Ciganer: Thank you very much.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
