Top-ranked Japan Equity funds: Three-year performance
Top-performing Japanese equity funds over the past three years have
witnessed a wide disparity in performance, with returns ranging between
a positive 0.3% and negative 17.3%. Overall, it is quite disheartening
for investors to see that the majority of these funds have lost money.
Nevertheless, these figures actually compare favourably with the larger
Topix Index loss of 25.4% over the same period.
In our recent reviews with Japanese equity managers, they have not been painting too rosy a picture for the near-term either, given domestic pressures in Japan such as weak consumer demand, excess capacity and deflation fears, and not to forget the frail demand felt by its export-oriented companies. A mix of new initiatives by the newly-elected Democratic Party of Japan and a quick global economic recovery could provide a good boost to the Japanese economy but it is too early to tell.
Good use of risk
The only fund in the list to generate positive returns has been Fidelity’s Japan Advantage, although it only just managed to keep above water with a meagre 0.3%. Its risk-adjusted return has been negative for the period but it is still higher than that of the Topix and suggests its manager has used risk relatively well.
But Ronald Slattery has only run the fund since February 2007, so he cannot take full credit for the fund’s three-year record (before Slattery, it had been run by Hokeun Chung since its launch).
He has driven the fund to good results over his tenure, particularly given the challenging market environment which followed shortly after he took charge. He had a promising start in 2007 and relative performance got better in 2008 as his fund resided in the first percentile of its Morningstar Japan Large-Cap Equity category.
Although it shed 1.8%, it was 25% ahead of the Topix. Slattery is supported by a large analytical heft at Fidelity of more than 30 Tokyo-based analysts and we are pleased to see him making good use of the resources at his disposal.
Damage control
Invesco Japanese Equity Core has also been one of the top-performers over three years. Although it shed 6.1%--and any capital loss is tough for investors--this was competitive relative to both the Topix and its Morningstar Japan Large-Cap Equity category, the average loss of which was over 19% for the period.
Manager Paul Chesson has built a solid record at the helm of this fund since its launch in 2001, as well as on board its UK-listed counterpart Invesco Perpetual Japan, rated Superior by Morningstar. Chesson invests predominantly in Japan’s largest companies, but he does not shy away from moving down the cap scale when opportunities arise. He is conscious of how much he pays for a stock but he’s less conscious of his positioning relative to the index and this high conviction approach has driven the fund to its strong returns through time.
Although Chesson has managed to keep volatility in check, investors should be mindful of the risks inherent in this investment style and should be prepared to stomach high performance gyrations for better and for worse. The fund, which is rated Standard by Morningstar, doesn’t come cheap either given its TER of 1.96%. This is a key reason we awarded it a lower rating than its UK-domiciled counterpart.
Finally, most of these top performers are characterised by the small size of their assets, with some as small as £5 million. The exception here is Orbis SICAV Japan Equity whose size has clearly not hampered its three-year showing or even its longer-term record.
Top-ranked Japan Equity funds: Newcomers
The top-performing newcomers share a notable feature absent for several
years in Japan: positive returns. Even better, the funds have generated
these in double-digits over the last year, ranging from 20% to 40%.
Outpacing all others has been Metzler Focus Japan, which delivered a remarkable 40.2% return for the year to October 26, 2009. The fund’s heavy weight in winning industrial materials issues, such as Komatsu Ltd and Kubota Corporation, and light weighting in lagging banks and other financials has boosted returns. Also, its propensity to dip down the cap ladder has helped it in an environment where smaller-cap stocks have outperformed their larger rivals. This can be seen in the MSCI Japan Small Cap Index which was 13 percentage points ahead of MSCI Japan over the same period. For similar reasons, LODH Invest Alpha Japan has followed closely behind with a return of 39.9%, although it has taken on more risk and dipped all the way down the cap ladder into racier small- and micro-caps.
The largest newcomer in this list by some margin is SGAM Japan CoreAlpha fund: It has grown to £519 million since its launch just under three years ago. This is a Luxembourg-listed mirror of the UK-domiciled GLG Japan CoreAlpha (renamed after the recent sale of SGAM’s UK fund business to GLG Partners in April 09). The fund boasts a highly skilled management duo in Stephen Harker and Neil Edwards. Although they believe Japanese large caps offer best value for money they’re not dogmatic in their approach and made an opportunistic investment in smaller caps in the second half of 2008. This made a significant contribution to returns when smaller caps bounced back strongly in the last quarter of the year.
Another strong newcomer has been GS Japan Core Equity. Although this institutional class was launched in March 2007, the actual strategy dates back to 2005. The team running this fund had suffered growing difficulties but these were largely addressed following David Townsend’s appointment as head of the team in 2005. He transformed the culture and structure of the team almost entirely. He allocated analytical responsibilities across the team so as to create a cohesive culture with longevity. Additionally, he changed the managers’ remuneration structure to greater reflect contributions regardless of seniority as this was previously a key issue. These changes have made managers on the team a valuable resource to one another and are borne out in this fund’s performance. Over the last year, this fund has returned a respectable 20.2%.
It is interesting to see this list has also embraced two exchange traded funds: ComStage ETF Nikkei 225 and PowerShares Dynamic Japan, both of which were launched in September 2008. The PowerShares fund is based on the Active Japan Index of the Quantitative Series Groups. It uses a multi-factor model to select the most attractive stocks and forms an equal-weighted portfolio of Japan stocks. As a result, its mid-cap tilt has given it a strong boost this year, although we note its extremely small asset size of £1.08 million. These low-cost vehicles are sound options in markets where few active managers have beaten their benchmarks over time--Japan is certainly one.
Top-ranked Japan Equity funds: Assets under management
As sizeable funds go, it’s evident that big isn’t always bad as most of
the funds in this list have been consistently strong performers through
time. Granted, investors would have been disappointed by their losses
over the last three years, but some of these funds have protected
capital better than most of their peers over the period. Also, despite
their size they have all managed to capitalise on the rally in small
caps over the last year in one way or another.
The largest fund is Orbis SICAV Japan Equity whose 7.6% loss over the last three years qualified it for a place amongst the top-performing funds in its Morningstar Japan Large-Cap Equity category, even with some £1.7 billion in its coffers. More recently, the fund returned a competitive 25.2% over the last year and, like the others in this list, its mid-cap bias helped (44% of the fund’s assets were tied-up in mid caps as of September 2009). The fund also appears in the list of top three-year performers. This offering was soft-closed for some time but it was re-opened in October last year. It’s interesting to note that the fund’s assets jumped from £1.3 billion to nearly £1.8 billion between September and December 2008 as investors looked to take advantage of its reopening.
Orbis’s discipline to close funds in order to protect the interests of fund owners is one which we value highly at Morningstar. We’ve often called for funds to be closed to stave off asset bloat as the more money the fund has, the less nimble it becomes. To lessen the damage that comes with asset bloat, managers tend to either move up the cap scale or spread the assets over a larger number of holdings. This fund has historically invested in large caps but is able to seize opportunities within mid caps; however, the compact portfolio of 25-35 stocks implies it will become more and more difficult for manager William Gray to unwind positions in less liquid names. We’ll be interested to see when Orbis closes this fund once again to protect their shareholders as that’s a big jump in assets. It takes it back to a size last seen in mid-2006.
Low cost option
We note there are four index trackers in this list. The iShares MSCI Japan, Russell Japan Equity and BGI Japan Index are in fact the second, third and fourth largest funds, respectively. While they are less popular investments in down markets and have lost over a quarter of their assets in the last three years, it’s not surprising to see investors opting for these low-cost, passively-managed funds given that Japan has been such a tough sell over the last decade--few active managers have been able to skilfully navigate the market to positive effect.
SGAM Fund Eqs Japan CoreAlpha does not yet have a three-year track record but it has been the best performer over the last year, returning 33%: that is nearly 12 percentage points ahead of its average Morningstar Japan Large-Cap Equity category peer. Although it has £519 million in assets, it sits at the bottom of this list. Its managers typically find their best ideas within Japan’s behemoths, but they opportunistically dipped down the cap scale and doubled the fund’s mid-cap exposure in the second and third quarters of 2008. This aided returns as these bounced back strongly in the last quarter of 2008. In 2009 they have shifted back fully into large-caps but their strong stock selection and the fund’s value-cast have propelled it to the top; value-oriented issues have staged a strong rally over the last year. While Tokyo-based managers pride themselves on their local presence, this management duo doesn’t feel disadvantaged by being based in York and it has indeed worked well for them so far.
This article was written by Muna Abu-Habsa, a Morningstar fund analyst, for publication in the December edition of International Adviser magazine.
