It is a very imperfect world when you search for investment funds to share in the Japanese recovery. And this is looking just at performance figures, which can never be the guide to fund selection on their own.
But these figures do show that where you are domiciled can have a considerable impact on the choice you have as an investor.
Most investors will naturally want to stay within their own borders as a matter of comfort and familiarity, or perhaps the desire to do business with domestic managers, all other things being equal. The sad fact is that things do not seem to be equal.
Just for the purposes of the argument, investors in mainstream US domestic mutuals do not appear to have a very exciting range of Japanese equity investment opportunities, despite the heavyweight groups that appear on the S&P Micropal listings of top performers over the past helter-skelter year in Japan.
Investors in the UK appear to be much better served, when it comes to domestic fund performance of the unit trust sector. The availability of closed-end funds to investors also increases the range of choice.
In a regular exercise for its monthly report ‘Japanese Funds’, the research department of Merrill Lynch in London looks at the returns in pound sterling terms obtained from both the unit trusts and the closed end investment trusts. The broker-dealer’s table shows the spectacular returns received from the top performers, outstripping the nearest open-ended rival.
The analysis last month found that closed-end funds were “still well ahead of their open-ended peers”. This is a well-established trend going back years, as the index of relative performance chart shows. But in the recent upswing they managed to widen this difference, even though relative performance has weakened recently as widening of discounts among general closed end fund led to steeper underperformance.
It is clear from those featuring at the top of the table that it is those companies that invested in the highly volatile ‘new Japan’ stocks produced the spectacular returns and will have suffered in recent corrections.
For Japanese investing in their domestic mutual funds the winners among the choice of 740 domestic equity funds were clearly those focused on smaller, growth-oriented stocks. The top 25 funds all appear to share these characteristics, and most are not mega funds, by the traditional standards of the market there, where the average fund size is ¥115m (E1.2m). But clearly there is a vast array of funds of varying degree of specialisation.
But even if foreign investors wanted to invest in Japanese funds there are considerable difficulties facing them, say the experts. For one thing, a withholding tax on capital gains means they are not tax-efficient. A retail investor might be prepared to bear this pain, but for the institutional investor this is not usually an option, though it could be possible for an exempt investor to get a tax credit later, if prepared to undertake the inevitable paperchase.
But there are other problems associated with investing in Japanese products, such as the churning of funds by the broker dealers usually to the detriment of investors, as funds can sweep in and out with a costly rapidity. However, the performance gap that used to exist between domestic and foreign managers is disappearing. The increasing sophistication of investors particularly among pension funds, aided and abetted by the arrival of investment consultants on the scene, means that the local management groups have sharpened up the processes and practices. “These managers can no longer be dismissed as they could be in the past,” says George Curuby of consultants Curuby & Co in Tokyo.
Foreign investors are increasingly being attracted to privately placed funds, a feature available in the market since 1998. These are usually established as domestic vehicles and offered by the major managers. Some $20bn is reckoned to have been used by a range of institutional investors, including pension funds and corporates.
On observer points to the opportunity that is now available to denominate an offshore fund sold into the Japanese market in yen. This can provide an element of stability in avoiding the volatility of a fund denominated in euros or US dollars, because the cash positions within funds are normally held in the currency of denomination. For the purist committed to Japan investing this split is not as desirable as having the entire fund yen-denominated.
The offshore funds route will be that that is that most often considered by investors, without attractive products available in their own market. According to S&P Micropal figures there are some 167 funds, with an overall average return of around 44% in the past 12 months, compared with 51% for the 37 US funds and the 36% average achieved by the 740 Japanese domestic funds.
The merits of these funds are increasing coming under scrutiny from rating services, such as London-based Global Fund Analysis (GFA) and Standard & Poor’s Fund Research services. In GFA’s recent study on Japan GAM Japan, the JF Japan Fund and Schroder Japan Fund obtained a four star-rating, with Dresdner RCM New Tiger Selections Fund Japan, MST Japan Opportuities and Zipangu funds being awarded three stars. These are given, says GFA, as quality indicators and as a measure of the group’s confidence in the fund, and not to be regarded as a predicter of performance.
As IPE went to press, Standard & Poor’s Fund Research was preparing to publish its latest ratings on Japan investing funds from a universe made up of offshore and other funds being sold internationally cross-border. All in all 64 funds receive a rating this time, of which 52 were large caps and 12 small caps, says Neil Clare of S&P. “About 20 of the funds get the triple A rating, and of the rest, more get a double than an single rating, but the difference is not significant.”
The AAA rating is designed to confirm consistent, strong performance, but is based on a 60% qualitative assessment as against 40% quantitative factors, says Clare. Of the 52 large cap funds, 29 were managed offshore and 23 managed in Japan and in the past 12 months the locally managed funds knocked the socks off the foreign funds in the universe performance-wise, by a staggering 60% in the 12 months to March.
“This shows it has been highly beneficial to have been based in Japan in this period. In pervious years, there has been no fixed pattern on this count. Last year’s margin was unprecedented,” says Clare.
With the analysis being undertaken by the rating groups bringing greater transparency to the offshore funds market, these funds are becoming more acceptable to institutional investors. What perhaps is missing is the under-representation of Japanese investment managers, as only a handful of these are managing funds offshore. With the great strength in depth that the asset management industry provides there, it looks like the choice for international investors is more limited than it needs to be.