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Individual Investor
Playing Japan's Ongoing Recovery
By: Alan Lavine (05/12/00)
From Ticker Magazine
After several years of lackluster performance, funds that invest primarily in Japan scored some hefty gains last year and earlier this year as they rode Japan's shaky rebound from a decade-long recession. But recently, returns have been hammered by the weakness in technology stocks.
Some global fund managers also fear that Japanese companies are overvalued, and are reducing their Japanese holdings, says Heather Haynos, an analyst at Morningstar, the Chicago-based fund tracker.
Another vexing factor, Haynos says, is that structural problems continue to haunt the economy even as it rebounds. Structural reforms in the country's banking system have been slow to materialize and government debt still is at an astonishing 130% of Japan's gross national product, Haynos says. There's still a lot of uncertainty about the country's economic progress, so funds invested in Japan remain volatile, she adds.
Funds that invest exclusively in Japan returned a whopping 113% in 1999, far outpacing the 37% return of the Nikkei 225 index. However, year-to-date through Wednesday, the Nikkei Index was down 6.51%, and the 44 Japan funds tracked by Morningstar are down 12.17%.
``An emphasis on corporate restructuring and shareholder value, combined with the Japanese government's willingness to create more of a free-enterprise market system, proved therapeutic'' for the country's economy last year, Brenda A. Reed, manager of the Fidelity Advisor Japan Fund (NASDAQ: FJPAX - news), wrote in the fund's annual report.
Japan's technology sector, particularly cell-phone manufacturers, took off last year, Haynos says, adding that the banking sector also performed well after the Japanese government decided to bail out banks strapped with billions of dollars in bad loans.
Overall, consumer spending increased in 1999, as the yen strengthened against the dollar. The government pumped money into the economy, while banks were lending at low interest rates. Corporations began to restructure, cut costs, and focus on boosting return on equity. Mergers and acquisitions are picking up steam as foreign investors buy stakes in Japanese companies.
Furthermore, economic reports indicated that the government would increase spending this spring, capital spending by corporations is already up, and the employment picture looks bright.
After evaluating funds that specialize in Japan, here are three attractive funds to consider: the Fidelity Advisor Japan Fund, the Scudder Japan Fund (NASDAQ: SJPNX - news), and the Warburg Pincus Japan Growth Fund (NASDAQ: WPJGX - news).
Fidelity Advisor Japan Fund
This load fund, which opened in December 1998, has $110 million in assets and returned an astonishing 136.1% in 1999, thanks to strong performance from its investments in technology companies. But like technology shares worldwide, the fund has been battered lately and is down 14.56% through Wednesday,
Portfolio manager Reed has a positive outlook on Japan, but is concerned that the country's companies might not follow through on their promises to restructure. ``I will be looking carefully for continuing evidence of the commitment to restructuring that many companies have expressed,'' she wrote in the fund's annual report.
Reed typically invests in large companies that dominate their markets, have strong franchises, and do business worldwide. Toyota Motor (NYSE: TM - news) is one such company. Like many other managers who invest in Japan, Reed has a strong stake in technology stocks. She's also heavily invested in banks, such as Bank of Tokyo-Mitsubishi (NYSE: MBK - news) and Sanwa Bank (NASDAQ: SANWY - news).
``A wave of consolidation, together with the accompanying cost-cutting, information-technology spending, and other restructuring initiatives, put the more solid Japanese banks in a position to be catalysts for restructuring throughout the Japanese economy,'' Reed wrote.
Recently, Reed cut back on non-bank financial stocks because many are overvalued, ``especially in view of the increased competition from banks for their business,'' she wrote. Reed upped the fund's exposure to telecommunications firms (which are classified as utilities), an industry that was ``particularly vibrant'' late last year.
The fund has sizable stakes in telecommunications companies, such as NTT DoCoMo (NASDAQ: NTDMY - news), the country's largest provider of wireless phone service, and Hikari Tsushin (NASDAQ: HKIIF - news), a wireless player that ``was a standout performer'' in 1999, Reed wrote.
``In contrast to the situation in the United States, wireless phones are much more common in Japan than personal computers. Consequently, a lot of investors concentrated their buying on companies offering products and services for the wireless telecommunications market, and the fund benefited substantially from numerous investments in that industry,'' Reed wrote.
Scudder Japan Fund
Seung K. Kwak, manager of this $890 million no-load fund, is bullish on the Japanese stock market. The country's economy is rebounding from a recession, and corporate profits are expected to increase at a 10% annual clip, Kwak says.
Moreover, many companies are cutting costs and eliminating unprofitable lines of business. ``We see evidence that (companies) are concentrating on improving profit margins and return on assets,'' he says.
The Japan fund returned 120% last year, thanks to its investments in telecommunications, technology, manufacturing, and financial stocks. About 28% of the fund's assets are in technology and telecommunications companies, such as Fujitsu (NASDAQ: FJTSY - news), Nippon Telegraph & Telephone (NYSE: NTT - news) , and NTT DoCoMo.
The fund returned an average 37.3% annual rate for the three years ended April 3, according to Morningstar. Through Wednesday, the fund is down 14.84%. Unlike other fund managers who have made big bets on technology in Japan, Kwak prefers to find value across a wide range of sectors.
Kwak's goal is for the fund to have a low correlation to the U.S. stock market-if there's a sell-off in U.S. technology stocks, it's likely that Japanese technology stocks would get hit hard, he says. As a result, he doesn't want to overexpose the fund to the technology sector, and he limits his holdings in companies that derive a large part of their business from U.S. exports.
Kwak invests in undervalued companies of all market capitalizations, based on cash flow and future earnings growth. He focuses on stocks selling at a discount to their three-year future value, a strategy that has led to investments in companies as diverse as Benesse, an educational-services provider, and Sanix, a regional-pest control company.
More recently, the fund manager increased his holdings in broadcasting companies, including Nippon Television Network and Tokyo Broadcasting System, because he sees the sector benefiting from an increase in media advertising.
In addition, Kwak is excited about the financial services and insurance sectors. Nomura Securities (NASDAQ: NRSCY - news), for example, is benefiting from the corporate restructuring and mergers, he says. The financial services and insurance sectors will also benefit from the aging of the population, which will create a demand for retirement products and long-term care insurance.
Warburg Pincus Japan Growth
Todd Jacobson, co-manager of this $446 million no-load fund, believes that technology companies-including electronics, computer, and telecom companies-have the brightest long-term potential within the Japanese sector. ``There are lots of profits to be had in technology,'' Jacobson says.
The fund returned 266.1% last year, largely a result of the manager's 65% stake in technology and telecommunication stocks. Positions in major Japanese brokerage firms such as Daiwa Securities Group (NASDAQ: DSECY - news) and Nikko Securities (NASDAQ: NIKOY - news) also contributed to the fund's sizzling performance. The fund returned 44.4% for the three years ended April 3, according to Morningstar. Through Wednesday, the fund is down 34.87%.
Although Japan is officially in a recession -- a result of two successive quarters of negative economic growth -- Jacobson says many businesses are flourishing. Technology companies, for example, are increasing earnings worldwide, he says.
The economy should receive a further boost as the $1 trillion invested in 10-year Postal Savings time deposits mature over the next few years. Thousands of Japanese consumers own these deposits, so if some of that money filters into the stock market, it should drive up stock prices, Jacobson says.
``Even if 10% of the savings, or $100 million, goes into stocks, it could have a huge impact on the stock market,'' Jacobson says. ``The market can't be sustained by foreign investors as it was in 1999.''
Technology companies, such as Hikari Tsushin and Softbank (NASDAQ: SFTBF - news) , an Internet incubator, comprise about 50% of the fund's assets, followed by 15% in telecommunications companies, and about 10% in brokerage firms.
``We believe that Japan's stock market continues to offer long-term upside potential,'' Jacobson says. ``There will be continued bouts of short-term volatility, but companies are benefiting from restructuring.''
Bottom Line:
Like the overall market, these funds have been victimized by the recent weakness in the technology sector. But the funds have corralled a number of growing companies in one of the world's largest economies and are well placed to capitalize on Japan's emerging rebound.
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