2 Top-Rated Japan Equity Funds

Outlook: Amid weakened yen and imported inflation, what are equity portfolio managers buying now?

Kate Lin 30.05.2023
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Kate Lin: Welcome back to the Morningstar Asia Outlook for 2023. I'm Kate. Today, we're focusing on Japanese equity funds. As the Japanese yen weakened after aggressive rate hike actions elsewhere in the globe, companies in Japan benefited, leading to a record level of share buybacks. Though, towards the end of 2022 a surprise policy tweak by the Bank of Japan led to volatility in both yen and the stock markets. So, what are equity portfolio managers buying now? We are asking Samuel Lo, senior manager research analyst, at Morningstar.

Hi, Sam.

Samuel Lo: Hi, Kate.

Lin: So, let's first look at the performance of Japan equity funds. How have they fared in 2022?

Lo: Yes. So, the year 2022 has been challenging for Japanese equity as it has been for most asset classes last year. So, in this context, Japanese equities actually fared pretty well compared with other major stock markets around the world. If we look at the TOPIX Index, Japanese stocks overall lost only 2.5% for the full year 2022 in local currency terms. Although, as Kate mentioned, given the depreciation of the Japanese yen, the decline amounted to 15% in U.S. dollar terms for overseas investors. But still, this is better than 18% loss for, for example, the S&P 500 or the 20% loss for the MSCI All Countries Asia ex Japan Index over the year. So, while Japan was not immune to the economic uncertainty that the world has experienced last year, the country's more benign inflation levels, the lower impact from geopolitical risk and also the maintenance of an accommodative monetary policy by the Bank of Japan last year have all contributed to the relatively good performance of Japanese stocks last year.

Lin: So, looking ahead, are there some bright spots that Japan equity managers are currently looking at?

Lo: So, while the Japanese market was rather resilient last year, there are actually a few things that are looming on the horizon. So, for one, while the inflation rate in Japan has so far remained quite limited, especially when compared to other major developed markets, the depreciation of the Japanese yen has started to result in imported inflation as the weak currency makes imports more expensive, which are already high to begin with due to the global supply chain disruptions. And in fact, the latest CPI figures in Japan showed an inflation level of about 3.5%, which is the highest in 40 years.

Secondly, while Japanese exporters have benefited from the depreciation of the currency, it still remains to be seen whether exports can remain resilient going forward given the deterioration in the global economic backdrop.

Finally, given that inflation has started to pick up in Japan, investors are also watching closely, whether the Bank of Japan will maintain the accommodation policy in terms of monetary policies and whether it will follow the majority of the other central banks across the world in raising interest rates, and if so, what is going to be the impact on the Japanese economy.

Lin: With these, how are portfolio managers positioned for this year?

Lo: So, in this context, we have seen some portfolio managers positioning into more defensive segments of the market or companies with more defensive business models. They've also sharpened the focus on companies with strong pricing power, which can pass on higher inflation and higher input costs to consumers as well as domestic companies with more local exposure with the expectation that they would be less impacted by the global economic slowdown. So, this often translates into a higher allocation into sectors such as consumer staples and healthcare at the expense of the industrial or IT sector.

A good example of a stock with the above characteristics that have received quite a lot of interest from performing managers in recent months would be Ajinomoto (2802), for instance. So, Ajinomoto is the largest producer of seasonings in Japan, and it enjoys a very strong pricing power as a market leader. Another example would be Kirin Holdings (2503), the major beer and beverage company. So, the company has demonstrated its ability to pass on rising input costs by raising the price of its beer by 5% to 10%, and it is also expected to benefit as the society reopens from the pandemic.

Lin: So, let's move on to your research and individual funds. FSSA Japan Equity and JPM Japan are currently medalist funds. Why should investors look at these two funds?

Lo: Yes, indeed. FSSA Japan Equity and JPM Japan are among our highest conviction ideas within the Japan equity coverage. So, FSSA Japan Equity is managed by a talented investor in Sophia Li, who has led this strategy since its inception in 2015. Sophia started her career at FSSA 12 years ago, and she is well-ingrained in the firm's investment philosophy and investment culture, which we believe is one of the best in the industry. The investment process is conviction-driven and based on detailed bottom-up research and stock picking conducted by the 23 strong investment team. And as with other FSSA equity strategies, this Japan Equity strategy has a strong focus on high-quality companies and with a particular emphasis on management quality. And the team carefully considers how company managers conducted themselves throughout their career and how they've treated stakeholders, especially during periods of market distress over the years. The strategy earns a People and Process rating of Above Average.

Meanwhile, JPM Japan is managed by Nicholas Weindling who boasts 20 years of investment experience and has managed this strategy for 15 years. We consider Weindling to be one of the most impressive Japanese equity investors within our coverage, and he has achieved an outstanding long-term track record. The supporting team consists of 25 members, and it is among the most well-resourced Japan-dedicated investment teams within our coverage. In terms of the process, the strategy follows a quality growth approach that has been consistently executed and time tested over the years. So, depending on the companies' economics, the duration of value creation and governance quality, the team would classify the companies into the premium, quality, and trading categories. And about 80% of the portfolio are in premium or quality stocks here, which tend to produce strong shareholder returns, have sustainable competitive position and can allocate capital effectively. This strategy earns a People rating of High and a Process rating of Above Average.

Lin: Thank you, Sam. And thank you for watching.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
FSSA Japan Equity III USD Acc17.30 USD0.21Rating

About Author

Kate Lin

Kate Lin  is an Editor for Morningstar Asia, and is based in Hong Kong

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