15 ways to ride Japan's equity bull market

The term "Abenomics" defines the economic stimulus package introduced by Japan's Prime Minister Shinzo Abe, which aims to restore the sluggish Japanese economy.

Abenomics involves the "three arrows" strategy. Broken down, the arrows include fiscal stimulus, monetary easing from the Bank of Japan, and structural reforms to boost Japan's competitiveness. So far, two of these so-called arrows have been fired - the reform arrow has yet to be unleashed.

Mick Gilligan, head of research at stockbroker Killik & Co, says: "The first two arrows of Abe's growth strategy [fiscal and monetary stimulus] have stirred the Japanese economy. Gross domestic product has shown a steady pace of expansion, business sentiment has improved and there is growing evidence that inflation readings are reversing previously stubborn deflation."

The success of Abe's Liberal Democratic Party in the upper house elections in July, which gave full control of parliament, will enable easier implementation of the third arrow, which consists of broad reforms to create self-sustaining growth.

Why should investors be looking at Japan?

Japan is the third-largest economy after the US and China. Patrick Connolly, certified financial planner at Chase de Vere, asks: "With these positive indicators and signs of real constructive change in Japan, should investors be looking to increase their weighting to the country? Maybe this time it is different in Japan, but we have heard that so many times before."

He adds: "A risk is that those investors who sit on the sidelines may regret not jumping on to the new Japan story. Of course, another risk is that those who jump in might again end up battered and bruised and wondering if they will ever learn their lessons over investing in Japan.

"Over the years, many financial commentators and investment managers have predicted that it's time for Japan to make a comeback and people should invest now. Sometimes these financial 'experts' have been right for a short period, but usually not for long."

Connolly recommends the Aberdeen Japan Growth fund and the Jupiter Japan Income fund.

How effective are Japan's three arrows?

Darius McDermott, managing director at Chelsea Financial Services, says: "Abe's arrows have been very market friendly, including a +2% inflation target, cutting the corporate rate of tax, unlimited easing in monetary policy and more robust foreign policies. The yen has weakened considerably, improving trading conditions for many companies."

McDermott says we need more details on Abe's all important third arrow, and there are bound to be disappointments along the way.

Over the years, many financial commentators and investment managers have predicted that it's time for Japan to make a comeback and people should invest now.Patrick Connolly

He adds: "I do think there is more good news to come. The Olympics-winning bid for Tokyo, and the feel-good factor that comes with it, will also help. As the domestic economy improves, smaller and medium-sized companies in particular should benefit further.

"The majority of UK investors will be underweight Japan (although global portfolios will have a higher weighting than they have had for many years). For these people I think there is still enough of an opportunity to consider increasing this weighting a little."

He recommends JOHCM Japan fund and GLG Japan Core Alpha fund.

Japanese equities attractive

HOwever Killik's Gilligan advises investors: "Don't be short Japanese equities".

He adds: "In addition to the fundamental catalysts, the Japanese equity market also looks attractive from a technical perspective, with the index having broken out of a consolidation pattern that it has been in since May."

He rates the Morant Wright Japan fund a 'buy' as well as the Vanguard FTSE Japan ETF (VJPN).

Japan's failed stimulus initiatives

Tony Yarrow, investment manager at Wise Investments, says: "The history of the last 20 years is littered with examples of the Japanese government wasting money on failed stimulus initiatives, 'bridges to nowhere', and the like. How do we know that Abenomics isn't another, larger one?"

He explains that Abenomics has already led to a significant weakening in the yen, which has caused a surge in exports and highlights that Japan's domestic economy is also picking up.

In addition to the fundamental catalysts, the Japanese equity market also looks attractive from a technical perspective."Mick Gilligan

The fact that both are growing together suggests a balanced approach to investment, holding both the largest exporting companies, and also selected smaller, more domestically-focused ones.

Yarrow praises the Baillie Gifford Japan team and particularly the Baillie Gifford Japan investment trust, but because it is now trading at a premium to its net asset value (NAV), he prefers the open-ended equivalent, Baillie Gifford Japanese.

Yarrow also likes the Polar Capital Japan fund and an investment trust called Atlantis Japan Growth, which invests in Japanese smaller companies, and still trades at a significant discount.

"Plenty more to go for"

Guy Foster, portfolio strategist at Brewin Dolphin, says: "Japan's gains at the beginning of the year have prompted investors to wonder whether the best is now behind it. Fear not, there's plenty more to go for.

"Economic policies are bearing fruit with inflation edging into positive territory and housing construction on the rise. Tokyo's successful Olympic bid has seen an explosion in construction orders.

"Economists lament the failure of Abe's reform arrow to be unleashed, but reforms are largely disinflationary [and generally politically damaging]. To see this Abenomic revolution through to a positive conclusion the reforms can wait - more important is raising nominal incomes through higher inflation, higher employment and higher corporate revenues. Japan is achieving on all these fronts."

Andrew Johnston, fund analyst at Brewin Dolphin, also rates the unconstrained Baillie Gifford Japanese fund highly.

He explains: "The Baillie Gifford team takes a long-term-growth approach looking for companies with attractive industry backgrounds, strong competitive positions and which will deliver sustainable earnings growth for shareholders. As such the portfolio is in a strong position to benefit from a recovery in Japanese domestic demand as well as certain companies more exposed to overseas markets."

Johnston also likes their closed-ended funds, Baillie Gifford Japanese Smaller Companies and Baillie Gifford Shin Nippon. "Their relative discounts/premiums currently look inflated due to the recent popularity of Japanese equities and at these levels we would consider an open-ended fund as a better way to access the asset class."

Forv more value-oriented plays, Johnston also recommends Schroder Tokyo and and the £155 million Schroder Japan Growth investment trust, managed by Andrew Rose.

Economic policies are bearing fruit with inflation edging into positive territory and housing construction on the rise. Tokyo's successful Olympic bid has seen an explosion in construction orders."Guy Foster

He says: "Although neither fund has participated to the same extent as the Baillie Gifford strategies in Japan's meteoric rally, Rose [manager for both Schroder funds] has proved his worth over the long-term and should be viewed as a safe pair of hands for investing in the region.

For investors with a large enough allocation available "we would suggest that, given the differences with Baillie Gifford's and Andrew Rose's approaches, these two strategies complement and sit well together."

Jeremy Le Sueur, investment director at 4 Shires Asset Management, highlights that as the yen weakens and exporters report higher profits on translation. The stockmarket should also benefit, and recent moves to encourage public sector pension funds to own shares will boost the market. Japanese consumers should also increase their exposure to shares.

He adds: "So, Japan is labouring under a high debt burden (the highest in the developed world), but the government policies are showing signs of taking effect. The mobilisation of domestic savings, both household and government pensions, should drive equities higher in the coming 12 months."

Le Sueur recommends the iShares Japan Sterling Hedged ETF, with a total expense ratio of 0.65%.

The manager says he has recently re-weighted away from the US due to its high cyclically adjusted price/earnings ratio and invested in Japan.

He also recommends the JPMorgan Japan Smaller Companies Investment Trust, which trades at a 7% discount. He says, despite the higher management fees than Baillie Gifford Shin Nippon, which is by far the best performer in the smaller company space over time, the Baillie Gifford Shin Nippon trades at a circa 8% premium to NAV.

Le Sueur adds: "We always like to have a small company fund alongside a large cap fund in bull markets, as smaller companies tend to outperform in such scenarios."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.