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Mutual Funds
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Japan's latest rebound is for real
Billions are pouring into mutual funds specializing in Japan as that nation's markets climb too high to ignore. And this time, Japan's boom may be here to stay.
By Timothy Middleton
Investors are stampeding into Japanese equities again, and for once they may be right.
Japan is a much improved place, says James L. Moffett, chairman of Scout Investment Advisors and co-manager of UMB Scout WorldWide Fund (UMBWX). Ironically, the thing that has kick-started their economy is growth in China. Thats their No. 1 customer now, instead of us.
Investors this year have plunged more than $5.3 billion into mutual funds investing strictly in Japan, according to AMG Data Services, the most since it started collecting such data in 1992.
Two weeks ago, I predicted T. Rowe Price Japan Fund (PRJPX) would be among next years best-performing funds.
Be warned: Japan has rallied and then cratered so frequently in the last 15 years that many investors have given up. Scout WorldWide has only 18% of assets there, compared with the 24% weighting in the MSCI EAFA Index, which is the main benchmark for many international funds. But the Scout Fund's Japan stake is up from 12% two years ago. Most mutual funds continue to underweight Japan, according to Morningstar Inc.
The investors flooding Japan funds with fresh assets might just be chasing performance. Those funds delivered average returns greater than 14% last year and are up more than that so far this year, easily beating domestic markets.
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Japan could crater again. But I dont think so. This time, the rally is different.
China as carrot and stick
Over the last 15 years, what Japan has given, it has also taken away. In 1999, the average mutual fund investing there soared 112%, only to plunge more than 30% in 2000 and again in 2001. The funds fell 12.9% further in 2002.
Japans problems began in 1989, when twin bubbles in financial assets and real-estate burst. That left the banking system in tatters and, as financial weakness spread through the whole economy, stock prices began a decline that only now seems to be coming to an end. From its peak at the end of 1989, the Nikkei 225 Stock Average declined 80% before hitting bottom in the spring of 2003.
Since then, however, the Japanese market has been clawing its way back. From the bottom, the Nikkei climbed 62.6% by the end of last year and a further 14% this year. The nations largest banks returned to profitability and began paying down the massive loans the government extended them in the 1990s. Competition with China and exports into its vast market have been both carrot and stick for economic growth.
Domestically, the biggest change has been that the Bank of Japan has broken the back of deflation by keeping interest rates so low they are effectively negative; i.e., below the rate of growth. That was crucial. For 15 years, Japanese consumers were rewarded for not spending, secure in the knowledge prices would be lower tomorrow. The end of deflation has stimulated domestic spending, bolstering export growth.
Unemployment is lower in Japan than in the United States and less than half that of continental Europe. Japanese voters endorsed the economic reforms of Prime Minister Junichiro Koizumi by giving his Liberal Democratic Party a landslide victory in September.
| Top Japanese funds | | Fund | YTD* | 5 year annualized | | Fidelity Japan Smaller Company (FJSCX) | 19.3% | 11.1% | | Vanguard Pacific Stock Index (VPACX) | 19.5% | 3.8% | | JP Morgan Japan A (CVJAX) | 20.5% | 3.3% | | Matthews Japan (MJFOX) | 4.8% | 2.8% | | Japan S (SJPNX) | 10% | 2% | | T. Rowe Price Japan (PRJPX) | 25.2% | 1.3% | | iShares MSCI Japan Idx (EWJ, news, msgs) | 14.1% | 1.3% |
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*Performance as of 11/30/2005.
Source: Morningstar
Japan funds would be doing even better this year if they had hedged their currency exposure. The strength of the dollar has roughly cut returns in half for U.S. investors. Most funds dont hedge, however, and that will be a plus when, as most investment strategists believe, the dollar resumes its long decline against other currencies.
Funds or ETFs?
If youre making a strategic, long-term investment in Japan, actively managed mutual funds are the way to go. The T. Rowe Price fund is the current standout, benefiting from exports and all domestic sectors except banking. Fidelity Japan Small Company has a better long-term record but is more volatile.
If you simply want to ride this wave or are otherwise making a tactical, short-term investment, exchange-traded funds are the better choice. They trade like stocks and have no redemption fees, which more and more mutual funds charge.
The only ETF in this space with a lengthy record is iShares MSCI Japan Index (EWJ, news, msgs). It does, however, have two newer rivals, S&P/TOPIX 150 (ITF, news, msgs) and Vanguard Pacific Stock Viper (VPL, news, msgs). These are all index funds, and that means they are forced to invest in sectors that active managers are currently avoiding, like Japanese banks. But it also means they have rock-bottom expenses.
I think its likely that foreign-stock fund managers will be adding to their Japanese holdings next year, because Europe is raising interest rates and its economies are already feeble. More money flowing into Japanese stocks will put upward pressure on their prices, so I think this year is a better time to buy them than next year.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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