Stack Sees a Rising Sun

08/06/2004 12:00 am EST

Focus:

James Stack

President, Stack Financial Management

"As we wind our way through 2004, opportunities have become more elusive," notes Jim Stack, editor of InvesTech. "But there have been several bright spots, such as Japan, where the headlines are increasingly positive." Here, he offers his top fund ideas for the region.

"Since Japan’s economy fell apart 14 years ago, attempts to stimulate a recovery have repeatedly failed, and the country has continued to struggle with banking problems, persistent deflation, and consumer apathy. After years of restructuring and 'pork barrel' government spending, there are finally signs that this time is different. Is it possible the upturn that began in 2003 could mark an end to the long, slow decline for this major economic power? Let’s take a look at the latest evidence…

  • Growth is picking up in Japan, which just experienced two consecutive quarters of the fastest economic growth in 13 years. In the first quarter of 2004, GDP increased at an annualized rate of 5.6%.
  • In a sign that banking problems may be easing, three of the four largest banks in Japan reported profits for the year ended in March, after writing off the equivalent of billions of dollars in losses over the last two years.
  • So far, this recovery has relied heavily on increasing exports – primarily to China– with benefits limited to Japan’s large manufacturers. According to the latest Tankan survey, which provides a gauge of Japanese business sentiment, the initial optimism among these large companies is spreading, and smaller non-manufacturing firms are reporting the steepest upturn in sentiment since 1999.
  • In March, Japan saw the strongest upswing in inflation pressures in 16 years as measured by ECRI’s Japanese. Re-inflation is actually good news for a country that has been fighting deflation for the past five years.
  • Most important, if this upturn is to be sustainable, the domestic sector must participate in the recovery. Household consumption is now growing at a rate not seen since 1992 (except for a purchasing spree in 1997 when consumers tried to avoid a pending increase in the value added tax.)

"Although risks remain, these factors paint a compelling picture for Japan. Of the Japan equity stock funds, our preferred selection and portfolio holding is The Japan Fund (SJPNX), which began as a closed-end fund over 40 years ago and is the oldest mutual fund to invest solely in Japanese equities. The fund has undergone significant management changes over the last several years, culminating with Fidelity taking over management from Deutsche Asset Management in 2002. While the current lead portfolio manager, Jay Talbot, has now been at the helm since October 2002, he has headed Fidelity Investments Japan Ltd. since 1996. Before joining Fidelity in 1993, Talbot worked as an equity analyst in Tokyo. Talbot's experience with Japanese companies is paying off. Since June 2003, The Japan Fund has more than doubled the return of the Nikkei average. Performance for longer time periods is also stellar, as the 1, 3, and 5-year returns rank in the top decile.

"The fund recently decreased its holdings in export oriented-industries in favor of sectors that would benefit from an increase in domestic consumption. The manager uses a bottom-up approach in constructing the portfolio, focusing on companies with consistent and growing earnings and cash flow trading at reasonable valuations. In addition to solid performance and a disciplined investment strategy, expenses and portfolio turnover compare favorably with the fund’s peers. The Japan Fund has an expense ratio of only 1.6% – well below the category average of 2.1%. Turnover, which measures trading activity, is only 80%, versus 215% for the category. Though the fund’s prospectus allows it to hedge currency risk, it rarely does and, therefore, provides valuable insurance against a falling US dollar.

"Other top Japanese equity funds worth mentioning include two more Fidelity offerings: Fidelity Japan Small Companies (FJSCX) and Fidelity Japan (FJPNX). Fidelity Japan Small Companies is currently outperforming its large-cap rivals, but the fund is volatile due to its smaller company focus. In 2000 for instance, it lost over 50% of its net asset value, while the Nikkei Average declined 27%. Fidelity Japan is a much closer match to The Japan Fund, though its performance has generally lagged our preferred selection. Another Japan investment to watch is the Matthews Japan Fund (MJFOX ). Performance is certainly competitive; however, expenses run a little high at 2.0%. We especially like the average market cap of this fund, which is in the mid-cap range. Due to the smaller market cap, this offering, along with Fidelity Japan Small Companies, is best suited for more adventurous investors. The funds mentioned here are offered no-load and are generally available without a transaction fee, though they all carry short-term trading penalties of 1.5%-2.0% for shares not held 3-6 months. For those investors who cannot, or do not wish to, purchase mutual funds, the recommended alternative is the MSCI Japan Index Fund iShares (EWJ ASE)."

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