Japanese smaller companies funds across the board produced negative returns over the year to the end of May 2001
Japanese smaller companies funds have all posted negative returns over the year to the end of May following a two-year period of remarkable growth on the back of the technology bubble.
The Gartmore PSF Japanese Smaller Companies fund is one of the best performing portfolios in the sector and has returned 204.2% over the three years to the end of May 2001, compared to a sector average of 119.17% over the same period.
The fund strongly outperformed during the height of the technology boom, returning 85.96% between June 1998 and May 1999, versus a sector average of 56.7%, and 95.8% between June 1999 and May 2000, compared to a sector average of 75.52%.
Despite its strong growth bias, the fund has only a slightly above average beta of 1.08%, compared to the sector mean of 0.99%. While a fund with such a beta would be expected to underperform in a bear market, it has marginally outperformed over the year to the end of May, returning -16.46%, versus a sector average of -19.56%, for the same period.
Yuasa Mitsuhiro took over management of the fund last October and has repositioned the portfolio, targeting lower beta and more defensive growth sectors. He has also upped the number of holdings to 69 in a bid to further diversify risk.
Mitsuhiro has been positioning the fund to enable it to benefit from the climate of cultural and structural change in Japan by taking a significantly overweight position in the services sector. The risk of such a large overweight position is mitigated by the diversity of its component companies, which range from coffee shops to software companies, he said.
Mitsuhiro has also been upping his weightings in non-bank financials, which he believes can benefit from the low interest rate scenario. 'We have moved overweight financials but not banks. We think the low interest rate environment will continue for the next couple of years and these companies will benefit from that,' he said.
From December, Mitsuhiro began to lower the fund's technology, media and telecoms weightings in light of the US slowdown. He has recently moved further underweight ahead of second quarter earnings results.
The Schroder Japanese Smaller Companies fund has produced more stable returns at the expense of the exponential growth some of its peers produced during the technology boom. Managed by Naoki Suzuki, the fund returned 63.31% over the three years to the end of May, compared to a sector average of 119.17%.
Suzuki puts its underperformance through 1998 and 1999 down to his avoidance of the technology sector in favour of a value approach.
He said: 'We have been overweight defensive value stocks since 1999. We were not very successful in that year, particularly in the second half, but we outperformed in 2000.'
Performance has picked up as the market has swung more towards a value style and Suzuki has been better positioned to achieve a greater degree of capital preservation than many of his peers. Over the year to the end of May, Schroder Smaller Companies returned -7.81%, outperforming the sector average by 11.77%.
The fund has the lowest annualised beta in the sector, at 0.66%, and has performed in line with that. 'The fund is low beta as a result of our stock selection and our preference for reasonably valued stocks,' Suzuki said.
Over the past couple of months, Suzuki has started to move out of defensive growth sectors into more aggressive growth areas as valuations start to bottom out.
He is starting to up his holdings in technology, moving toward a neutral weight, and is overweight non-bank financials and retail.
Suzuki is zero weight banks and underweight services, construction and materials, which represent more than a third of the index combined. This has resulted in the fund having the lowest R-squared in the sector, at 0.69, as its holdings are less correlated to the benchmark than its peers.
The best performing of all funds in the sector is the Invesco Perpetual Japanese Smaller Companies fund, up 211% over three years to the end of May. This breaks down as -27.57% over one year, 119.1% from June 1999 to May 2000 and 96.86% from June 1998 to May 1999.
The fund is run by Masato Kawada in a highly aggressive bottom-up fashion and offers the highest levels of both risk and return in the sector.
Kawada was overweight technology during 1998 and 1999, which enabled the fund to deliver spectacular performance in those years. Although he continues to invest in technology and software stocks, he has been underweight throughout the year in favour of more defensive growth plays. He said: 'We are preferring defensive growth to cyclical growth because we expect the economy to slow down.'
Kawada expects Prime Minister Koizumi's reforms to raise unemployment but believes the short-term deterioration in the economy will be positive in the longer term.
In light of this, Kawada has moved overweight in services, favouring discount service providers, whom he believes should benefit from corporate and individual belt-tightening.
The services sector also provides a dual opportunity, according to Kawada, in that the services rendered are generally expensive, providing good scope for earnings as well as the potential for discount services providers to prosper.
He said: 'Service prices are much more expensive in Japan than the West so there are a lot of opportunities in the sector. I tend to buy these companies rather than manufacturing exporters, who cannot compete with the likes of Honda.'
Regression analysis: Regression statistics can be used to compare the relationships between funds, markets or a specific benchmark index. They do not make the assumption that the variables (funds) are related as cause and effect, but permit them to be influenced by other variables (markets).
Alpha: The Alpha describes the theoretical reward obtained by one investment when the second investment has a zero return. To calculate the Alpha, the returns of each are taken and compared together to identify their relationship. This reveals relationships between investments in both bull and bear markets. When applied to portfolios, it can be considered to be the return over and above (or below) the market through portfolio strategy. Good managers have a positive Alpha.
Beta: The Beta is the amount the first fund moves when the other moves by one unit. Beta is a measure of relative volatility (absolute volatility is calculated by standard deviation).
If one fund always goes up and down by 1.5 times of the performance of the index, its Beta will be 1.5. This implies that if the return of the index is positive, then 1.5 times this positive return can be expected of the fund. If the index goes up (or down) 10%, the fund goes up (or down) 15%. Beta represents the volatility of the first investment versus the second. It is only an estimate and to be accurate there has to be a perfect correlation between the two investments.
Correlation: Correlation shows the strength of a linear relationship between two funds. A perfect correlation is when the investments behave in exactly the same manner. A perfect positive correlation is represented by 1, perfect negative correlation by -1 and no correlation with a 0. A perfect negative correlation suggests that for every 1% movement by the index we would expect to see -1% movement return on the fund and vice versa. This is an important factor when using modern portfolio theory.
R-squared: The R-squared indicates the level of movement that can be ascribed or determined by the movement of an index. When the R-squared equals 1 there is a perfect correlation between the investments ' 100% of the movement in a fund can be determined by the movement in the index. When the R-squared equals 0, there is no correlation between the investments. An R-squared between 0.7 and 0.99 suggests that between 70% to 99% of the movement in our fund could be explained by the movement in the index. Below 0.3, there is effectively no influence.
Monthly volatility (or standard deviation): Standard deviation is a measure of absolute volatility. It is the measure of the square root of the variance of each monthly return from the mean. The larger the figure, the higher the volatility of a fund and thus its risk. A typical example of the kind of funds and their associated risk ranging from low risk to high risk are: cash funds, fixed interest funds, balanced funds, UK equity funds, overseas equity funds and warrant funds.
Source: Standard & Poor's
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