While Japanese and Far Eastern funds offer the potential for strong returns for investors prepared to accept volatility, the prospects will remain bleak if the global economic recovery falters
Until global stock markets moved sharply downwards in June, Japanese and Far Eastern investment funds had provided a positive return for investors.
This has been the case since the start of 2002 against a backdrop of substantial declines in the mainstream markets of the UK, Europe and North America.
However, after many years of underperformance, the majority of UK investors have had little exposure to this region and as a result have gained few benefits from its recovery in values.
Over the past five to 10 years, Japan and other Asian stock markets have fared poorly and although some limited exposure to Far Eastern funds was considered the norm for most growth investors a decade ago, this has seldom been the case in recent years.
Despite some short-term rallies, late 1998 to mid 2000 being the most recent, Japanese and Far Eastern markets have continued to decline in value. For many investors used to countless false dawns in these markets, this has been the final straw and they have gradually reduced or entirely disposed of their holdings accordingly.
This is understandable with the average Japanese fund showing a loss of 25% over the past five years and only a modest gain of 33% over the last 10 years.
It is therefore little wonder that investors have largely lost their appetite for this region. It is a similar picture outside of Japan, with the average Far Eastern fund having lost 33% over five years but gaining a more respectable 65% over 10 years (all figures from Standard & Poor's, offer to bid, net income reinvested to 1 August 2002).
Investment Trusts have fared slightly better, with the average Japanese trust losing 21% of its value over five years and gaining 49% over 10. Far Eastern investment trusts (excluding Japan) have lost, on average, 15% over five years, but gained a satisfactory 85% over 10 years.
With above-average volatility inherent in these markets, the timing of investment in Japanese and Far Eastern funds tends to be highly important and can be the difference between an excellent and disastrous medium-term return. On that basis, if the current level of valuations are generally perceived as being too low, significant returns are possible should the market begin to establish its true value. The question must, therefore, be whether or not now is an opportunity for investors or should they retain a cautious approach.
The Japanese economy continues to struggle with a weak consumer environment, continued deflation and a strong yen proving detrimental to exporters. However, individual companies are restructuring and pursuing share buybacks in an attempt to create better shareholder value, which is a positive factor in favour of investment.
While there were significant purchases of equities made by foreign investors earlier this year, this has now faded as a result of the general downturn in global stock markets. To compound matters, Japanese trust banks have recently been large sellers of equities, which has in turn contributed to short-term declines. So, despite the concerted efforts by many companies to restructure and the reasonable valuations that currently exist, it is difficult to see any significant progress made without an established global recovery.
It is a similar picture across the China region with many positive factors offset by a number of negatives. Again, valuations would appear to be at an undemanding level and earnings growth, although slowing over the short term has recently been encouraging.
However, the region is very vulnerable to the global economy, the US in particular and will suffer should the US recovery begin to falter.
The development of the Chinese economy offers vast potential for the region and with GDP growth of 8%, progress is being made at a substantial rate. Industrial production has increased year on year by 13% and ratings on stocks are generally low with high yields and growing profits.
All of this could potentially benefit those who can readily trade with Chinese companies and provide goods and services to an ever-demanding population. The most obvious benefactors are other Far Eastern nations. On the near horizon, an expected change of leadership in China creates some political uncertainty and may affect short-term returns with the long-term potential remaining vast. The Fleming Chinese investment trust offers access to this potential having been launched in 1993 with the aim of generating long term growth from Chinese quoted equities. Performance has been very poor over the last five years with investors losing half of their investment despite experiencing dramatic gains in the periods 1998 to early 2000.
As you would expect, volatility is very high and this fund could be highly rewarding for investors who are prepared to accept the higher than average level of risk.
Alternatively, for those seeking a broader based investment in Far Eastern equities the Fidelity South East Asia fund has a AAA Standard & Poor's rating in recognition of consistent returns since its launch.
The fund manager KC Lee has been at the helm since the launch in 1984 and runs a highly concentrated portfolio with approximately 50% of the fund's assets invested in the top ten holdings. He is backed by one of the largest teams in the region with 18 analysts and seven regional managers and has produced 10-year annualised return of 8.5% compared with the sector average of 4.9%.
Although short-term returns have been disappointing, the experience and resources available through this fund should ensure a return to above average performance.
For those selecting to invest solely in Japan, the Deutsche Japan Growth unit trust offers above average prospects. This fund has attracted an AA Standard & Poor's rating for its consistency coupled with lower than average volatility compared to the sector.
The recent integration of the Deutsche and Scudder Tokyo investment teams should place more experience and resources at the disposal of the lead fund manager, James Pulsford, and help maintain the high standards already achieved. With only £23m currently under management this is a relatively small fund but, as a result, can be more flexible than its larger counterparts.
For investors who are prepared to accept the possibility of above-average volatility and believe the global economy is set for recovery over the medium term, Japanese and Far Eastern funds offer the potential for above average returns.
However, should the recovery falter, then prospects are unlikely to be bright and the recent poor performance may continue for some time to come.
After many years of underperformance, the majority of UK investors have little exposure to the Far East.
The development of the Chinese economy offers vast potential for the region.
The Japanese economy continues to struggle, with a weak consumer environment, continued deflation and a strong yen proving detrimental to exports.
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