Scotsman.com Business - Top Stories - Investors can profit by turning Japanese

Scotsman.com Business - Top Stories - Investors can profit by turning Japanese
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Sun 22 May 2005

Investors can profit by turning Japanese

WEALTH WATCH

JULIE DENT


IN RECENT times, investors have been obsessed with China and India, two of the world's most rapidly developing and populous nations. A host of new funds have been launched and one investment trust has even voted to ditch its Latin American investment remit to make a wholesale leap across the globe and recreate itself as an India investment trust.

Listed western companies are at it as well, talking up their "China/India-related" themes, in much the same way that in the late Nineties businesses stressed how they were set to benefit from the internet.

These markets have enormous long-term growth potential and strategically it makes sense to be overweight in these areas. However, on a tactical basis now may not be the most appropriate time to buy.

Global growth is slowing and higher commodity and oil prices are biting. As bearishness has spread across the globe, investors have been quick to take profits and withdraw from riskier areas such as emerging markets. Despite the sharp falls, emerging markets still look vulnerable over the short-term.

So where else should investors be looking for long-term returns? It may surprise some readers that my eye is on Japan. It is an area where the portfolio of British Assets Trust is overweight. This may sound odd to those with long memories of the dramatic rise and fall of Japan in the Eighties, but after a decade of decline I believe it is time for investors to reassess the opportunities afforded by Asia's most mature economy.

While Chinese growth rates outpace Japan, it is important to understand that in a global context the Chinese economy is still relatively small compared with Japan, the world's second largest economy. As the Japanese economy stops shrinking in nominal terms, a domestic demand-led recovery could reawaken this sleeping giant.

The really positive story about Japan has been the gradual resolution of its structural problems. Firms have been quietly reducing excess capacity and exiting unprofitable businesses. Deflation is clearly easing.

Another major past concern for investors has been the slow progress in resolving Japan's nonperforming loan problem and the lack of demand for loans. Here, also, we are seeing improvements. Asset quality at the major banks continues to improve. While progress is hardly rapid, banks are clearly pulling loans from weak companies and putting pressure on them to restructure. Many companies are still repaying debt but there is demand for loans in the economy, driven by smaller, non-manufacturing firms, mainly in the service sector.

The labour market has also become more flexible with an increasing shift to part-time workers, marking a switch away from the "job for life" culture. A new, younger breed of entrepreneurs and company directors is emerging in Japan.

A sign of the renewed vigour in Japan is the pick up in mergers and acquisition activity as companies restructure. This has been further boosted by corporate regulatory changes that will take affect from 2006 which will enable foreign companies to fund acquisitions in Japan through stock swaps, rather than the current situation where purchase can only be made in cash. Many Japanese companies are urgently seeking to get bigger quickly in order to stave off foreign takeovers.

Japanese companies have also recognised the need to shift up the value chain. China is very important in this respect, providing a low-cost manufacturing base while they focus on new product development at home. This is absolutely necessary given Japan's ageing population and the ongoing fall in the number of workers. Despite the recent tensions between the two countries and anti-Japanese demonstrations in Beijing, China is viewed as an opportunity rather than a threat, and now the two can work together for their mutual benefit.

China needs steel, capital equipment and construction machinery - exactly what the Japanese are very good at making. Hence Japanese exports to China are soaring.

While Japan is not without its problems, they are slowly but surely being resolved. There is no doubt that global trends are important, but that is true of all markets. Valuations are reasonable and profitability is improving. Corporate Japan is rising to the challenge and, crucially, the Japanese themselves are starting to believe that the outlook, after a decade of adjustment, is looking brighter.

Julie Dent is head of global equities at F&C Edinburgh and fund manager of the British Assets Trust plc



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