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INVEST IN JAPAN? IT'S NOT OUT OF THE QUESTIONGiven the steady weakening of the Japanese economy, investing in the country hardly seems like a good idea right now. Morgan Stanley's Japan Index has registered a 14% annual decline for the past three years. For at least the past two years, intrepid investors have been venturing back into Japan in hopes of having found the market bottom -- only to see stocks fall further. And as cheap as stocks have become, they can always get cheaper. Indeed, if the government doesn't start to take steps to restore consumer and investor confidence and clear up its hidden debt mess, more bad news will wallop the Nikkei. So, are there any reasons to consider investing in Japan now? Actually, yes. Some investors believe that the consensus on the economy is getting too negative. "There's a feeling in the West that Japan is disappearing down a vortex," says Nick Edwards, who manages two top-performing no-load Japan funds for Warburg Pincus. "That is overdone." Although investors were clearly disappointed with the 16 trillion yen (or about $120 billion) stimulus package announced by the government a few weeks ago, Edwards believes that large amount of money will certainly help matters. "That goes a long way to stabilizing the economy," he says. AGAINST THE GRAIN. In fact, some investors are starting to interpret the current deep pessimism as a sign of a market bottom. The fact that some people think Japan may never work its way out of this mess "is a good reason to start looking seriously at it," says David Herro, director of International Equities at Oakmark International. He believes Japan will eventually recover. "The louder the [negative] cry gets, the closer we are to the bottom," he says. The best argument for investing in Japan is that the stocks are very cheap. Edwards says half of Japanese stocks are trading below book value, which is still a low valuation, even given Japan's somewhat suspect book values. He has identified about 30 companies that are trading at a market capitalization below net cash and 130 that hold net cash equal to 50% of their market capitalization. "In other words," he says, "many companies are worth more dead than alive." That should lead eventually to a huge boom in mergers and acquisition activity, he believes. Indeed, Herro, who looks around the world for stocks that are cheap based on their cash flow, says he's beginning to find good values in Japanese companies. "Assets cannot remain this undervalued for so long," he says. The large-cap fund he manages, Oakmark International, has 4% of assets invested in Japan. Its sister fund, Oakmark International Small Cap, is 15% in Japan. Herro says it's harder to find opportunities among large-cap companies, since their managements have been slower to emphasize shareholder value. The smaller, family-owned businesses are quicker to adapt, he has found. But Herro doesn't favor one industry over another. "You have to take things company by company, because some are getting it and some are not." 'MORE FAT.' Edwards, who also looks for companies with strong management selling at a reasonable price, says he's leaning more to the large-caps. "I think bigger companies do better," he says. "They have more fat to trim." Edward's Warburg Pincus Japan Growth Fund, up 3.4% in the past year, has the best returns in that time frame and is the only one out of the 14 Japan funds that is in positive territory. "The thing we have done right," says Edwards, "is to own the best run companies, like Sony, Honda, and TDK." Warburg Pincus Japan OTC Fund, also managed by Edwards, is the third-best Japan fund in that time period, even with its -12% return. Another argument for investing in Japan: It's clear that Japan's market does not correlate with U.S. markets. "It may offer a potential hedge," says David Masters, senior fund analyst with S&P's Micropal, a mutual fund research firm. To make a play on Japan's eventual economic recovery -- clearly a contrarian bet at this point -- the best route for U.S. investors is to buy a mutual fund. There you have a manager in place to select the stocks with the most potential and, hopefully, manage currency risk. Edwards, who thinks the yen will continue to weaken, hedges to protect investors from currency fluctuations. The Japan funds can basically be divided into two groups: those with a large-cap focus and those that focus on small-caps. None have performed well. The average open-end mutual fund has lost 8% a year over the past three years -- which is at least a far sight better than Morgan Stanley's -14% Japan index. The only fund in positive territory over three years is GAM Japan Capital Fund. It has gained 5% annually over the past three years and seems to be the most consistent performer, says Masters. But he notes that it also carries high fees: a 5% up front sales load and 2.15% in annual expenses. It's probably more prudent to choose a broader international fund that invests in a number of countries, including Japan. The portfolio manager can then allocate assets to Japan when the economy is on an upswing. But for investors who think they can call the bottom for Japan's markets, it may make sense to tuck away a small investment in the country and try to not even look at it until economic conditions improve. Of course, that means you could be looking elsewhere for quite a while.
By Amey Stone RELATED ITEMS
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Updated May 7, 1998 by bwwebmaster
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