Diversification - Japan

Geographical restrictions

Currently my portfolio is entirely invested in businesses listed in London, although they are mainly large international businesses, which have only a small proportion of their revenues from the UK. The list of companies I would be comfortable investing in is also drawn almost entirely from the London indices at the moment. I want to focus on quality businesses irrespective of their location, and am gradually adding to the list of potentials with some US based additions. Whilst I have some grasp of what's happening in the US and Europe, I'm less familiar with businesses listed on Asian indices. Since the US and Europe are potentially easier to purchase on my current ISA platform, and Asia more difficult, I’ll take a look at some alternatives to see if there are any attractive funds, investment trusts or ETF’s available. I’ll start with Japan.

Going passive

The simplest first option would be to put money into a passive tracking fund, something that simply tracks the performance of an index.

There are two indices of note in Japan – the Tokyo Stock Price Index, known as the TOPIX, and the Nikkei 225. The TOPIX is like the FTSE, in that it ranks it’s constituents based on market capitalisation, whereas the Nikkei ranks it’s 225 members according to price (using the Japanese Yen). The difference being that the Nikkei gives a greater weighting to higher priced stocks, whereas the TOPIX is influenced by higher capitalisation companies.

So what sort of easily accessible trackers are there for these indices? A quick rummage on the internet found a cheap Vanguard offering but tracking the MSCI Japan index rather than either the TOPIX or Nikkei. The MSCI provides a number of tools, analytics and (of most relevance here) - benchmark indices that institutional investors can use for measuring performance of their funds. According to the MSCI Japan Index documentation, the index is "...designed to measure the performance of the large and mid-cap segments of the Japanese market..." and covers around 85% of the market.

The Vanguard tracker accumulation fund has an ongoing charge of 0.23%, and according to the performance data they provide, over the last 5 yrs would have turned a £10000 investment into £16633 (in March 2019), a 66% increase, which is an annualised return of around 11%. I'll take this as my benchmark and see if there are other funds out there fishing in this pond that offer a better return.

Funds

There are more funds offering some sort of investment action in Japan than is sensible - 76 on offer from my current ISA provider. In order to restrict this a little I’ll take only the accumulation version of the funds (i.e. dividends are automatically reinvested into the fund), and only those with a rating from Morningstar (this tends to exclude newer funds). Based on the on the annualised return over 5yrs gives me the following 5 funds at the top of the list:

Fund name	5yr annualised return (%)	Ongoing Charges (%)
Legg Mason IF Japan Equity X	23.55	1.02
Bailey Gifford Japanese Small Co B	22.07	0.63
Lindsell Train Japanese Equity B	17.78	0.79
JPM Japan C	17.33	0.90
Bailey Gifford Japanese B	15.60	0.63

All of the above have a Morningstar rating of 5 stars, and all have a KIID risk rating of 6

If I make the assumption that the annualised returns and charges are going to remain roughly the same, I will subtract the charges from the annualised return to give a "Charge adjusted return":

Fund name	5yr annualised return (%)	Ongoing Charges (%)	Charge adjusted returns (%)
Legg Mason IF Japan Equity X	23.55	1.02	22.53
Bailey Gifford Japanese Small Co B	22.07	0.63	21.44
Lindsell Train Japanese Equity B	17.78	0.79	16.99
JPM Japan C	17.33	0.90	16.43
Bailey Gifford Japanese B	15.60	0.63	14.67

Quite a range of returns. Just for fun I’ll add in the total returns based on the charge adjusted figures:

Fund name	Charge adjusted returns (%)	Total returns (%)
Legg Mason IF Japan Equity X	22.53	176
Bailey Gifford Japanese Small Co B	21.44	164
Lindsell Train Japanese Equity B	16.99	119
JPM Japan C	16.43	114
Bailey Gifford Japanese B	14.67	98

So at the top of the table, Leg Mason would have turned every invested £100 into £276, whereas Bailey Gifford Japanese would have the same £100 into £198. Doesn’t take a genius to see which investment is preferable, so two funds moving into position as favourites.

The fund managers have been in charge for different periods too:

Fund name	Total returns (%)	Mgr start date
Legg Mason IF Japan Equity X	176	1996
Bailey Gifford Japanese Small Co B	164	2015
Lindsell Train Japanese Equity B	119	2004
JPM Japan C	114	2012
Bailey Gifford Japanese B	98	2016

I wonder if it is coincidence that that best performing fund has had the same manager for the longest period? The dates also suggest that the two Bailey Gifford funds have had a relatively recent handover, so any credit/ blame for the fund performance should be directed at the managers’ predecessors rather than current incumbents. A plus mark for Lindsell Train in that regard having been in charge of their fund for considerably longer.

And finally if I want to invest in an actively managed fund, I’m paying the fund manager to put my cash into the businesses that they see having the best return on investment both today, and going forwards. I’m expecting them to have selected a relatively small number of businesses – having a massive fist of different businesses doesn’t strike me as helpful – I might just as well get myself a cheap tracker fund and save myself some money on charges. I’m completely ignorant about the state of the Japanese economy, but I’d rather any funds I invest in are in more defensive companies, such as consumer goods, healthcare, and in tech, rather than, for example in highly cyclical companies or commodities. My preference would be for a fund to build it’s portfolio, then leave it alone for compounding to do the heavy lifting. Here's how the funds' portfolios breakdown across sectors:  

Fund name	Sectors invested (%)				Number of holdings
	Consumer Defensive	Healthcare	Technology	Total
Legg Mason IF Japan Equity X	17	18	24	59	44
Bailey Gifford Japanese Small Co B	5	11	35	51	71
Lindsell Train Japanese Equity B	41	21	24	86	23
JPM Japan C	16	6	25	47	53
Bailey Gifford Japanese B	3	9	12	24	39

Two funds clearly stand out here:

• Lindsell Train investing in only 23 companies, of which 86% of their fund is in Defensive/ Health/ Tech holdings
• Bailey Gifford Japanese are only invested 24% in Defensive/ Health/ Tech holdings.

Based on this bird’s eye view of these funds I’m losing three of them. JPM and the two Bailey Gifford funds. Leg Mason, and Lindsell Train have experienced managers at the helm; I don't consider the Leg Mason portfolio of 44 companies excessive in number and it’s difficult to argue with their returns. The portfolio structure of Lindsell Train appeals but it does lag Leg Mason, however, if either the global economy or the Japanese economy has a few wobbles, Lindsell Train would appear to have positioned the fund to cope. Whereas Leg Mason may require an amount of chopping and changing. Leg Mason has the highest ongoing charges, which would likely increase if there needed to be a bit of buying and selling, however, Lindsell Train have a cheeky 4% initial charge – so just buying into the fund would leave me down 4% (not taking into account broker fees etc.) – maybe not a big deal with a longer term investment horizon, but unnecessary in my view.

To return to the Vanguard benchmark tracker, the 66% return on offer doesn’t really stack up against the two above funds – Leg Mason making nearly 3x and Lindsell Train 2x the tracker returns.

Investment Trusts

The final area to check out is that of Investment Trusts, now I know the performance of some of the funds against which the Investment Trusts are competing, I can narrow the search a little more. Two offering higher returns are both run by Bailey Gifford:

Fund name	5yr annualised return (%)	Ongoing Charges (%)	Charge adjusted returns (%)
Bailey Gifford Shin Nippon (BGS)	25.35	0.76	24.59
Bailey Gifford Japan (BGFD)	19.13	0.73	18.4

Both trade on a small premium of around 4% (i.e. the cost of a buying a share in the Trusts is around 4% higher than the Net Asset Value (Assets – liabilities)). This isn’t massively different from the average premium for the last 12 months, so I’ll make an assumption that this is going to remain fairly stable and not impact any investment. So both Trusts look like they have put in a decent performance that is comparable to the funds above, outperforming the Lindsell Train offering for example, by putting in a total return over 5yrs of 200% for BGS, and 133% for BGFD.

The manager of the BGFD team retired in 2018, with her deputies now running the Trust which is invested in 70 businesses, whereas BGS has had the same manager in charge since 2015 and is invested in 74 businesses. Whilst I don’t really see the need for such a large number of holdings both teams have outperformed the tracker fund by some margin. Given my preference for more defensive businesses and tech over some other sectors, here’s how the two trusts fair:

Fund name	Sectors invested (%)				Number of holdings
	Consumer Defensive	Healthcare	Technology	Total
Bailey Gifford Shin Nippon (BGS)	6	13	32	50	74
Bailey Gifford Japan (BGFD)	2	8	22	32	70

Both Trusts would have been great investments over the past few years, but the change in management leaves me a little uneasy. On balance, I think I’d want to see the performance of these teams under the new management for a little longer before committing any cash. However, I’ll keep an eye on both, and should either develop a discount I may get tempted.

Conclusion

The two favourites for a bit more research are Legg Mason and Lindsell Train. Both have long standing management that have delivered a decent return, and significantly outperformed my tracker benchmark. Both managers appear to prefer a longer term investment horizon and preach patience over churning their portfolio. And both have fees that are unappealing in some regard. I’m off for a cup of tea and a ponder.