A yen to get into Japan?

Choosing the right sector is the secret to picking funds, writes Simon Read

Investment is not an exact science but investors can reduce the odds to their benefit by picking funds which are likely to meet their investment goals. There are more than 1,500 unit trusts to choose from, for instance, but the choice can be cut by picking a fund sector.

Funds are classified in 24 different sectors, which are defined by the industry's trade body, the Association of Unit Trust and Investment Funds (Autif). Within some sectors there may be just a handful of funds, while others consist of hundreds.

All the funds in a sector have similar investment activity or areas of operation - for example investing in fixed-income stock or companies in the Far East.

The two most popular sectors - those attracting most investment - in recent months are UK Gilt and Fixed Interest, and UK Growth and Income while the two least popular are Japan and North America. Unsurprisingly, the most popular sectors tend to be better performers while the poor performers are the least sought-after. There are wide variations in the performance and potential investors would be wise to do a lot of homework before handing over their cash.

To illustrate this we can look at two different fund managers which each have top-performing funds in the top-performing sector - UK Smaller Companies - and among the worst-performing funds in the worst performing sector - Japan.

The Gartmore UK Smaller Companies fund is the top performer over one and three years according to HSW, a specialist firm of fund analysts, while Schroder's Smaller Companies fund is third in its sector over one year. At the other end of the scale Gartmore's Japan fund is 78th out of 90 in its sector over one year, while the Schroder Japanese Enterprise fund is 86th out of 90.

So, why is there such a difference between funds from the same fund management houses? A lot is to do with market and economic conditions, of course. The UK has been going through a period of recovery and small firms have benefited from that.

Meanwhile Japan has been going through very tough economic times. At the turn of the decade the positions were almost exactly reversed.

But to understand the differences between the four funds in the two different sectors, you need to look at their individual investment objectives. Gartmore's UK Smaller Companies fund "is designed to provide investors with above- average capital growth from a portfolio of carefully selected shares of smaller companies quoted on the UK stock market. The income yield is considered to be of lesser importance."

Not surprisingly, Schroder's Smaller Companies fund has much the same stated objective: "To achieve capital growth through investment in UK smaller companies. The fund will invest in smaller companies with the prospect of above-average growth potential. Income is of secondary importance."

Compare that with the stated objective of the Schroder Japanese Enterprise fund: "To achieve capital growth through investment in Japanese companies. The fund will follow a highly active investment policy with emphasis being placed on aggressive switching between sectors and a concentrated approach to stock selection. The relatively small number of stocks held will be in established Japanese companies with a proven record which offer the prospect of above-average capital growth."

There's not much long-term investing going on there, clearly. But this is in response to a sluggish market where aggressiveness is practically the only way to make money. The Gartmore Japan fund adopts a similar approach: "The fund is designed to provide investors with long-term capital growth from an actively managed portfolio of investments in Japan. The income yield is considered to be of secondary importance and is likely to be minimal."

The key words are "actively managed". Looking a little closer at sectors can reveal much, and is a particularly useful way of finding a match for your own investment strategy. Choosing sectors simply on the basis of historical information could be a mistake, however.

While the UK Smaller Companies sector is currently a high-flyer, it hasn't always been so, and history is littered with investors who've lost almost everything backing the potential of small firms. Conversely while Japan is bottom of the pile now, it wasn't always the case and there have been plenty of profits to be made in the country in the past.

Now could be a good time to be thinking about getting into Japan, according to John Kelly, investment director at Barclays Unicorn, whose Japan fund is among the worst six performers of all funds over five years. "We are optimistic about Japan," he says. "After a very extended period of adjustment, it is coming right. Japan had a period of excess growth and has to adjust to that. The pace of recovery is very slow but things are gently getting better."