The Analyst: Japan really is the place to look at

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The Independent Online

Asia has been in the spotlight over the last couple of months as markets across the region rocket upwards. In fact, I would not be surprised to see a short-term setback; I suspect some investors are just waiting for an excuse to bank their profits. If that does happen I would probably consider it a buying opportunity because these markets have massive long-term growth potential.

This week, however, I will be focusing on one of the less glamorous Asian markets. When I first came into the industry, Japan was a very much a hot area. In fact the first two unit trusts I ever bought were Japan ones, and boy did they go up. This has been almost completely forgotten in recent years, perhaps because it has disappointed UK investors for such a long time.

The Japanese market peaked in 1989 with the Nikkei index sitting at almost 40,000. Today it is only around 17,000, so you can see that Japan has experienced a really long bear market. Since the late 1980s it has shown brief periods of recovery, most recently in 2004/5 when it rose very strongly.

However, 2006 was a disappointing year, particularly for small and medium-sized companies, which effectively fell more than 50 per cent.

That might put some people off, but I am always interested in areas which are deeply unloved, unwanted and unfashionable. Over the years, I've often found them to be the best places to look for the next great opportunity. Japan definitely fits the bill.

One fund that, in the words of its manager David Mitchinson, had an annus horribilis last year was JPMorgan Japan. I must hold up my hands and admit to recommending this fund in early 2006; my timing couldn't have been worse but I maintain that it is one of the best funds in the sector for the long term.

Mitchinson's strategy means that the fund tends to have significant investment in small and medium-sized companies, which resulted in the fund battling a strong headwind last year. Some of these companies fell by as much as 60 per cent, but what is truly remarkable is that in many cases there was no real reason for the fall.

Some stocks that had been valued at 17 times their earnings fell to such an extent that they were only valued at seven times their earnings, despite their earnings having actually increased! The market simply wasn't interested in them.

Distressed investors have been switching to Japan's largest 30 companies in their droves recently, but Mitchinson believes that the management of those companies are often dull and lack dynamism.

The fund has a bias towards growth-orientated stocks and the manager is basically looking for companies that are cheap, but which he thinks are likely to beat earnings expectations. Today Mitchinson can find stocks that are cheaper than they have been for years, but with annual growth rates in excess of 25 per cent.

He has reacted to the problems that have hit the fund by being ruthless in his selling of poorly performing shares and letting the winners persist in the portfolio. One of Japan's best known companies is Nintendo, which has been a highly profitable holding for the fund due to the runaway success of its DS and Wii systems. Another company David Mitchinson likes is Asics, a sports-shoe business, where new management led to renewed focus on the company's core business and the jettisoning of areas where they had no competitive advantage, such as golf clubs and ski-wear. Japan Tobacco is also in the portfolio as a great restructuring story; it bought Gallagher last year and now generates half its sales profit from overseas.

Japan is not known for being rich in natural resources, but Mitchinson had identified an attractive prospect in Inpex, Japan's largest pure oil and gas company. Another stock of which he has been a long term holder is Moshi Moshi Hotline, a leading call-centre operator that is expanding its market share in this growing sector.

Japan's economy doesn't look particularly exciting, but there is no doubt that many of the companies in this focused portfolio do look extremely cheap. Compared to other Asian investments this represents a fund and market that has been left behind in recent years and could be set to catch up.

I realise some of you might be sending for those men in white coats to take me away, but I really think Japan, and particularly the JPMorgan Japan Fund, is worth reconsidering.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent

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