Lured by Eastern promise

Japanese companies are notorious for their low dividends, so any investor who needs to have an income should steer well clear

Investors are more bullish about Japan than they have been for some time. But be wary, says Steve Lodge

BIG investors are more positive about making money from Japan than any other stock market and are pouring money into its shares. Smaller investors with strong returns tucked under their belts from other markets this year are being encouraged to follow with the launch of a number of new investment funds.

More than two-thirds of investment managers are bullish on the Japanese market looking out over the next year, according to a survey by Smith New Court and Gallup. More than a third plan to carry on buying - more than for any other market.

Smaller investors have in general had little to complain about this year, with the UK market soaring to new all-time highs, Wall Street blazing ahead and other markets such as Hong Kong bouncing back. Many who took out PEPs in the spring are sitting on profits of over 10 per cent, while investors with unit and investment trusts in exotic markets could be up 20 per cent.

In fact, Japan has been the major disappointment. It has fallen in value this year and, with its Nikkei index at around 18,000, still stands at less than half its all-time high of 39,000 in 1989.

But now investment managers are calling its recovery again. Three - Morgan Grenfell, Flemings and the small Scottish investment company Martin Currie - have just launched new ways into Japan through unit trusts or investment trusts. The view that "Japan has to recover sooner or later", combined with a sense of other markets not being able to continue to perform strongly are driving much of the bullishness.

But additional pluses for Japan this time, say managers, are that the yen is weakening - good for exports - and that the government has started taking seriously the need to stimulate a recovery.

Denis Clough, manager of Schroder Tokyo unit trust, a popular and strong- performing existing fund, says he is "in the optimistic camp". The bullish argument is that Japan is "unusually behind" in terms of economic and stock market recovery. Whereas company profits have already recovered strongly in the UK and the US, Japan's recovery is ahead of it.

Schroders expects company profits to grow dramatically - by a total of more than 100 per cent over the coming two years. That and healthy economic growth should be sufficient to push the stock market up by more than 20 per cent over the next year and by more than 40 per cent over the next three years, says Mr Clough. Bill Thomas, manager of Morgan Grenfell's new Japan Growth unit trust says a return of 60 per cent-plus is a "quite feasible" proposition over the next three to five years.

But against this are siren voices that say just because recovery is expected does not mean the stock market will necessarily recover in the short term. Peter Tasker, an investment strategist with Kleinwort Benson, sounds a cautious note in the article below. Japan still has enormous problems left over from its "bubble economy" period in the late 1980s. The "bust" has left Japan's banks with 50 trillion yen (pounds 320bn) of loans on which borrowers cannot afford to pay the interest.

Even the bulls are at pains to point out the high risks to investors. Mr Clough notes the Japanese market can rise and fall sharply over a short period. Furthermore, investors do not get much of an income cushion against this volatility from Japanese investments. Japanese companies are notorious for their low dividends. Investors who need an income should steer clear.

"It is a big bet," says Graham Hooper, investment director of independent adviser Chase de Vere Investments. He says only investors who are up to their full limits on PEPs and Tessa accounts should even consider it.

Mr Hooper adds that Japan is a bigger bet with the market at 18,000 than 14,000 as it was at one point earlier this year. But equally, most observers believe the risks relate more to how much the market will rise and how quickly rather than the risk of a further setback. Morgan Grenfell's Mr Thomas notes the low correlation between the US market and the Japanese, suggesting that were the US market to suffer a fall, then Japan might be relatively protected while the UK would be more at risk.

Some tips, then, for investors:

q Unit trusts and investment trusts are the best way in for the small investor. Buying individual shares is impractical and riskier.

q Do not automatically go for the new offers. There is nothing wrong with the latest three - Morgan Grenfell's Japan Growth unit trust, Martin Currie's Japan investment trust, and a new share issue from Fleming Japanese investment trust - but there are good existing funds too.

q That said, existing Japanese investment trusts have become so popular that they have become expensive. So avoid.

q Existing unit trusts are a better bet. Our table lists five of the best-performing Japanese unit trusts over the past five years. They all carry top AAA ratings from professional analysts Fund Research, which rates funds according to not just how well they have performed but also an assessment of the management's capabilities. Despite the market's poor performance over this period, British investors have still benefited from the weakening of the pound against the yen, which has boosted the value of their investments.

q Investment trusts are riskier and more complex than equivalent unit trusts. So new investment trusts are not for beginners.

q Equally, funds of either type specialising, say, in Japanese smaller companies are more risky than the rated funds in the table that all invest generally. But smaller company funds are more geared into Japan's recovery. Kleinwort's Tasker, writing below, believes smaller companies will give higher returns. Schroder Japanese Smaller Companies unit trust is cited by advisers as a leading specialist fund.

q Past performance is no guide to the future with individual funds. But picking a general fund from a big investment company with a good record that a professional adviser recommends is probably the best bet.

q Limit your investment only to money you are prepared to tie up for at least five years, and only to a proportion of that money.

Surviving in Japan

What pounds 100 is worth after five years

Unit trust pounds

Hill Samuel Japanese

General pounds 176

HSBC Japan Growth pounds 166

Martin Currie Japan pounds 184

Perpetual Japanese

Growth pounds 164

Schroder Tokyo pounds 184

Average unit trust pounds 148

Friends Provident

Japanese Smaller Cos pounds 101

Source: Five named funds carry top AAA rating from Fund Research. Performance figures from Micropal