The failure of Japan's banking system is at the heart of the problem, says Martin Batty, who looks after Newton's Japanese funds. "In the past, the Japanese banks made massive bad loans. Instead of being written off, these were allowed to continue. It is now reckoned that these bad debts amount to 10 to 20 per cent of the country's gross domestic product."
The Japanese are at last beginning to correct the situation with a nationalisation programme for some of the main culprits. The non-performing loans are being written off and the banks are being backed with government funds.
Just as importantly, Japanese culture is changing. Deregulation is starting to break down the trade barriers which keep out foreign goods. There is even a planned hand-out of vouchers worth 22,000 yen (just under pounds 1,000) to the poorest sector of the population.
But the Japanese still show no signs of beginning to spend money or invest on their stock market. Economists debate whether the country is in recession or depression.
"There is a reluctance among the Japanese to spend money," says John Ross, senior portfolio strategist at Fidelity. "It still has tremendous overcapacity. Unprofitable businesses need to be closed down."
So will long-term investors soon start to see a better return on their investment? And should anyone consider investing in Japan ?
We have seen false dawns in Tokyo before. There have been times in the past decade when analysts thought there would be an upturn, only to see their hopes dashed. This time there are some signs that at last the medicine is being swallowed. Unemployment is beginning to rise in a country that prided itself on giving its workforce a job for life. Corruption has been exposed.
This year there has been a rise in the share prices of some smaller companies and some of the leading exporters. Fund returns over one year are good.
However, a large part of the share rise has been fuelled by an influx of 400bn from foreign institutions over the past month or so.
Some companies are beginning to change their management styles. "They now realise profits are the order of the day," says Mr Batty. "In the past equity funding was unimportant, as were earnings, but this is beginning to change. In the past, you only saw Japanese senior management in London when they made a stop-over on their way to golf courses. Now they are coming in to talk to British institutional investors about how they will give a return."
Taking a three to five-year view, the managers of leading Japanese funds are more optimistic than they have been for a long time. They believe that if the economy can return to a normal business cycle, the current price of shares in companies that will survive the shake- out could be good value. "We need to be very selective," says Mr Batty, "but now that many good companies are trading at net asset value, there could be reasonable profits to be made."
And some of the managers have put their own money into Japan. Mr Ross, for example, has around 10 per cent of his personal pension fund in Fidelity Japanese Special Situations: "While there could still be more bad news, I do think we have bottomed and that next year could see the start of the recovery. So while there does not appear to be a lot of growth stock in Tokyo, those companies that survive could recover rapidly when the economy turns."
There are 15 investment trusts and 90 unit trusts or open-ended investment companies that offer specialist fund management in Japanese equities. Any long- term investor would be showing a loss after allowing for the effects of inflation - even in the top-performing fund. And because of the widening discounts on net asset value that have affected investment trusts since July, they have badly underperformed their unit trust cousins.
Top performers over 1 year (to 25/12/98) - bid to bid, net income reinvested
Fund % growth
Johnson Fry New Japan 33.19
S&P Japan Small Cos 31.92
Threadneedle Japan Sml Cos Gth 2 26.93
Invesco Japan Sml Cos 26.75
Threadneedle Japan Sml Cos Gth 1 26.30
Invesco Japan Discovery 25.00
Prudential Japanese 23.22
Baring Japan Sunrise 22.66
Baillie Gifford Japan Sml Cos 22.10
M&G Japan Sml Cos 21.70
Average unit trust 8.03
Average investment trust 1.41
Top performers over 3 years (to 25/12/98)
Baillie Gifford Japanese -10.75
GT Japan Growth -11.62
Newton Japan -12.31
Martin Currie Japan -15.81
Fidelity Japan -19.19
Aberdeen Prol Japan -21.05
Schroder Tokyo -24.46
Baillie Gifford Japan Sml Cos -24.47
Friends Provident Tokyo -24.93
Mercury Japan -26.04
Average unit trust -36.78
Average investment trust -54.28
Top performers over 5 years (to 25/12/98)
Martin Currie Japan 3.78
GT Japan Growth -0.66
Baillie Gifford Japanese -0.67
Newton Japan -2.55
Schroder Tokyo -6.33
Hill Samuel Japan Tech -7.20
Fidelity Japan -8.74
S&P Japan Growth -15.0
Friends Provident Tokyo -16.1
Aberdeen Prol Japan -16.41
Average unit trust -28.14
Average investment trust -53.3
Top performers over 10 years (to 25/12/98)
Perpetual Japanese Growth Acc 48.88
Schroder Tokyo 42.93
Baillie Gifford Japanese 32.48
GT Japan Growth 29.35
Edinburgh Japan Sml Cos B 18.07
Edinburgh Japan Sml Cos A 17.55
Hill Samuel Japan Tech 15.93
Stewart Ivory Japan 9.97
Schroder Japan Sml Cos Acc 8.76
Sun Life Canada Japan 7.76
Average unit trust -13.36
Average investment trust - 13.63
Source: Standard & Poor's MicropalReuse content