Mark Headley Sees Values Great and Small in Japan

Most investors gave up trying to find anything to like in Japan. Mark Headley is forced to find good plays -- it's his job as manager of the (MJFOX)Matthews Japan fund.

Like everyone with exposure to Japan, Headley's fund has had a hard time of it, losing 2.87% a year on average since its December 1998 inception through March 31. That trounces the 8.6% average annual loss of the benchmark MSCI Japan index, but you can't eat off relative outperformance when everybody is losing money.

Nonetheless, Headley -- a top pick in this week's Five Winning Funds on Japan -- is finally starting to see real promise in the country. The 30-odd stocks in his fund range from giants to micro-caps, a balance that has helped Matthews Japan smooth out the rough patches.

We talked with Headley about what he likes and doesn't like about Japan, what could turn things around for the nation's second-largest economy and if the U.S. really has Japan-like symptoms these days.

What have you learned after nearly five years of running a fund in Japan?

We launched this fund at the end of 1998. Straight out of the gates, we put a fair amount of money in small caps. And the Japanese market exploded higher. People kept saying, "You guys timed the market bottom when you launched the fund!" [The fund rose 107.4% in 1999, slightly below the category average that year.]

It's been three bitter years. (Laughs.) We certainly took our lumps along with the rest of the group. Bets on technology and financial companies have been a disappointment.

I came into Japan with extensive experience in Korea after that country had to make tough reform decisions. I had a profound sense that Japan must fix its financial system of all is lost.

While I still feel that the country will reform itself, their efforts have been frustrating. Rather than deal with it, they will endlessly half-deal with it. The Asian financial crisis forced other Asian countries to confront the problems in their systems and take drastic measures to rectify matters.

The country remains rich. Japanese citizens have trillions of dollars in savings. The nation has lower unemployment than the U.S. They haven't gone through a great depression, opting instead for a slow, grinding mini-depression. But corporate dynamism and organic economic growth have been sacrificed by slow-motion deleveraging of their bubble in the 1980s. Now the question is: Where do you go from here?

Japan's wealth is in fact something of a lifejacket from an economy that has suffered horrible management. The old method worked so well after World War II and they just can't seem to let go of it. People talk about a new generation being necessary to revitalize Japan. It's slowly starting to happen.

The funny thing about Japan is they've done everything wrong that they could and they are still there. If your economy falls apart, even if you are Argentina, people still go to work. You can't write off a country as large and diverse as Japan -- many companies have good management, good technology, good brand names.