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Japan Fund Leapfrogs Its Country's Economy

But despite the fund's recent gains, Japan's continuing economic weakness is one reason for caution.


Japanese Prime Minister Keizo Obuchi


President Clinton

put their heads together this week on how to rouse Japan's Rip Van Winkle economy, Seung Kwak, the 38-year-old manager of



Japan fund, will be paying scant attention. "We're not banking on recovery in the economy," he says emphatically. It's possible, Kwak says, that massive government infusions will turn out to be "too little, too late."

Not that it's seemed to matter lately to Scudder Japan. For the past three- and five-year periods, the fund has ranked third among its peers, logging small but positive gains while the average fund was in the red. For the past 12 months, Scudder Japan is up 45.6%, according to


, placing it in the top 10 and well ahead of the average Japan fund's 31% gain.

Kwak, born in Tokyo and based there now, stopped by my Washington office last week on the final leg of a U.S. tour to talk about the fund, about stockpicking and about how the latter has gotten a lot easier since Japan discovered its shareholder constituency. A soft-spoken former philosophy major who attended

Middlebury College

in Vermont and then earned a master's at


in international relations, Kwak joined the Japan fund's management in 1989.

Perfect timing. Nothing like becoming a portfolio manager of the oldest and biggest Japanese stock fund just in time to watch the bottom fall out of the


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at the start of what has turned out to be one of the worst bear markets in history. Unbowed, Kwak became the lead manager of the fund in 1994.

Now, he is hoping to oversee a comeback. Though still nearly 60% below its 1989 high of 38,915.87, the Nikkei has risen nearly 17% so far this year, well ahead of the

S&P 500's


And when Kwak looks at all the sidelined cash, he sees nothing but pure equity fuel. Pension funds are net buyers now, and in the second-largest pension market in the world, assets are growing 7% to 8% a year. Meanwhile, foreign investors have started bottom-fishing in a big way. In the past three to six months at Scudder, for instance, portfolio managers have moved from underweighting Japan to neutral weighting, says Kwak. And Scudder's not alone. "We're talking hundreds of billions of dollars in asset shifts," Kwak says.

Kwak is also counting on Japanese households -- owners of $10 trillion in financial assets, half of which is in low-yielding term deposits. Until last year, the Japanese bond market and foreign investments claimed most of those deposits as they matured. But investors were betrayed by both as the bond market collapsed and the dollar weakened against the yen. In the first quarter, equity trading volume by individuals hit a two-year high, says Kwak.

But Kwak is far less comfortable prognosticating about the market overall than he is assessing its stocks, one at a time. He clearly revels in his analyst roots and considers himself a stockpicker above all else. "I interview over 200 managements a year. That's our edge," says Kwak, adding, "I don't try to make macro

economic calls, stylistic bets or market-cap bets." Kwak's portfolio is a reflection of the broad market and includes blue-chips as well as small- and mid-caps, disk-drive makers as well as bicycle-part makers.

Here's what he looks for:

  • Companies with a franchise. Benesse, a leading provider of correspondence courses, is Kwak's top holding. One-third of Japan's elementary and junior high students supplement their schooling. Benesse is rolling out an Internet service that will slash the company's major cost: mailing expenses. With the cash flow the company generates growing at 10% a year, Benesse is buying up related franchises. The company now owns Berlitz, for example. "It's what Warren Buffett might want to buy in Japan," says Kwak.
  • High-growth companies. Fijitsu Support and Services is Japan's leading network design, service and maintenance company. The stock has tripled for Kwak, but he's no momentum player and adheres to strict price targets. Accordingly, Kwak is scaling back on Fijitsu Support; the stock dropped from No. 3 to No. 9 in Kwak's top 10 holdings over the first quarter. "We're no back-door technology fund," says Kwak.
  • Restructuring stories. In the first quarter of 1999, some 200 companies announced major restructuring plans. "The scale of change we're talking about is like going from the feudal system to modernization," says Kwak. Among his restructuring plays is Nikko Securities, the No. 3 brokerage, which announced plans in November to trim assets, streamline businesses and reorganize overseas operations. Nikko also will benefit from individual investors' shift from bank deposits to other investments, says Kwak.

Kwak made a pretty convincing argument. I can see the value in Japan's market. But I wouldn't blame anyone who's still a little xenophobic, and I would go slow in committing assets to the land of the rising (we hope) sun. After all, if you'd put $10,000 in this Japan fund in 1989, it'd be worth $10,893 now. That's better than the $10,249 delivered by the Japanese market on average, but not even comparable to the $60,700 you'd have if you'd sunk your money in the

S&P 500

in the U.S.

And yes, stock markets are supposed to be leading indicators, but it's hard to look past the persistent weakness in Japan's economy, which shrunk 3.6% last year, especially given last Friday's report of record unemployment.

Plus, any weakness in the yen is another worry, particularly for Kwak's shareholders, because he refuses to hedge after a bad experience some five years back. With the yen trading around 100 to the dollar, Kwak bet on its weakening to 120 and hedged accordingly. Instead, the yen climbed to around 80 -- "ludicrous for the currency of such a weak country," but what happened nonetheless. "That one macro call hurt our performance significantly -- to the point where I spent sleepless nights figuring out what I should have done better," he says. The fund lost 9% in 1995. "Since 1996," says Kwak, "we focus on our strength: stockpicking."

Kwak's record speaks to his stockpicking ability. And he says there's no better place to ply his trade than in Japan. Of course, given the fund's mandate, where else would he go? His personal investments are another matter, however, and something Kwak mentioned in passing near the end of our chat put his comments in a slightly more convincing light: "I've shifted my children's funds from the U.S. and global markets to Japan."

Now that's an endorsement that carries some weight.

Anne Kates Smith is a senior editor at U.S. News & World Report in Washington. At the time of publication, she had no positions in the fund mentioned, but positions may change at any time.