With the risk of being one more sucker tempted to buy low before the great Japanese stock market comeback, I'm going to go out on a very shaky and lonely limb and say that now is a good -- nay, great -- time to invest in Japan.
No major stock market in the world is more perpetually beaten down. Current levels for Japan's Nikkei index are still down some 80% from highs reached more than a decade ago. The battered market trades at 20-year lows.
Contrarian investors, those who try to zig when others zag, have long been trying to make the case for Japan. Japan has all the hallmarks of the perfect contrarian play. Unfortunately, it's had them for years, sucking in investors one by one with the possibility that stocks are now officially cheap, or that the economy is improving, or that the government is finally getting its fiscal act together. There have been occasional spits and sputters and some massive rallies; all have crashed and carried the market to new lows.
Contrarian bets work best if two things happen: 1) Whatever is scaring the masses away vanishes; 2) the masses stop eschewing the area. Contrarian investing is sort of like value investing; it only gets exciting when your stock is discovered, runs up in price and stops being such a great value (like we've seen these last few years). Otherwise you just sit around collecting (yawn) dividends and talking about what a great bargain the stock you own is.
Reasons abound: low valuations, an economy showing signs of life such as reports of falling unemployment, a banking system on the road to recovery. But experts who know far more than I do have laid out sensible reasons in the past, only to be humiliated by an economy that just won't stop stinking.
My case for Japan is a little more qualitative. One thing I've noticed in working with funds and studying fund cash flows over the last 10 years is that fund investors and the fund analysts and reporters who steer them around with articles, rankings and ratings are almost always late to the party. They are last to get in on a good thing and last to get out of a bad thing.
While Japan remains the world's second-largest economy and home to some of the best and biggest companies on earth, it recently lost what little respect it still clung to from the mutual fund community.
Morningstar, the pre-eminent provider of mutual fund analyis and data and promoter of the popular star rating system, recently decided to drop Japan as a category of funds worthy of an analyst's pick. Taking this action essentially says to fund investors, "If you want a Japan fund, you are on your own, because our experts find little reason to bother with this fund category."
Fund data companies such as Morningstar slice and dice funds into dozens of categories, from small-cap blend to high-yield to real estate sector to Japan. To help people chose from the sometimes hundreds of funds in each category, the experts at Morningstar choose their favorites, which are called the analyst picks. Most categories have one, if not several, picks -- there are currently over 150 total analyst fund picks.
The reason given for disrespecting Japan funds is that "the category does not have any standouts," a conclusion reached because the funds in the category all stink performance-wise, or have recently lost managers.
Isn't the whole point of favorite category picks to choose the best funds in the category? There has to be a best of the worst. Maybe the real problem is that Japan is the absolute worst category, performance-wise, over the last 15 years in the universe that Morningstar tracks. A fund-rating company built on past-performance-based ratings just can't stomach the worst past performance in history. It's disrespectful to their system of rewarding past success.
More suspicious was a recent article by Russel Kinnel, director of fund analysis at Morningstar, highlighting 10 long-term losers. The usual suspects made the list: Undiversified
American Heritage, with its big bet on the bizarre biotech stock with the erection injection patents;
Frontier Equity, with its 32% expense ratio; the old, reliably miserable Steadman funds rebadged
-- the fund equivalent of changing a tobacco company's name to
to bury its past.
Many of these funds make for easy targets and often wind up on various evil-fund lists. Making a surprising appearance to the list was the
Dimensional Japanese Small Company fund, a low-fee institutional fund from Dimensional Fund Advisors. DFA is a well-run company that has done a useful job dividing the market into clearly defined custom indexes for categories and sectors with no style drift, so advisers and professional investors can control allocations to specific areas or the world markets. This DFA fund appears next to the black sheep of the industry, because it happens to be investing in an out-of-favor area, not from high fees or mismanagement. The article explains, "Obviously, few individuals need a fund dedicated to Japanese small-caps."
Is investing in the second-largest economy's small-cap stocks after they are down dumber than investing in the largest economy's small-cap stocks after they go up? Is small-cap a non-legitimate asset class in Japan that deserves breaking down to small-cap value, blend and growth here in the U.S.?
Even the now clearly despicable American Heritage received glowing reviews from Morningstar shortly before it tanked. Kinnel says, "Cost-conscious investors would have been tipped off right away that
American Heritage was headed for trouble. So would those who know something about stocks." Apparently Morningstar analysts were neither in 1993, when they said the fund "could make a very interesting addition to a more adventurous portfolio."
Adding insult to the already thoroughly injured Japanese market, Morningstar plays favorites in other fund categories of questionable investment merits. The recently hot precious metals category, which has fewer funds to choose from than the Japan category, gets rewarded with two analysts picks to help guide the flood of investor interest in this sector, which just a few short years ago was the worst category for the last 10 years.
The fact that
has more revenue than all the gold and silver mining stocks combined doesn't seem to add any legitimacy or respect to Japan with Morningstar.
Mark this day on your calendar: March 10, 2010. That's the day many U.S. tech and telecom funds -- funds that used to have five-star ratings on March 10, 2000 -- will have 10-year negative returns. Maybe Morningstar will stop picking favorites in those fund categories at that time, too.
Besides the blatant contrarian appeal, investing where even experts shun, there is good reason to invest in any category that investors ignore: Less investor money means more profits for you. Investors are most comfortable in crowds; it reinforces the intelligence of their decision. While comforting, doing so means sharing limited profits with the other, sometimes near limitless, investors. Mutual fund investors tend to follow past performance into "proven" areas in great herds, so they often wind up doing a lot of sharing of a limited pool of profits.
To be fair, Morningstar has done reports on how unloved fund categories tend to do well going forward -- and it's some of their best research. Why they haven't always put it into practice when picking funds is the great mystery.
If past mutual fund investors flows and subsequent returns are any guide, we can expect currently out-of-favor areas such as Japanese stocks to outperform areas fund investors are now enamored with, areas like small-cap value and longer-term U.S government bonds.
Those looking for some Japan funds can check out
Fidelity Japan Small Company, Dimensional Japanese Small Company,
T. Rowe Price Japan and
Vanguard Pacific Stock Index funds. The latter is not a pure Japan fund, but the market-cap weighting gives it a large Japan allocation.
To be a true contrarian choose one of the two smaller-cap funds since they are the most despised, and to really stand apart from the crowd, consider the more growth-oriented choice, the Fidelity Japan Small Company fund. The only reason that particular fund missed the list of bottom-10 funds of the last 10 years is that it didn't exist 10 years ago.
Maybe Japan funds will get the last laugh. So far this year, the DFA fund was in the top 25 funds out of over 7,000.
Note: In the interest of full disclosure, readers should know how incredibly biased I am. I run a Web site that analyzes funds, and I pick my own favorites. Additionally, in the past, I've worked in the fund industry at and with some funds Morningstar has ignored, penalized or lambasted at one time or another.
Jonas Max Ferris is a founder of MAXfunds.com, a fund research and analysis company, and partner in an investment advisor. He welcomes column critiques, comments, or baseless accusations at