Political pressure to boost Japan rally, says Polar Capital

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The managers behind the Polar Capital Japan fund increased their large cap weighting, adding regional banks and exporters to the €755 million portfolio.

A perceived policy shift towards a more concerted effort to induce inflation and the Bank of Japan's announcement of an additional 10 billion yen asset purchasing programme boosted Japan's equity markets in 2012 and left the managers relatively bullish.

Management duo James Salter, who holds a Citywire Euro Stars AAA rating, and Gerard Cawley believe that this, combined with the calming effect of the additional €529 billion of emergency lending by the European Central Bank, has lifted investor sentiment towards risk assets globally - and especially in Japan.

The Japanese market has been buoyant since the turn of the year, with large caps and the core 30 largest companies leading the way. Polar Capital Japan's  yen-denominated share class rose by 11.02% in February alone, compared to the Topix benchmark's return of 10.73% and the pair remain optimistic that the early year rally has further yet to run.

Improving fundamentals

In their latest investment note they say:' While we are well aware of the fact that the market is technically overbought, we are confident that the sharp rally was supported by real improvement in underlying fundamentals and are positioned accordingly.

'We are encouraged by the Bank of Japan’s efforts at monetary easing and look forward to additional political pressure for greater stimulus. The possibility of additional easing, a sustained and robust US recovery and further yen depreciation may drive further gains in the months ahead.'

The duo believe the BoJ's focused efforts on targeting inflation have been far more successful than previous efforts to devalue the currency.

Rotating out of big banks into regional banks

'The BoJ's inflation targeting is succeeding where record intervention in the currency markets failed in an effort to weaken the yen.'

With the currency almost at a nine month low, exporters and those firms geared into a domestic recovery such as the banks have done well, and the duo have looked to adjust their portfolio accordingly to make the most of the share price gains.

As sentiment has improved, they have added to their large cap weighting, through exporters such as Kyocera, Bridgestone and Mitsubishi Electric.

Top performers in the last few weeks include banking giants Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group as well as Fujifilm Holdings.

Salter and Cawley have been starting to rotate out of some of these bigger banks after the strong recent run, and are recycling the proceeds into some of the country's smaller regional banks. Proceeds have been invested in two regional banks, Bank of Yokohama and Chiba Bank.

Overall, the fund has around 13.1% in banks compared to the index weighting of 3.5%, while retailers were also overweight as well as chemicals and machinery stocks.

'Turnover was focused on rotating out of winning names into lagging stocks within higher beta sectors. Profit taking in [hi-tech manufacturer] Nitto Denko and the large city banks [Sumitomo Mitsui Financial Group and Mitsubishi UFJ Financial Group] have been used to fund new positions in regional banks and increase weightings to large -cap exporters.

The fund remains almost evenly split between small medium and large caps, at 34.8% , 32.7% and 32.5% respectively at the end of February.

Over five years to 15 March, the fund has returned 27.72% compared to the Topix benchmark return of -3.68%, while over one year to the same date, the fund is just ahead of the index, posting 9.23% to the benchmark's 8.65%.