From 2003 to 2006, investors were well served with Japanese equity funds. Then in 2007, the average Japanese equity fund posted a loss of 6.42%, even as the S&P 500, a barometer of U.S. stock market performance, rose 6.77%. So what's the outlook for 2008?
S&P's International Equity Strategist Alec Young expects Japanese equities to continue to underperform other major equity asset classes throughout 2008.
"While below their long-term average, Japanese equity valuations remain elevated on a relative basis," Young says. "At 15.7 times consensus estimated 2008 earnings, the S&P Topix 150, a good barometer of Japanese stock market performance, is trading at a significant premium to the S&P 500, which has a P/E of only 14.3%."
Others disagree. Robert Smith, the international equity strategist at T. Rowe Price, says he considers price-to-book valuation a better indicator than P/E. And on a price-to-book basis, Japan, at 1.9 times, is cheaper than the S&P 500, at 3.0 times.
And putting aside relative valuations, "I think you can make an absolute case for Japan; it's my number-one investment idea for 2008," says Patrick Tan, CIO for international equities at Legg Mason.
The Vanguard Pacific Stock Index fund (VPACX) makes the list of top five performers in the Japan equity fund category for the one-year, three-year, and five-year periods. Although the fund maintains a majority allocation to Japan, it is diversified across the Pacific region, holding stocks of companies headquartered in Hong Kong, Singapore, and Australia, as well. As of the end of November (the most recent date for which this data is available), the fund had 66.8% of its holdings in Japanese stocks, down from 73% a year earlier. The fund's top holding is Japanese car maker, Toyota.
Fidelity Japan makes the top five list for the one-year and three-year periods. It also has Toyota as its number-one holding. Unlike the Vanguard index fund, the Fidelity fund is, as its name states, very concentrated in Japan, with more than 96% of its assets invested in Japanese equities.