Investing Knowledge

Last week, I put forward the case for Japan being a good bet for the armchair investors amongst us who are prepared to take a long term, wide-angled view of things -- as part of a balanced portfolio. The basic reasoning for this has as much to do with contrarianism as anything else, but the fact that Japanese stocks are trading around their book value also lends a lot of weight to the bull case.

If you agree with the basic premise, there are various ways of trying to play a long-term recovery and quite a few pitfalls to avoid.

Of course, it would have been a lot better to have invested in Japan just a couple of months ago when the Nikkei (news) hit a 26-year low. The share prices of most of the Japanese unit and investment trusts have risen since then and the markets may yet present another such opportunity. But the Nikkei is not a long way off its lows if you zoom out a little -- and is still down around 75% from its 1989 peak.

Exchange rate risks

One of the biggest downsides facing UK-based investors in Japan is the sterling-yen exchange rate. Today, a pound will buy you around 160 Japanese Yen. A year ago, it would have bought you over 210. So, to invest in Japan today, you'd have to hope that the exchange rate stays around its current level. Otherwise, if you buy Japan now and sterling recovers, you may still be sitting on a sterling loss even if your investments do well. 

You could get round this problem by hedging your bets selling the yen and buying pounds for the same amount of as you invest into, say, a Japanese unit or investment trust. That way it would be possible to benefit from any rise in the Nikkei without worrying about a recovery in sterling vs. the yen. But it's also feasible that you could lose both ways following this method if, hypothetically, your Japanese investments fared badly, but the yen strengthened further still against sterling.

Endemic risks

Other risks are more to do with macro-economic policy, culture and demographics. Motley Fool poster "OhIngardail" makes excellent points about the last 15 years of "ineffective fiscal profligacy" in Japan which has left the country with a public debt about 180% of GDP. The country also is also sitting on a demographic time-bomb with 40% of the Japanese population set to reach retirement age by 2050.

These are very legitimate concerns. But the fact remains that Japanese stocks are very good value -- and there are some potentially very exciting ways to play for a long term recover depending on your individual risk-reward profile.

Investing in the land of the rising sun

There are numerous investment and unit trusts specialising in Japan. Quite a few of these are at healthy discounts to net asset values, so could do well over time given a Nikkei recovery.

For overall information on the merits of various trusts, have a look at Trustnet -- an excellent source of information which includes performance records. There are scores of Japanese trusts to choose from depending on your preference (big companies, small, capital growth, income etc.).

Warrants warrant a look

Perhaps the more exciting prospects for the thrill-seekers amongst us are the warrants attached to some of these trusts. Warrants are traded independently of the stock and entitle the holder to buy shares in a company that issued it at a specified price at a future date which is usually higher than the price at time of issue. They can, of course, end up worthless, but some warrants are far less risky than others. So, as an example, the JPMorgan Fleming Japanese Smaller Companies Investment Trust warrants (JPSS) look interesting. 

The trust's final results at the end of March revealed a net asset value of 131.8p per share. This has since gone over 150p, whilst the shares stand at 134.25p. The warrants, meanwhile, confer the right to buy shares until 31 March 2014 on a stepped basis. To the end of March 2010, the exercise price is 135p, to March 2012, it's 147p, whilst at the end of March 2014, the exercise price is 174p. 

The warrants are somewhere around 35p to buy at present, so aren't great value "technically". But the shares peaked in January 2006 around 450p. If they get back there again before 31 March 2014, this infers a warrant price of around 300p. Whilst certainly not for the faint-hearted, warrants offer an interesting way to play for a long-term Japanese recovery.

On balance, as part of a long term strategy -- it seems wise to have some Japanese exposure to me.

David owns JP Morgan Japan Smaller Companies warrants.