An unknown country is Japan. Masa Takeda has helped manage the $ 750 million Hennessy Japan fund since 2007. He follows a large cap “best ideas” strategy. In an interview, he explained how the Japanese stock market makes it easier for active managers to outperform broad indices than it does for US managers.

The S&P 500 is not diversified

Go back to diversification, an easy way to follow the S&P 500 SPX index,
-0.20%
is by buying shares of the Spider S&P 500 ETF SPY,
-0.20%.
The $ 294 billion ETF holds all 500 stocks in the index, weighted by market capitalization. Its five main titles – Apple Inc. AAPL,
-0.64%,
Microsoft Corp. MSFT,
+ 0.85%,
Amazon.com Inc. AMZN,
-0.32%,
Facebook Inc. FB,
+ 0.99%
and Alphabet Inc. GOOG,
-0.23%

GOOGL,
-0.33%
– represent 23% of the portfolio. They are great companies, but the index is not that diverse after all.

A better way to diversify an S&P 500 investment is to use an equally weighted index fund, as Mark Hulbert explained recently.

But you might also be surprised at how easy it is to invest in another developed market with completely different exposure to stocks of quality companies that have been competitive against the S&P 500.

Follow the American index

First, take a look at this performance comparison for stocks in the Hennessy Japan HJPNX Fund investor class,
+ 0.60%
and its HJPIX institutional class shares,
+ 0.61%
(after fees) against the S&P 500 ETF and against the Japan Nikkei 225 Index NIK,
+ 0.27%
and the Topix 180460 index,
+ 0.08%.
The data was provided by FactSet:

Scroll down to see long-term average returns. For five and 10 years, the fund’s two share classes have outperformed the S&P 500 ETF after fees, while clearly beating both Japanese indices for five, 10 and 15 years. The annual expenditure for investor stocks is 1.44% of assets, and for institutional stocks, 1.04%. Both funds are rated five stars (the highest rating) by Morningstar, in the “US Fund Japan Stock” category of the financial research firm.

Why Japan? An advantage for active managers

Some US investors may still think of the Japanese economy and stock market as places where growth is hard to come by. Over the past 10 years, the Nikkei 225 Index has underperformed the S&P 500:

Most US equity investors are probably aware that the vast majority of managers active in this market underperform the S&P 500. But things are different in Japan, where around 40% of active managers outperformed the Topix index between 2010. and 2019, according to this painting on the Japanese Morningstar site.

Takeda, who is based in Hong Kong, explained that the Japanese stock market is “inefficient”.

“Japan is still a great market for active managers to make money. If you look at the Nikkei or Topix indexes, they are full of mature, big, sleepy companies that have no prospect of growth, whether they are financials, utilities, or traditional auto companies. If you avoid them, you can still come up with great investment ideas, ”he said.

Takeda is also optimistic about the state of the Japanese economy, due to the government’s stimulus efforts during the COVID-19 pandemic. The unemployment rate in Japan rose to 3% in September from 2.5% in March.

Longer-term, Takeda cited the economic reform policies of Japanese Prime Minister Yoshihide Suga, a close ally of former Prime Minister Shinzo Abe, who resigned in August for health reasons.

“We have a very reformist and pro-growth government. We also have a central bank that is business friendly and inflation friendly. Never in the past have we had this combination, ”Takeda said.

Buffett and trading companies

Takeda also highlighted Warren Buffett, CEO of Berkshire Hathaway BRK.B,
-0.60%,
which recently bought a 5% stake in each of Japan’s five trading companies, traditionally known as “sogo shosha”, including Mitsubishi Corp. 8058,
+ 0.39%

MSBHF,
-1.79%,
Mitsui & Cie 8031,
+ 0.04%

MITSY,
-0.40%,
Sumitomo Corp. 8053,
-0.83%

SSUMY,
-0.90%,
Itochu Corp. 8001,
+ 0.72%

ITOCY,
+ 0.67%
and Marubeni Corp. 8002,
-0.15%

MARUY,
-0.32%.
(For all five trading companies, two tickers are included, the second being the U.S. Certificate of Deposit, or ADR.)

Takeda described the five companies as originally importers of raw materials and exporters of finished goods – a business model that became obsolete in the 1980s and 1990s. Thus, trading companies are now direct investors in various companies and securities portfolios. And Buffett made a major vote of confidence in the Japanese economy.

Mitsubishi is the only trading company owned by the Hennessy Japan Fund, which initially bought the shares in 2007. Takeda said the trading houses had “ditches,” made up of networks of experts from various industries making deals in the whole world.

“Mitsubishi has aggravated [its book value] at 8.3% per annum after paying 20% ​​of net income, on average, over the 10-year period ending in fiscal 2019, ”he said.

The shares have a return of around 4.7% and Takeda expects annual returns “in the teens” going forward.

Other holdings of the fund

Takeda discussed six other shares held by the Hennessy Japan Fund:

• Keyence Corp. JP: 6861 KYCCF was the fund’s largest holding as of September 30, accounting for 6.6% of the 24-stock portfolio, according to Morningstar. The company manufactures and sells factory automation systems around the world. Takeda called Keyence a “big” company and said the pandemic was accelerating growth trends for its products and services.

• Sony Corp. 6758,
  -0.64%

  END
  illustrates one of the great advantages of Japan, according to Takeda: high-quality manufacturing as a “reliable and sustainable competitive gap”. He has been impressed with the company’s turnaround over the past 10 years, as it has shifted from a focus on consumer electronics to content distribution, through Sony Music, Sony Pictures and PlayStation.

• Takeda said Daikin Industries Ltd. DKILY,
  -0.54%

  DKILY,
  -0.54%
  is the world’s largest manufacturer of air conditioning systems by revenue and the company is gaining ground in the United States

• Shimano Inc. SHMDF,
  + 0.51%
  is “the Intel of the bicycle industry,” according to Takeda. Chances are, your bike has at least a few Shimano parts. This is another industry that has benefited from increased sales during the pandemic.

• Nitori Holdings Co. 9843,
  +1.37%

  NCLTY,
  + 3.83%
  is a furniture retailer in Japan, China and the United States, which Takeda has described as “vertically integrated” because it designs products to be manufactured by contractors, for a “Ikea-like” business model .

• Unicharm Corp. 8113,
  + 1.73%

  UNICY,
  +1.77%
  manufactures consumer paper products, such as toilet paper and diapers. Takeda called the company “the Kimberly-Clark” of Japan, emphasizing Unicharm’s high-quality manufacturing.

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