Japan's down but still worthy of investment

Don't make mistake of ignoring bright spots in a slumping market

Dollars & Sense

March 10, 2002|By Gregg Wolper | Gregg Wolper,MORNINGSTAR.COM

In many ways, Japan looks like a basket case. Its economy has been in the dumps for a decade, its banks are drowning in bad debts, and its entrenched politicians and bureaucrats - despite prodding from Prime Minister Junichiro Koizumi - have exhibited little interest in instituting reforms. Recently, The Economist wickedly dubbed Japan "the nonperforming country."

Not surprisingly, the Japanese stock market has been mired in gloom for most of the past 12 years. Last year, the benchmark Nikkei 225 index plunged 34 percent in dollar terms - the worst showing, by far, of any major market.

Clearly a market to avoid, right? Not so fast. If you seek an international fund, don't exclude Japan-heavy offerings. It turns out that some of the best-performing international funds, both in 2001 and over the long term, have not only invested in Japan, but have higher stakes in that beleaguered market than the category average and index weightings.

Longleaf Partners International was perhaps the most noteworthy of the top-10 crew. In a year when the MSCI EAFE index lost more than 21 percent, that fund notched a 10.5 percent gain, despite having nearly one-third of its assets in Japan. That's nearly double the category's average Japan stake and well above the EAFE's weighting, which ranged between 20 percent and 23 percent. First Eagle SoGen Overseas posted a 5.4 percent gain, though it had a Japan stake of more than 20 percent.

DFA International Small Cap Value, GMO Currency Hedged International Core III and Morgan Stanley Institutional International Small Cap are the others with outsized Japan stakes that landed in the top 10 performers in 2001. Aside from the DFA fund, a passively managed portfolio, the rest of these funds have strong longer-term records, too - and it's worth noting in many cases the funds' Japan picks actually contributed to their solid performance.

This wasn't just a fluke involving smaller funds at the top of the charts, and it didn't result merely from currency hedging (which helped some of the above funds). Fidelity Overseas, one of the category's largest members, landed well into the top half last year - and it had a Japan stake close to 25 percent most of the year. It doesn't engage in currency hedging.

Two related lessons emerge. First, as Morningstar managing director Don Phillips recently noted while discussing the U.S. market in February's Morningstar Fund Investor, just because a stock market's indexes are down doesn't mean that every stock dropped and that it was therefore a good idea to be out of that market.

Second, when choosing a foreign fund, don't dwell on its country weightings. While it makes sense to keep an eye on your portfolio to ensure diversification and to note whether your funds veer far from their stated strategies, trying to micromanage your funds can backfire. Once you've decided to put some of your money into international funds, choose good stock-pickers and let them do their jobs.

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