A look at Japan equity fund volatility

There are 42 Japan equity funds registered for sale in Hong Kong and only three of them are less volatile than the peer category average, according to FE data.

For three years to July 12, the annualised volatility was the lowest for the HSBC GIF Economic Scale Japan Equity Fund, followed by BOCHK Japan Equity and BOC-Prudential Japan Equity products (see chart below).

During the measured period, only six funds in the category had volatility lower than the reference index, the Topix (12.25%).

Volatility sources

Japan is a relatively sleepy market compared to counterparts in China, Europe and the US. What could be the sources of volatility?

To some degree, sections of the market are reacting to the US-China trade dispute. It indeed has had consequences in Asia, as many countries are linked to mainland China via product supply chains, according to Barings. Large Japanese manufacturers have factories in China and due to the trade dispute some have been shifting production to other Asian countries.

Perhaps that’s why the low volatility funds have tended to have the biggest exposure to domestic consumption. The HSBC product, which has the lowest volatility in the whole sector over the measured period, has one-third of the portfolio invested in the consumer discretionary and financial sector, the factsheet shows.

Roughly the same sectors make up one-third of the second least volatile fund from BOC Prudential.

Turning to the most volatile fund in the category, the JP Morgan Japan (Yen), several factors are likely involved.

The trade dispute and slowing GDP growth in China (the lowest in almost 30 years in Q2) could be a key factor. Top holding Keyence (6.4%) has manufacturing in China and other top holdings Shiseido (5.7%) and Kao Corp (5%) for example, have a large portion of Asia sales derived from China.

Another reason could be that the fund has traditionally held small caps, which tend to be volatile. “While the strategy has a large-cap bias, it has historically had an overweighting to small caps relative to the Topix Index, as the small-cap arena tends to be under-researched and more inefficient,” according to a Morningstar report.

However, since the return of volatility in US markets, Japan may be the smoothest ride in the developed world.

Even though the global economy is slowing, the trade dispute continues long-term, and the US has turned around and will likely cut interest rates, Japan is less impacted by the list of macro concerns faced by other developed economies.

“If China’s economy declines, these neighboring emerging countries could all be influenced. But we feel that the impact on Japan is relatively small,” said Yifan Hu, managing director of UBS wealth management in a media briefing.

“Because in fact, the complementarity of Japan’s economy and China’s economy are very strong, and in the high-tech field, Japan can meet many of China’s needs,” she added.

Five most and least volatile Japan equity funds

Source: FE. Annualised three years to 12 July 2019.