Fat Prophets take profits

In the last review of the Martin Currie Japan Fund (MCJF) in December (FAT113), we recommended Members reduce their holdings by a half. Under-performance by the Trust's management was the main driver of the decision, however technically a period of consolidation also looked increasingly likely. Following a review of our exposure to Japan, and given further technical guidance, we are now recommending Members exit their Martin Currie Japan holdings completely.

On the charts, a strong performance over the past thirteen months saw the Martin Currie Japan Fund appreciate 67 percent, climbing from 94.91p to a high of 158.50p in April. This was the highest level achieved in five and a half years.

Since the April peak however there has been a notable deterioration in upward momentum. This combines with the break below 150.8p to weaken the near term outlook and threaten a test of support at 138p. The price action has coincided with weakness in the Nikkei 225 index, adding to downside risks.

The MCJF invests primarily in large Japanese companies. The weighting of large caps in the portfolio is 57 percent whilst medium caps represent another 38 percent. On the other hand, portfolio holdings in other Japanese investment trust recommendations (BGFD, FJV and IJD) focus more on smaller caps.

We remain steadfast in our belief that that the Japanese economic recovery has strong foundations, particularly from a domestic self-sustaining perspective. Consumer confidence is at a 16 year high and strong corporate earnings are forecast in the year ahead. The end of quantitative easing by the Bank of Japan and the prospect of an interest rate hike later this year indicates a return of modest inflation.

In this context, we believe the domestic led recovery will favour smaller companies whose focus is on local rather than international markets. This becomes clear when considering the impact of a strengthening Yen on Japanese exporters. Profit margins would come under pressure if exporters absorbed the exchange rate effects. Alternatively, higher prices would lead to rising inflation in foreign markets and most likely reduce demand. Neither outcome would be welcome.

The Japan Fund's focus on larger caps therefore has made us wary. This is borne out when looking at several heavy individual weightings in the portfolio.

Toyota Motor Company is a world class organisation. However last year the company produced 1.8 million vehicles in the US and Europe but sold 3.6 million in said markets. The additional cars came from Japan where production far exceeded sales. Despite Toyota's acknowledged high performance we believe adverse currency effects from a stronger Yen are unavoidable.

Office supply manufacturer Canon provides another example. Last year turnover in America and Europe represented US$19.7 billion of a total US$31.8 billion. Lower profit margins and/or faltering demand as a result of Yen strength would have a significant impact.

Recent market volatility aside, we believe Japan's economy and stock market still retain positive upside. However, with some cracks appearing in the US economy, we cannot discount further volatility in Japan and around the world for that matter. With this in mind those trusts and funds with the greatest leverage to Japan's domestic health are preferable to those we feel have more exposure to the vagaries of export markets.

In addition, given the fading technical momentum of the Martin Currie Japan Fund, we also believe it is time to take profits. As such, we recommend Members sell their remaining holdings around 144p. The Martin Currie Japan Fund will be removed from the Fat Prophets Portfolio.