Japan Fund’s Manager Looks to Long Term

Elizabeth Allan should be one of the loneliest mutual fund managers in America. Instead, she’s found that misery does indeed love company.

Allan runs the Japan Fund, the oldest and largest American-based fund that invests exclusively in Japanese stocks.

By now, the problems of Japan and its 2 1/2-year-old stock bear market are well-known to many U.S. investors. What’s more, the latest headlines suggest that the outlook for the Japanese economy and financial markets is getting worse instead of better.

The Japanese, at least, are in no hurry to buy their own stocks, as the Tokyo Stock Exchange’s Nikkei index hovers at 16,717, down a stunning 57% from the December, 1989, peak of 38,915.

Yet Allan suddenly finds herself deluged with cash from Americans who apparently see Japanese stocks as spectacular bargains.

“April was a record month for us, and we’ve been netting $5 million to $6 million a week lately in new money,” Allan said on a recent visit to Los Angeles. “In June our phone center said the phones were ringing off the hook. I think there’s so much interest because of the doom and gloom.”

Of course, “buy low, sell high” is the only way fortunes are made in stocks. But if Allan’s new investors are convinced that Japanese stocks are at or near the bottom, Allan herself is less sanguine.

A full 20% of the $350 million in fund assets remains in short-term cash investments. If Allan were truly bullish, she admits that she’d have less than 5% of the fund in cash, and the rest in stocks.

“Essentially, we think it’s impossible to know where the bottom is,” says the language-student-turned-money-manager, who moved back to the United States last year after three years in Tokyo.

But Allan also senses that there is more trouble ahead as Japanese banks finally begin addressing the problems of their real estate borrowers. Many of the borrowers have been slammed by a plunge in real estate values that has accompanied the bursting of Japan’s “bubble” economy--which featured stock and real estate prices being inflated to outrageous heights by easy money and rampant speculation in the ‘80s.

“What you hear in Japan about real estate values is that they have tripled over the last three years and halved over the last two,” Allan says. That suggests that many real estate investors are still above water. But Allan figures that the troubled ones are about to face their makers--that is, the banks that financed them.

Unlike in the United States, where regulators have already forced banks to write off billions of dollars in uncollectible real estate loans, the Japanese government has so far allowed the day of reckoning to be delayed.

“The way their banks work is that, even if a borrower has paid just one yen on a loan a year, they consider that a performing loan,” Allan says. In reality, of course, such loans may be worthless to the banks.

At some point, those borrowers will have to be purged, at potentially tremendous losses to the banks and thus to the entire Japanese financial system. “We think we’re in the process of seeing that ‘other shoe’ drop,” Allan says.

How that will play out is unclear, but Allan figures that the near-term effect will be a further slowdown in the already decelerating Japanese economy. “In Japan, they consider anything less than 3% annual growth to be a recession. By that definition, you’ve got a recession going on there now,” she says.

Given that backdrop, investing in Japan in the short run may indeed prove fruitless. So Allan says she remains focused on companies that should profit long-term from the major societal and economic changes that she believes are overtaking Japan--even though the Japanese themselves may have a hard time admitting to those changes.

Take discount retailing, for example. “When I lived in Japan, the Japanese wanted the highest quality of everything,” Allan says. “Now there is much more of an emphasis on price. So we like stocks of some downscale retailers that are picking up customers from more upscale stores” as Japanese consumers become more value conscious.

Hence, one of Allan’s largest stock holdings is Aoyama Trading Co., a discount clothing retailer that focuses on suburban areas. Another big holding is Familymart Co., a convenience store chain that is expanding into Southeast Asia.

Allan also believes that the workaholic Japanese will be pulled kicking and screaming into a more Western-style work week. A severe labor shortage already is dictating that Japanese factories automate more and improve working conditions to keep employees happy.

Amano Corp. is a play on those trends, Allan says. “Amano makes time-keeping devices that can eliminate the need for a payroll person at small operations,” she says. “They also make dust-control devices that keep the factory floor more pleasant, which helps companies that have a hard time keeping workers.”

Another large Japan Fund bet on increased automation is Daifuka Co., which makes materials-handling equipment favored by smaller companies in Japan that until now have felt less need to automate.

Also, while Allan has generally avoided banking and real estate stocks, Dai to Trust is a different story, she says. The company specializes in developing the tiny plots of land that have until now remained in agricultural use throughout major metropolitan areas.

“Until very recently, any agricultural land was taxed at extremely low rates,” Allan explains. “This exacerbated an already tight land market,” she says, because small land owners felt no urgency to convert their plots to better uses.

As of this year, however, such properties will be taxed at much higher rates, encouraging the owners to develop their plots--even if that simply means putting up a much-needed neighborhood convenience store, Allan says.

All of these changes, she notes, will ultimately make Japan much more livable--something previous generations didn’t consider a priority.

But now, Allan says, “Their ‘baby boom’ generation feels that, ‘this is right, this is what we’re entitled to.’ ”

Allan has been a student of Japan since 1970, when she began studying Japanese at Colby College in Waterville, Me. “It was a very weird thing to do then,” she admits, “but I was a language junkie.”

She moved on to Indiana University, where she earned a master’s degree in East Asian languages and cultures. After graduation, Allan decided “I didn’t want to teach, because I saw too many people in that field out of work. So I went to Wall Street.”

A stint with Nomura Securities in New York ultimately led to a position as the first American researcher in the Tokyo office of Scudder, Stevens & Clark, the parent of the Japan Fund, in 1987. After three years in Tokyo, she was brought back to the United States last year and named manager of the fund.

Of Japan today, she says, “It’s a lot more user-friendly for foreigners than 20 years ago. But it’s still very crowded and expensive, and it’s tough to get away and relax. It’s really hard to think about going back after you get used to a yard with trees and grass here.”

Allan won’t argue with experts who insist that it will be impossible for the Japanese stock market to perform over the next 30 years as it has the past 30. But she says a good chunk of her own money is in the Japan Fund, which means that she’s betting along with her shareholders on an eventual resurgence of the Japanese market.

But she hastens to add, “If you want to double your money in the next six months, I wouldn’t recommend that you invest in the Japan Fund.”

Inside the Japan Fund

As the oldest U.S.-based fund investing exclusively in Japan, the Japan Fund has known incredible success--and also painful losses, at least since the Japanese stock market peaked in December, 1989. Some facts about the fund:

* Established in 1962, the Japan Fund was a closed-end fund trading on the New York Stock Exchange until August, 1987, when it became open-ended--that is, a typical mutual fund. It now has $350 million in assets, and holds about 60 stocks. The fund is no-load (no sales charge) and is operated by Scudder, Stevens & Clark in Boston.

* A $10,000 investment in the fund in 1962 was worth $1.3 million by the end of 1991, assuming dividend and capital gains reinvestment. The huge gain reflected Japan’s industrial coming of age in the 1970s and 1980s, when its stock market rocketed.

* The fund’s performance during the Japanese bear market, since December, 1989: A 16.4% decline in 1990, versus the Nikkei stock average’s 39% drop; a 3.1% gain in 1991, versus the Nikkei’s 3.6% drop, and so far in 1992, a 15% drop versus the Nikkei’s 27% slide. The dollar’s decline against the Japanese yen since 1989 has helped cushion the Japan Fund’s fall, because Japanese stocks are worth more in dollars as the currency weakens.