Japan's stunning market rebound - if it holds - should reward the few active international managers this quarter who bet on that market.
Managers such as Morgan Stanley Asset Management, Seligman Henderson Co. and Bessemer Trust Co. caught the wave. Apparently, many others did not.
The average active international manager in Frank Russell Co.'s universe had a 19.7% exposure to Japan as of March 31 vs. the 29.1% weighting of the Morgan Stanley Capital International Europe Australasia Far East Index.
Thus, the average active international manager was poorly positioned for the Japanese market's April-May rally.
For active managers, this was an unusual turn of events. In the recent past, many had outperformed the EAFE in large part by underweighting Japan, said Lawrence Davanzo, managing director, Asset Strategy Consulting, Los Angeles.
But the tide turned against them in April, when the Nikkei 225 stock index climbed 14.4% between April 10 and May 23. (Between April 10 and May 19, the index had climbed an even higher 17.1%.)
In addition, the yen regained some losses, giving dollar investors in Japan an additional performance boost.
Such results are a dramatic change from early January, when Japan's market sank. The Nikkei 225's Jan. 10 closing level of 17,303.7 was its year-to-date low. On that day, the Nikkei fell some 4.5%
The declines at the time made Japan's market seem oversold to Morgan Stanley Asset Management, New York. So, MSAM subsequently raised its Tokyo market exposure to 31% to 32% of its EAFE portfolios, up from 18% to 20%, said Barton Biggs, chairman. In a few cases, Japanese exposure was raised slightly higher.
Morgan Stanley Asset lifted its Japan weightings not only because Japan's market seemed to be significantly lagging the gains in other developed markets, but also because economic signs seemed hopeful.
"We became increasingly convinced that Japan's economy was recovering and deflation coming to an end. And we had the sense that (the trough in) Japan's commercial real estate market was bottoming," Mr. Biggs said.
While the currency exposure had been hedged back to dollars, hedges were removed as the yen appreciated, Mr. Biggs said.
Bessemer Trust, on the other hand, reinvested in Japan's market. After having no exposure for about five years, it allocated 13%.
"The drops in both the market and the currency were the kind of falls we were looking for," said John Trott, executive vice president in charge of non-U.S. investing in London. "For the first time in 15 years, Japan's market had become comparable in rating to other developed markets of the world."
Mr. Trott said he's "pleasantly surprised at the speed at which the market and the currency have recovered in the past month."
At Seligman Henderson, New York, allocations to Japan were raised twice in April. The firm now has a fractionally overweighted 31% target exposure to that market - up from 28% at year end. Recent buying centered on increasing ownership of companies focused on the Japanese domestic market, such as Sumitomo Metal and Mitsubishi MaterialsCorp.
For First Quadrant L.P., Pasadena, Calif., and other firms long overweighted in Japan, it was payback time.
Said Max Darnell, a director at First Quadrant: "We have had a hefty weighting to Japan and still do."
The firm got back into Japan at the end of 1992's first quarter. Although Mr. Darnell conceded the move "pulled down (international) results as other markets outperformed," he said "it was only one bet among many."
Overall, he said, "we've been making money. . . . And since 1992, we've been making money on the volatility in Japan's market - although that wasn't enough to counter the effect of the overweighted position."
First Quadrant's model presents a very bullish picture: on a rating from one to 100 - with 100 being the most attractive - Japan's market ranks in the 88th percentile. What's more, the firm believes Japan should continue to outperform other major equity markets in the next three to six months.
Among other firms, Bailard, Biehl & Kaiser, San Mateo, Calif., went from underweighted to neutral in Japan late last year, while Clay Finlay Inc., New York, slightly lowered its underweighting to Japan. Invista Capital Management, Des Moines, Iowa, recently began scrutinizing the market in search of prospects for its international small-stock accounts.
Of course, investors realize a myriad of economic woes - including the nation's much ballyhooed banking problems - remain. And just last week, reports about a possible rise in Japanese interest rates caused a midweek sell-off.
But attractive valuations also caught some investors' eyes. So did the previous yen weakening, when viewed as an obvious aid to exporters.
Also, early returns suggested less-than-expected economic damage from April's two percentage-point rise in the consumption tax.
At least two other factors - more local pension deregulation and a rise in corporate share buybacks - also seem to have helped the market.
What's more, recent yen stengthening failed to unsettle the overall market. That happy development cheered some investors, although it helped to prompt a switch in interest from exporters' stocks to those of more domestic-oriented companies.
Japan's gains should slow down in the short term. While more appreciation could occur, the market should hit resistance at the 21,500 to 22,000 level in the Nikkei, several managers and analysts predicted. Among the key reasons: A sizable number of new issues is expected to come on the market in the second half of 1997.
Some managers believe Japan still will be holding up by the end of the year. For instance, Michael Balfour, chief investment officer of Edinburgh Fund Managers, Edinburgh, expects a market consolidation around the 21,500 level "before further progress can be made."
But the market may have another run toward the end of the year, leaving it 7% to 8% higher than current levels, he said.
