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What are we looking for?

How Japanese stock funds are managing so far this year.

Japanese equity markets have been strong in 2013, but recent concerns over rising government bond yields and political uncertainty have caused plenty of volatility.

The screen

We looked at the year-to-date returns of Japanese equity funds to April 30. U.S. dollar and duplicate versions of funds were excluded.

What did we find?

The Japanese Nikkei index has climbed 35 per cent this year, and the investment funds in the screen also posted strong returns.

The Canadian-dollar hedged iShares Japan Fundamental Index ETF posted the gains of 35.5 per cent for the year to April 30. The ETF tracks the top Japanese companies with the largest fundamental value as determined by characteristics such as total cash dividends and free cash flow. Its largest position is in Toyota Motor Corp., for example.

Of the mutual funds, the Mackenzie Focus Japan Class was the top performer with a 22.3-per-cent gain in the period.

The weakening yen has allowed Japanese exporters to be viewed as more competitive. And that has contributed to a more positive view of the country. "Anecdotally, we've heard that stores are busier and consumers are feeling better," said portfolio manager Mark Grammer. "Even though in reality they're poorer with the yen weakening significantly, there's a view internally that if inflation is coming back, then consumption will come back."

The equity markets in Japan have been the driving force behind the growth of the Japanese funds this year, but long-term investors haven't realized profits amid the last two decades of deflation. Because of that, Mackenzie plans to merge the product into a broader International Growth fund (with exposure to Japan), pending investor approval. "We think that our clients will be better served by letting the managers choose the country," said Mr. Grammer.

That said, many of the names he likes in the Japan fund are also holdings of the Mackenzie's International Growth fund. Some, such as real estate developer Mitsubishi Estate Co. Ltd. and financial giant Sumitomo Mitsui Trust Bank Ltd., have performed well for Mackenzie, and Mr. Grammer calls them "reflation plays" that benefit from the current economic environment.

The next hurdle for Japan is the upcoming parliamentary election in July, says Mr. Grammer. So far, voters have expressed support of Prime Minister Shinzo Abe's policies to wake up the country's economy (so-called "Abenomics"), but he'll need to get the most recent round of reforms pushed through to support a sustained rally.