Asia-Pacific markets rallied last year, as investor confidence returned following co-ordinated action by central bankers and governments, both locally as well as in developed markets.

Yet, most Asian markets are on shaky ground this year, as inves-tors are taking profits amid uncertainty about China’s currency and its impact on exports. The exception is Japan, which is leading other Asian markets and, according to some fund managers, represents better value.

“In many ways, we are seeing a reaction against what happened last year, when Japan was a big underperformer relative to all major markets,” says John Millar, co-manager of TD Pacific Rim Fund and a Japanese equities specialist with Edinburgh, Scotland-based Martin Currie Investments Inc.

“Japan failed to participate in the upside, to anything like the same extent as other Asian markets,” Millar says. “If people are a little nervous about liquidity conditions going forward, there is more profit to take in Asia ex-Japan than in Japan. Those are the markets that did extremely well last year.”

After being underweighted in Japan for some time, Millar’s firm has been increasing its funds’ exposure to that market as it offers more compelling value.

“You could argue that has always been the case: Asian markets always traded at a premium to Japan,” says Millar. “But the price-to-book-value ratio for the Japanese market is around 1.1 vs the 10-year average of 1.5-1.6. The ratio for Asia ex-Japan is around two times book value, compared with a 10-year average of 1.8. I am not suggesting that Japan deserves to trade on the same multiple as Asia ex-Japan, given the growth differential, and Japan still has deflation. Yet Japan’s discount relative to its own history is excessive, given the earnings growth that we expect.”

The big question is: why did Japan underperform last year? “The problem was the strength of the yen,” says Millar, who shares duties with Jason McCay, lead manager and head of Martin Currie’s Asia and global emerging-markets team.

“More than half of listed company earnings [in the Southeast Asia region] come from outside Japan,” says Millar. “Every time the yen strengthens, it has a negative impact on volumes, and translation back into earnings.”

For the medium term, the yen will weaken, he believes, mainly because the Bank of Japan will not raise interest rates and the differential with other jurisdictions will push Japanese savers to invest abroad.

“With valuations as cheap as they are, and the likelihood of very strong profits growth over the next 18 months, we have been raising our Japanese weighting,” says Millar. “Although our investment case is not entirely dependent on a weaker yen, that would be the icing on the cake.”

From a strategic viewpoint, Millar and McCay have increased Japan’s weighting in the TD fund to 38% of assets under management from a low of 30%. The benchmark MSCI all-country Asia-Pacific index’s weighting is 42%.

“As we’ve been trading out of some Asia ex-Japan names,” says Millar, “we’ve been reinvesting the proceeds in Japan.”

There is also 12% of AUM in China vs 10% in the index, 14% in Australia (16%), 6% in India (4.5%), 4% in Hong Kong (5%), 10.5% in South Korea (7.5%) and 5% in Taiwan (6.5) — with smaller weightings in markets such as Singapore.

Running an 80-name portfolio, Millar likes Toyota Motor Corp., the world’s largest automaker, whose shares have tumbled because of the recent faulty gas pedal issue.

“There will be some short-term damage to Toyota’s brand image, especially with the high-profile U.S. congressional hearings,” says Millar. “But the damage has been far less than expected. That’s partly because [Toyota] has been aggressive on incentives, and that has prevented volumes from falling to anything like we expected.”

A longtime holding, Toyota’s stock is trading around 3,760 yen — or about 1.1 times book value. Based on recovering earnings, Millar sees about 40% upside in the next 24 months.

Another favourite is Westpac Banking, an Australian bank. Although Millar had concerns about the overheating housing market, Australia “has come through this [recession] in very good shape. Bank earnings have come through very well,” he says, adding that banks have benefited from falling credit costs and rising demand for credit. “We had a feared a nasty and protracted credit-cost cycle; in fact, it has passed off in a benign fashion.”