Towards the half century: Baillie Gifford Japan Trust

Please remember that the value of an investment can fall and you may not get back the amount invested.

The year 1981 conjures up all sorts of memories, some good, others less so: Bucks Fizz and the Eurovision, The Royal Wedding and the launch of MTV.

The beginning of the 1980s also may have been the peak of Japan-phobia. Strategists and commentators were terrified that the island nation would rule the economic roost.

Eminent management theorist Peter Drucker, writing in the Harvard Business Review passed on a lawyer acquaintance’s warning: “I am more afraid of the Japanese than I am of the Russians… The Japanese too are out to conquer us, but their unity comes from within”.

By the end of 1981, the Japanese stock market index, the Nikkei 225, was pushing ever higher and was bubbling under 7,700. Not surprisingly, UK investors thought that Japanese equities looked exciting, and Baillie Gifford’s Japan Trust was launched.

Forty years on – and with just 10 years to go until the 50th anniversary – Japan, Japanese equities and the Baillie Gifford Japan Trust look very different.

In the intervening 40 years, Japanese stock markets have crashed and then slowly but steadily recovered. That index, the Nikkei 225, is now above 28,500 points and the idea of Japanese world domination – at least in the economic sphere – has been well and truly laid to rest, probably replaced by fears relating to a close neighbour to the west. But Japan and its local markets have changed immeasurably over the last 40 years.

Take the ever-expanding frontier that is technological advance and disruption. Mention tech stocks and the name Silicon Valley tends to pop up quickly, perhaps followed by the sudden advance of the Chinese tech giants.

Perhaps the UK and its fintech and biotech stocks get a passing mention, but Japanese businesses are now at the cutting edge of many technology markets.

Portfolio holdings within the trust are now benefiting from a range of concurrent ‘disruptions’: Moore’s law suggests exponential growth in computing power, 5G creates far better connectivity, and routine deployment of machine learning and AI is quite plausible within the decade.

Japanese beneficiaries range from well-known names such as Softbank (which founder Masayoshi Son now describes as “vision capitalists”) through to less familiar businesses such as GA Technologies, which is trying to apply technology to the archaic world of real-estate transactions.

Technological rivalry between major economic powers also brings out another key transformation that will almost certainly accelerate in the next few decades.

Japan is a well-established liberal democracy that respects the rule of law, and the concept of societal harmony is well established. Following significant reform in the last decade, through the introduction of the Stewardship Code and the Corporate Governance Code, Japan now has some of the strongest protections for shareholders globally.

For example, in Japan it is possible to remove a company president through a simple majority shareholder vote. Many of the old concerns about corporate governance in Japan are beginning to fade away just as they look set to increase in other Asian nations.

That improved corporate governance comes at an important moment for Japanese markets. The advance of the technology sector has helped change investors’ perceptions.

The major index constituents are increasingly technology focused, which compares favourably to the large bank and old conglomerate domination a decade ago. Yet that fundamental shift in the composition of local markets hasn’t always been reflected in local equity market valuations, with local indices trading at relatively cheap valuations, and with a 2 per cent dividend yield.

That last mention of dividends is also crucial. Many technology companies may be reluctant to pay out much in the way of dividends, but overall corporate Japan is becoming more dividend-friendly, partly as a result of the changes introduced over the last 10 years by both the Japan Corporate Governance Code and Japan Stewardship codes. The combined effect of these is to make boards much more thoughtful about some traditional practices, such as crossholdings and large cash holdings, and significantly more likely to pay a dividend based on a percentage of profits.

Yet, this growing interest in payouts contrasts with the large amounts of cash still on Japanese balance sheets. Logic suggests that it is highly likely that dividend growth will be able to outpace profit growth over the next decade. And in fact, The Baillie Gifford Japan Trust paid its first dividend for many years in 2018, increasing it every year since.

As Japan and Japanese markets change over the next decade – running up to the fund’s 50th anniversary – the Japan Trust is well positioned to adapt and grow.

The Baillie Gifford approach is to take the long view: shares are fractional ownership of a business, and those businesses that succeed have share prices that increase over the long term. But this says nothing about why share prices fluctuate in the short term which can be for any number of reasons.

It’s also important to remember that as markets adapt and evolve there are bound to be failures. Investment history is littered with once-promising companies that have become irrelevant over time. The key is to focus on trying to identify as many of the major winners as possible: find attractive growth businesses, invest your money in them and patiently to benefit from their growth over time.

And the fund has one other additional advantage – keeping costs as low as possible. The total expense ratio has fallen from 1.27 per cent to 0.66 per cent over the past decade*.

That speaks to a proactive approach by the trust to maximise shareholder returns, while also keeping a close eye on costs and liquidity. On the latter point, when the shares have traded at a premium to the asset value, the board has been prepared to issue shares. On the rare occasion when they have fallen to a meaningful discount, they have been prepared to buy back.

Most commentators now reckon that this century, and certainly this coming decade, will be Asia’s moment, with most economic growth and technological change, originating in the Asia Pacific region. If so, Japan, as a stable liberal democracy with thriving local markets full of innovative, increasingly shareholder-friendly businesses, seems in an ideal position.

• Watch MoneyWeek editor-in-chief Merryn Somerset Webb interview Matthew Brett, manager of the Baillie Gifford Japan Trust by registering here.

* Ongoing charges as at 31 August 2021. Calculated in accordance with AIC

The Baillie Gifford Japan Trust invests in overseas securities. Changes in the rates of exchange may also cause the value of your investment to go down or up. The Trust’s exposure to a single market and currency may increase risk.

This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. Data as at 30 September 2021, unless otherwise stated.

Baillie Gifford & Co and Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The investments trusts managed by Baillie Gifford & Co Limited are listed UK companies and are not authorised and regulated by the Financial Conduct Authority.

A Key Information Document is available at bailliegifford.com

The Baillie Gifford Japan Trust – annual past performance each year (net %)

Source: Morningstar, total return in sterling.

Past performance is not a guide to future returns.