It’s been a disappointing two years for investors in Japan despite valuations being demonstrably cheap. The Topix index rose just 1.9% in sterling terms in 2021 and has fallen 7.3% in the year to date. Returns in yen were better, but the yen fell 10.8% last year and a further 5.3% in the year to date.
Yet inflation in Japan is below 3% and ten-year bond yields are just 0.25%. The last 18 months don’t follow a period of stellar returns – over the previous three years, the Topix returned only 14% in sterling. No wonder the bulls of Japan have gone quiet and global investors have lost interest: the average allocation of global investment trusts is around 4%.
The better-known specialist trusts managed by Baillie Gifford, Fidelity and JPMorgan are growth-orientated, so they have severely under-performed over both one year and three years.
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The top performing Japanese value fund
The best performer last year was AVI Japan Opportunity (LSE: AJOT), a value fund that returned 14% but is down 4% this year. With £170m of assets, it trades at net asset value (NAV). AJOT invests alongside its sister trust AVI Global, a £1bn trust with around a quarter of its assets in Japan.
It holds “a focused portfolio of overcapitalised small-cap companies with a view to engaging with company management and helping them to unlock value”. The key here is that although AVI is an activist investor, it is not a hostile one, realising that a confrontational strategy does not work in Japan.
“AVI can point to a number of engagement successes that have led to share-price out-performance,” say analysts at Kepler Research. They attribute this to AVI investing in high-quality, under-researched businesses at very attractive valuations: the market value plus debt of the average investment is 5.6 times operating profits, just a third of the benchmark index.
The portfolio is highly concentrated, holding 25 stocks with an average market value of £500m. These companies may be listed subsidiaries of larger firms, have surplus assets that could be disposed of without affecting core operations, or just out of favour with investors.
A specialist in small-cap Japanese value stocks
Morant Wright also mostly invests in small-cap Japanese value stocks, but does not take an activist approach. It is a small specialist manager with £1.5bn under management in five open-ended funds, two of which are aimed at UK investors. The LF Morant Wright Japan Fund has 52 holdings, trading on an average price/book value of 0.69 and an average price/earnings ratio of 9.6.
Around 73% of its net assets are in listed investments or cash and 39% of the portfolio is in firms with a market value above £4bn. The higher cost A shares (annual management charge of 1.5%) have returned 311% since inception in May 2003, 22% ahead of the Topix index in sterling. It was 4% ahead last year and 7% ahead in the year to date, but 16% behind in 2020 and also behind in the two previous years.
Outperformance from pure stock pickers
The LF Morant Wright Nippon Yield Fund has similar characteristics, but is less backed by cash and investments (54% for the average holding). It yields over 4.5% and its A shares have outperformed the Topix in sterling by 225% since inception in 2008, with a 18% return in the last 12 months.
Morant Wright invests in firms with “strong balance sheets, attractive business franchises and low valuations”. Like AVI, the managers are pure stock pickers but “low valuations for our firms have combined with a depressed currency to create a compelling investment opportunity”.
Similarly, AJOT says it “has been able to buy into a number of new firms whose previously high valuations had held them back from investing” and also notes “it has become increasingly easier to successfully engage with firms”.
The growth funds are probably ripe for recovery, but investors should find room in their portfolios for long-term value-orientated funds as well.
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