In a world where leading stock markets seem fully valued investors are turning to Japan. Its stock market looks cheap after years of fighting deflation, yet is exposed to growth in the global economy.
That’s potentially good news for funds investing in Japanese smaller companies, two of which delivered investor updates on Tuesday.
Half-year results from Fidelity Japanese Values (FJV) and the full-year numbers from Atlantis Japan Growth (AJG) made interesting reading. Both are run by good, experienced fund managers who have only relatively recently taken on the task.
Meanwhile, Taeko Setaishi succeeded former star manager Ed Merner in May last year. She has a Citywire AA rating for the three-year performance of the dollar-denominated Atlantis Japan Opportunities fund she has run for nearly 14 years.
Both highlighted signs of sustained economic recovery and continued stimulus policies by the Bank of Japan as positives for investors.
They both face two challenges though: firstly, convincing investors they should take the currency risk and volatility of investing in Japanese ‘small caps’; and secondly, if they do take the plunge, why they should buy their shares in their investment trusts, rather than that of Baillie Gifford Shin Nippon (BGS), which as our table shows, dominates this small sector completely.
Baillie Gifford vs the rest
|Size (£ m)||1-yr shareholder return %||5-yr shareholder return %||Share price premium (- discount) to net asset value %|
|Baillie Gifford Shin Nippon (BGS)||301||23.2||287.5||5|
|Atlantis Japan Growth (AJG)||79||18.5||118.5||-8.7|
|Fidelity Japanese Values (FJV)||167||23.1||144.4||-12|
|JPMorgan Japan Smaller Companies (JPS)||199||22.8||161.6||-14|
Source: Numis Securities
As we noted in Investment Trust Watch at the start of June, Shin Nippon’s rivals have held their own over the past 12 months and have shown signs they can perhaps start to close the gap.
One advantage they have over Baillie Gifford’s fund is their shares are cheap and, unlike Shin Nippon, which generally stands at a premium to net asset value (NAV), their stock can be bought at a discount to their NAV.
Fidelity finds favour
In the first six months of 2017 this worked to Fidelity Japanese Values’ advantage as good economic data and corporate results combined with a period of weakness in the yen against the dollar attracted overseas investors in search of a bargain, particularly in June when there were more foreign buyers than sellers in Japan.
The good underlying performance of the £170 million fund clearly caught some UK investors’ attention. Its net asset value grew by 10.9%, beating its benchmark, the Russell Nomura Mid/Small Cap index, which returned 6.7%.
However, its shares did far better than this, giving a total return of just over 22% as demand for the stock saw the discount – or gap between its NAV and share price – narrow from 17% to just below 9%, according to Morningstar data.
Price (pictured) said domestic, consumer stocks drove the performance with Tokyo Base, a ‘relatively under-researched’ fashion business, emerging as the ‘standout contributor’ in the portfolio.
‘The speciality retailer has successfully differentiated itself in a tough market by focusing on products sourced from Japanese designers and made-in-Japan private brand goods,’ he said.
Ryohin Keikaku, the owner of the Muji fashion and homewares chain, also reported strong revenue and profits and continued to benefit from overseas expansion, especially in East Asia, he added.
Atlantis in awkward spot
The picture at Atlantis Japan Growth is more complicated. Over the year to April its shares rose 16.7% in sterling terms, well behind the 26.9% increase in Japan's main Topix index which is its benchmark.
Its NAV grew 17.9% although 2.7% of this was diluted away by issuing 7.6 million new shares in its annual subscription rights programme last October.
Performance was also affected by the Bank of Japan buying huge quantities of index-tracking exchange traded funds (ETFs) as part of its efforts to stimulate the economy and raise inflation. The move pushed up the share prices of large Japanese companies more than it did smaller companies.
In addition, a switch by investors in the first half of the year to lower quality, cyclical and interest rate sensitive stocks, which Setaishi (pictured) doesn’t like, also hurt performance. Fortunately, the second half saw investors pay more attention to company fundamentals. This was more in tune with the manager’s pursuit of businesses benefiting from outsourcing, factory automation, healthcare and the demand for miniaturised semiconductors from Japan’s big technology sector.
Share issuance challenged
The trust says shareholders have told its board they don’t like the subscription policy of allowing investors to buy one new share for every five they own. Although it helps grow a fund that has a market value of just £79 million, investors believe it complicates the trust and makes it less attractive.
In his statement chairman Noel Lamb recognised the impact of share issuance masked the underlying improvement in performance that had been achieved since Setaishi took charge. The board is reviewing its position and will report back next month.
The subscription policy also looks at odds with the board’s hard discount control mechanism under which it buys back shares in an effort to prevent the shares trading more than 10% below NAV. To encourage the stock to stick closer to asset value, the trust can also allow investors to sell their shares in two redemption points a year.
It is also obliged to hold a continuation vote at its next annual general meeting should the average discount exceed 10% in a 90-day period.
Following its survival of a continuation vote called by activist investor LIM Advisers last year, the fund is due to hold another vote in 2019. Whether it survives again will depend on whether Setaishi can deliver the performance of her open-ended fund and whether that return is passed on to shareholders. On a near 9% discount in line with the 12-month average, the jury is still out.