The second quarter of 2020 saw a strong recovery in equity markets, as fears of a prolonged shutdown from the coronavirus outbreak receded. Growth stocks were very much in favour, with investors willing to pay up for companies exposed to accelerating changes in the digital landscape. The MSCI Japan Small Cap Growth Index returned +17%, outpacing the +13% return from the MSCI Japan Small Cap Index and +9% from MSCI Japan Small Cap Value Index. AJOT, with a value bias, returned +13%, in line with the MSCI Japan Small Cap Index.
Japan appears to have weathered the Coronavirus outbreak. It has dealt with the spread remarkably well and is in a good position to recover more swiftly and sustainably than most countries. Probably the least manipulatable and best metric of a country’s handling of the Virus, is COVID-19-related deaths per capita. At 0.6 deaths per 100,000 of population, Japan ranks favourably (81st in the world) versus the UK and US with figures of 53 and 28 respectively This is more striking given that Japan recorded its first death on 13th Feb, a full 18 days before the US – Japan is further through the pandemic.
Following the very sharp declines in global equity markets and AJOT’s NAV in March, performance during April has been somewhat brighter with a positive return of +7.2% over the month – ahead of the Benchmark’s return of +4.3%.
We do not yet know what the full extent of COVID-19 will be on the operations of our portfolio companies. Some companies are in businesses that will be more resilient its effects, whilst others will be affected either by virtue of their connectivity to the global manufacturing supply chain, or because they operate in sectors of the economy that will have been impacted by lockdown regulations. Early indications from portfolio companies are that the impact will not be as bad as feared, but we will have to wait for further clarity and detail in order to get a fuller picture.
It has been a turbulent quarter to say the least. The outbreak of COVID-19 and the related lockdowns have led to a broad sell-off in global assets. There have been few safe havens, and although Japan has experienced a lower infection rate to date than Western countries, Japanese equities have suffered nonetheless.
Investors may wonder why we have announced a placing for up to £30m during this turbulent time on world stock markets. Firstly, as we explain below, this is an opportune time to invest in the strategy. Secondly, this is a long-term strategy and we believe that the underlying thesis of improving corporate governance and compelling valuations has not changed. As we have experienced demand from investors in recent months we want to be in a position to continue to meet this interest with further issues over the next year to achieve the target fund size of £200m.
We launched our second public engagement campaign this month, highlighting the inefficiency of Teikoku Sen-i’s balance sheet and its destruction of shareholder value. AVI funds have been shareholders in Teikoku since March 2018 and we now collectively hold 5.2% of the outstanding shares. It manufactures and distributes disaster prevention equipment, with 56% of its market cap covered by net cash and investment securities.
This quarter’s strong performance, with a NAV return of +9.5% vs the MSCI Small Cap Japan’s +0.6%, was particularly pleasing after we added to positions which suffered from weakness over the summer. Six of the top ten contributors this quarter were amongst the largest detractors last quarter. Toshiba Plant, for example, was this quarter’s largest contributor with a share price increase of +48% following a fall of -10% last quarter, and Teikoku Sen-i was the third largest contributor this quarter (+34%; -15% as the largest detractor previously). While only a small sample size, this highlights the benefits of taking advantage of short-term price declines which increase the discrepancies between fundamental value and the market value of our investments.
November was a particularly strong month for AJOT’s performance. This was primarily driven by Toshiba Corp’s offer to acquire 100% of two of its listed subsidiaries that we held in our portfolio. Both NuFlare Technology and Toshiba Plant received bids from their parent, Toshiba Corp, at significant premia to prevailing share prices. The two Toshiba subsidiaries have been successful investments for AJOT, generating an IRR of 110% in the case of NuFlare, and 35% for Toshiba Plant.
Most companies are reporting Q2 results and, so far, they have broadly been in line with expectations. Encouragingly, it seems that fears of a prolonged slowdown in earnings have subsided and in October foreigners turned net buyers giving a boon to the Japanese market.
As we approach AJOT’s first anniversary it is interesting to note how difficult this period has been for Japanese equity markets. The MSCI Japan Small Cap has fallen -1% since launch against the S&P 500 which rose +10% and the MSCI Europe which gained +15%. The fractious US-China trade war and the view from foreign investors that Japan is a never-changing, expensive proxy for global growth has continued to take its toll.
AVI Japan Opportunity Trust p.l.c is referred to as ‘AJOT’ throughout the website. AJOT’s investment managers, Asset Value Investors are referred to as ‘AVI’