Discovering overlooked and under researched investment opportunities to unlock long term value.
Investing in the Japanese market for over two decades, with a dedicated team in London and Tokyo
|Software and Services||14.2%|
|Commercial and Professional Services||10.4%|
|Foods and Staples Retailing||5%|
|Automobiles and Components||4%|
|Health Care Equipment and Services||2.9%|
|Media and Entertainment||0.4%|
Despite improving earnings, increasing levels of corporate activity and buoyant markets, small-cap companies in Japan have been largely ignored by stock market investors. For the quarter ending 31st Dec 2020, the MSCI Japan Small Cap Index, in GBP, returned 2.2% while its larger counterpart, MSCI Japan, returned 9.0%. Foreign capital flows into Japan were positive in November and December – a rare occurrence over the past five years. For the time being much of that capital appears to be going into large cap names, although in time, we expect this to broaden out to include smaller companies too. AJOT’s return of 1.0% over the quarter is disappointing considering the very strong earnings recovery reported by portfolio companies, as well as the encouraging backdrop of a recovery in global economic activity.
By November all the companies in our portfolio had reported quarterly earnings, giving us greater insight into the pace of the recovery. As we commented last month, our companies reported a V shaped bounce in earnings. Although profits for the quarter were down -22% year-on-year, they bounced by +42% compared to the last quarter; based on management’s conservative guidance, profits should be up another +29% by next quarter. Remarkably, this has not been reflected in the share prices of our companies.
“Corporate governance reform is key in raising the value of Japanese companies.” These were the words of Japan’s new Prime Minister Suga at a policy speech given at the end of October. His speech was laden with mention of reform, including digitalisation, and attacking bureaucratic decision making and the notorious habit of following past precedents.
At the end of August Japan’s longest serving prime minister, Shinzo Abe, resigned on health grounds. As the driver and key promoter of reforms to improve corporate efficiency, it naturally raises the question – does his resignation mark the end of the policies that have collectively become known as “Abenomics” and within that the so called “third arrow” that focuses on structural reform that has led to a corporate governance revolution in recent years?
Markets continued their rebound as social restrictions eased. While growth orientated stocks have led the rebound, August saw a slight reversal with the MSCI Japan Small Cap Value index outperforming its Growth counterpart by +2.4%.
This quarter’s earnings season is likely to be a volatile one, with the quarter to the end of June being the first full quarter reflecting the impact from the Coronavirus outbreak. Our companies have been affected to varying degrees although we expect this quarter to be weak across the board.
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.
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’