Why growth and income are both big in Japan
Although the Japanese economy and its corporates haven’t escaped the effects of coronavirus, the number of COVID-19 cases has been relatively contained in Japan and the government has not had to resort to the extreme lockdown measures seen elsewhere. This likely explains why the Japanese stock market has been relatively resilient compared to others globally.
Yes, the pandemic-driven postponement of the Olympics is not ideal and will impact sectors such as hotels and advertising, but the effects are likely to be far milder than the full cancellation of such a massive sporting event would have been.
As Hisashi Arakawa, a manager of the Aberdeen Japan Investment Trust (AJIT), informed Shares: ‘Whilst fiscal and monetary stimuli will help to support the economy, the more important factor will be how quickly infections have been contained and economic activity can be restored.
‘The outlook therefore remains uncertain, at least in the near term, but Japanese corporates generally retain strong balance sheets with businesses generally being cash rich. We believe most of them will be able to survive the crisis.’
REASONS TO LIKE JAPAN
Japan is overlooked by many investors, some with hang-ups about its ageing, falling population, others put off by the preponderance of banks, car makers and office equipment companies that populate the stock market.
But this is a shame since the Japanese market is home to many thriving world-class companies in fields such as robotics, automation, medical innovation, semiconductors and consumer goods.
ATTRACTIVE VALUATIONS AND YIELDS
Japanese shares are cheap by historic metrics and many have attractive dividend yields which offer greater surety than in other developed economies, where dividends have been cancelled or cut by cash-strapped companies.
Rather than select individual Japanese stocks, UK investors should invest in the region through funds, particularly actively managed portfolios whose managers have boots on the ground, access to management and an understanding of Japanese business culture.
They include country specialist investment trusts, nearly all of whom trade on a discount to net asset value (NAV) in both the Association of Investment Companies’ (AIC) Japan and Japanese Smaller Companies sectors.
INVESTMENT TRUST OPTIONS
The big beasts by total assets are Baillie Gifford Japan (BGFD), the best 10-year performer on a share price total return basis, and JPMorgan Japanese Investment Trust (JFJ), a recent Shares Great Ideas selection trading on an attractive 9.6% discount.
JPMorgan Japanese is first and foremost a capital growth-focused fund and boasts a five-star Morningstar rating. Managers Nicholas Weindling and Miyako Urabe seek the most attractively valued Japanese investment themes and companies in what remains an under-researched stock market.
Weindling says the pandemic has accelerated many of the themes to which JPMorgan Japanese already had exposure. The managers focus on quality companies with strong cash flows and ones that boast strong future growth prospects and bring investors exposure to Japan’s new products, technologies and markets.
Another option among Japanese-focused investment trusts is the Nicholas Price-managed Fidelity Japan Trust (FJV), which uses local know-how to spot untapped potential in the country.
With around 90% of Japan’s small and mid-sized companies receiving little or no analyst coverage, Price and his team of analysts carry out detailed research that allows them to pick stocks that are often under the radar.
The trust offers exposure to market share gainers that are well positioned to emerge from the current pandemic-driven downturn in better shape than their competitors. Names in the portfolio include factory automation business Keyence and musical instruments-to-electronic devices maker Yamaha.
Two relatively new trust launches are AVI Japan Opportunity Trust (AJOT), managed by Asset Value Investors’ Joe Bauernfreund, who looks for asset-rich companies with the ability to increase shareholder returns through improved corporate governance, and Nippon Active Value (NAVF), an activist investor in smaller Japanese companies.
SOURCES OF INCOME
CC Japan Income & Growth (CCJI) trades on a 13.2% NAV discount and offers a 3.8% dividend yield underpinned by a tighter focus on shareholder returns in Japan. The wide discount is a feature of a disappointing recent NAV performance.
The only Japanese equity income-focused trust on the London market, CC Japan Income & Growth seeks to provide dividend income combined with capital growth from companies listed in Japan.
Manager Richard Aston focuses on shareholder-friendly, high-quality companies with resilient cash flows and strong management teams. He sees significant scope for future income growth as ongoing corporate governance reforms in Japan have improved conditions for income investors in what has traditionally been a challenging market.
CC Japan Income & Growth this year intends to at least match the previous year’s 4.5p dividend. Holdings include mobile phone operator Softbank, optical technology company Hoya and Sumitomo Mitsui Financial.
Also trading on a wide discount to NAV (13.4%) is Aberdeen Japan Investment Trust (AJIT), which has recovered nearly all the share price losses caused by the global market sell-off earlier this year. It is focused on high-quality businesses with tried-and-tested management teams, wide competitive moats and solid balance sheets.
Portfolio holdings include Elecom, a maker of keyboards and cables. ‘The fabless maker has always had a good procurement system in place and during the pandemic it has been able to switch suppliers and modes of transportation flexibly to meet the surge in demand for its products as more people worked from home,’ explains Aberdeen’s Hisashi Arakawa.
The trust is also invested in Nippon Paint, the number one paints maker in many countries across Asia including China. Arakawa says it is well known for treating employees well. ‘This time around it was quick in securing employee safety as well. This helped it resume operations quickly as demand in China begun to recover.’
Aberdeen Japan holds work-from-home beneficiaries that have delivered positive earnings growth through the pandemic such as network integrator NEC Networks & System Integration, IT solution provider Otsuka, online business contact management service provider Sansan and furniture maker Nitori.
The trust also holds Chugai Pharmaceutical, which delivered 57% operating profit growth in the first quarter of 2020. One of the company’s drugs is being trialled as a potential treatment for critical cases of COVID-19.
In the open-ended funds universe, IA Japan sector star performers on a five-year view include Lindsell Train Japanese Equity (B3MSSB9), a fund awarded a five-crown rating by FE fundinfo for its superior performance in terms of stock picking, consistency and risk control.
Also adorned with a quintet of FE Fundinfo crowns is Comgest Growth Japan (BYYLQ08), ranked first quartile on a one, three and five-year view, while the sector’s other strong performers include Nomura Japan High Conviction and Legg Mason IF Japan Equity.
Within the IA Japanese Smaller Companies sector, the stand-out five-year performer is Baillie Gifford Japanese Smaller Companies (0601492), according to Fe Fundinfo data.
Managed by Praveen Kumar, this £860 million OEIC generates growth by investing in innovative business models, companies disrupting traditional Japanese business practices, or Japanese companies growing fast outside Japan.
As at 30 June the fund’s active share, a measure of how much a fund differs from the benchmark, was 95%, demonstrating that Kumar dares to be different in terms of picking long-term winners for the fund.