By Mark McSherry
The £890 million Baillie Gifford Japan Trust plc said its net asset value (NAV) total return was 10% and “as market sentiment continued to be poor” its share price total return was a “modest” 4.4% in the year to August 31, 2024.
The fund’s comparative index (TOPIX) appreciated by 14.7% over the same period.
Over the five years to the end of August 2024, the NAV total return of Baillie Gifford Japan Trust was 12.6% and over 10 years it was 151.8% compared to the TOPIX total return of 36.7% and 140.0% respectively.
The investment trust aims to achieve long-term capital growth principally through investment in medium to smaller sized Japanese companies.
The fund is run by managers Matthew Brett and Praveen Kumar.
The managers wrote in their report: ” … In the second half of the year the NAV total return was +2.0% compared with +1.5% for the TOPIX but this very modest outperformance was not sufficient to offset the weak performance in the first half of the year …
“The most significant positive contributors to performance were Rakuten (+1.9ppt), where the company’s mobile telecoms network, following heavy investment, is now close to breakeven, as continued acquisition of new customers has encouraged the market to recognise the potential; and SWCC Showa (+0.8ppt), where the shares went up 2.7x as its high voltage cable business has prospered.
“On the other hand, Shiseido (-1.2ppt) has continued to struggle against a background of weak Chinese demand for cosmetics and Rohm (-0.8ppt) has suffered from increased competition in the Silicon Carbide market. Because the company delivered a positive return in Yen over the year, gearing made a positive contribution to performance (+1.7ppt) …
“Given our focus on the prospects for individual businesses, it is unsurprising that we have built a portfolio that is quite different to a Japanese market dominated by large, traditional, and highly cyclical businesses. The major portfolio exposures remain internet and digitalisation, automation and robotics with additional areas of focus in Asian consumer stocks and healthcare.
“We actively avoid areas where we think long-term prospects are poor, which currently includes car manufacturers, steel companies, and old-fashioned industrial conglomerates. We also continue to believe that having a founder in charge of a business is effective in aligning the interests of management and shareholders.
“For your company, 32% of the portfolio has a founder-owner in charge, compared with 7% of the TOPIX as a whole (source: MSCI).
“Key internet and digitalisation stocks include Softbank, Rakuten, SBI, GMO Internet, Recruit and CyberAgent. As well as its holding in ARM, which has a near-monopoly in mobile phone chip design, SoftBank has broad exposure to leading early-stage AI and digitisation companies through its Vision Funds.
“Rakuten and CyberAgent have both invested heavily in developing new businesses in recent years and both are close to the point where those investments begin to make a positive contribution to profits.
“SBI continues to gain market share within the financial industry in Japan, while GMO Internet provides exposure to datacentres. Finally, Recruit is working on simplifying labour-intensive hiring processes.
“Although it is not a new concept, the ability of internet-based businesses to offer a compelling triad of cheaper, better, and quicker services continues to enable them to take market share from more traditional operators.
“Major automation and robotics positions include Fanuc, Kubota, Keyence and Misumi. Each of these businesses allows their customers to improve efficiency, quality and consistency of their production and we continue to believe developments in machine vision will expand the opportunities available in this area.
“Asian consumer stocks include those in skincare such as Shiseido, Pola Orbis and Kose, and those in paint as already noted which are very durable and high returning businesses. Meanwhile in healthcare we have exposure to several companies including Olympus, which makes endoscopes, and Sysmex, which produces blood analysers as well as the recently bought Eisai.”
Six new investments were made during the period. These were Nippon Paint, Kansai Paint, Eisai (drug developer), Nakanishi (dental drill handsets), Kose (skincare) and Daikin (air conditioning and heat pumps). Five positions were sold during the period as gearing rose slightly to 18%.
In addition, the fund undertook a successful private placement debt raise.
A final dividend of 10p per ordinary share (2023: 10p per ordinary share) will be put to shareholders for approval at the Annual General Meeting.
The trust also announced a change to the investment management fee structure, removing the 0.75% fee rate on the first £50 million of net assets. This results in an annual saving of £50,000 for the trust. The fee payable to the managers, with effect from September 1, 2024, is 0.65% on the first £250 million of net assets and 0.55% on the remaining net assets.
In their outlook, the managers wrote: “The obvious question on shareholders’ minds following a 5-year period with a disappointing relative outcome will be whether they should remain confident in the prospects for their company’s portfolio. Nothing in life is guaranteed but we believe there are both philosophical and practical reasons for optimism.
“Philosophically we think that shareholders should draw comfort from the consistent approach being applied, which has been successful for long periods in the past, the low turnover of the portfolio, which means that future returns are dominated by business performance rather than trading activities, and the lack of recent interest in what the company is offering, which means that it is unlikely that we are at a peak of optimism where everything is already in the price.
“Furthermore, Japan remains a useful diversifier for a UK based investor that benefits from an established and stable political system, the rule of law, and an increasing focus on shareholders.
“Practically, it feels increasingly that the new normal post-Covid is similar to the old normal pre-Covid – limited global economic expansion, controlled inflation, with opportunities and risks being presented by technology changes.
“This makes growth a scarce and valuable feature of a business and presents conditions that we believe are more favourable to our style than the recent rapid economic expansion coupled with high inflation which has enabled even weak businesses to show profit growth.
“Finally, although the portfolio that the company holds has demonstrated more sales growth than the market over the past 5 years the gap between the portfolio and the market is forecast to widen with the company’s portfolio forecast to grow by 9.2% p.a. over the next 3 years versus 3.1% p.a. for the market; and earnings growth of the portfolio is also forecast to be more rapid.
“If this superior business growth materialises as anticipated, we are confident we will be able to report on more share price success over the coming years and build on the very modest outperformance over the last half year.”