Fund Spotlight: can Japanese stocks keep up the momentum?

Japanese equities, following a strong 2023, have made a fast start to 2024 and are leading the way for developed markets, with the Nikkei 225, Japan’s primary stock index, returning 9.3% year to date.

This year, the Nikkei index has already breached multi-decade highs and is slowly on course to reach the record high of 38,957 touched on the final trading day of 1989. A key driver for this growth is the pressure the Tokyo Stock Exchange is putting on companies with inefficient capital structures to produce improvement plans that will benefit shareholders. The question for investors is whether there is room for this bull market run to continue.

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The Japan CoreAlpha team at Man GLG, led by Jeff Atherton, believes Japanese markets have further to run and there are enough tailwinds for Japanese stocks to keep moving higher this year. This is a long standing Japanese large-cap equity strategy run by the highly experienced team at Man GLG. Atherton took over as lead manager on the fund in January 2021 and is well versed in the fund’s investment philosophy and process having worked on this team since 2011. He is supported by portfolio manager Adrian Edwards and two analysts.

Valuations both absolute and relative to history are a key element to the investment process. The portfolio is constructed using a bottom-up approach from a universe of 300 large-cap stocks in the Tokyo market and is benchmarked against the TOPIX index, which represents Japan's largest firms by market capitalisation.

What does the fund invest in?

Opportunities in the portfolio can be viewed as either “Core” or “Alpha” although there is frequently some overlap between the two. The team look to maintain a core portfolio of large-cap value stocks, which are generally well-regarded in terms of quality and are often considered “blue-chip”, but remain at attractive valuations.

They also target contrarian “alpha” opportunities: stocks that have underperformed the market for an extended period, often related to macroeconomic and business cycles. They seek value opportunities in stocks with a potential catalyst for change and significant potential to improve corporate value, driven by individual management teams. The result is a concentrated, conviction-led portfolio of around 50 stocks (currently 48) with 36% of assets in the top 10 holdings.

There have been some refinements to the investment process under Atherton, including giving more prominence to catalysts, and to some quality metrics, such as return on equity and quality of earnings, which reduces portfolio risk. The process enhancements should lead to a slightly higher-quality portfolio without sacrificing the contrarian-value nature of the guiding investment philosophy.

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Domestic reflation, the policy designed to expand output and stimulate spending,is a key theme for Man GLG Japan CoreAlpha. The portfolio has a notable overweight to financial services with an allocation of 20.4%, and real estate at 10.8% of the portfolio, relative to the index which contains 12.6% and 3.3% respectively. Management have identified these as sectors set to benefit from the commitment of the government and the Bank of Japan to stimulate the economy.

Nomura Holdings Inc ADR (NYSE:NMR), Japan’s largest investment bank and brokerage group is the second-largest position (4.1%) and a key contrarian bet in the portfolio.Its shares are trading at a significant discount due to difficulties in their overseas businesses. Simplifying and restructuring the business has the potential for significant value to be realised, according to the fund managers.

Another example is Softbank Group, a multinational investment holding company, which also sits in the portfolio’s top five positions with a weighting of 3.8% and trades on a heavy discount. It owns 90% of ARM Holdings ADR (NASDAQ:ARM), which was once described as “the jewel in the crown of British technology”. Its Nasdaq IPO price of $51 in September 2023 was a resounding success and the British semiconductor and software design company now trades at $128 a share, a significant win for Softbank. 

How has the fund performed?

The fund has a strong track record over the long term, returning 9.4% and outperforming the TOPIX by four percentage points over 10 years. More recently, in spite of a poor 2020, the fund continues to beat its index and peers, buoyed by the outperformance of Japanese value stocks over growth through the past three years.

Over the past year, financial services has been the top contributing sector to the fund’s performance led by Nomura, returning 33% in the past year. Auto manufacturers also performed well for the fund with Toyota Motor Corp ADR (NYSE:TM) and Honda Motor Co Ltd ADR (NYSE:HMC) returning 30% and 39% respectively, with just over 4% allocated to each. Sumitomo Chemical company was the largest detractor for the portfolio over the period, with its share price falling 38%.

Source: Morningstar Total Returns (GBP) to 31/01/24. Past performance is not a guide to future performance.

Why do we recommend this fund?

There are several tailwinds for Japanese value stocks in 2024 and this fund is well positioned to benefit. Despite the MSCI Japan Value index reaching an all-time high, valuations of Japanese equities remain attractive. Two-thirds of companies within Japan CoreAlpha have a price-to-book ratio, which compares a company’s assets to its share price, of below 1. The Tokyo Stock Exchange is putting pressure on these companies to allocate capital more efficiently and behave in a more capitalist way, which has the potential to boost shareholder returns.

From a macro perspective, the Japanese economy is finally emerging from decades of deflation and the Bank of Japan remains set on stimulating inflation, which is a further tailwind for domestic equities. The final and quite significant boost for Japanese equities is the fact that foreign investment in Japan has finally returned after a long hiatus, with Warren Buffet being a notable advocate of Japanese stocks in 2023.

This combination of factors makes a compelling case for the Man GLG Japan Core Alpha Fund, due to its successful track record, stable management team and competitively priced ongoing charges figure (OCF) of 0.77%. The fund is a new addition to ii’s Super60.

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