Changing Japan
Nicholas Price
Portfolio Manager, Fidelity Japan Trust PLC
A lot has changed since I started covering Japanese companies in the early 1990s. Back then domestic firms had relatively low margins and high multiples, but we have seen since an adjustment process that has reversed this situation as valuations have come down yet returns on equity have risen. As a result, from a price/earnings perspective, Japan is now among the most attractively valued major equity markets globally.
Notably, it is also encouraging that we continue to see signs of a change in corporate mindsets with Japanese companies increasingly focusing on greater capital efficiency. Historically, Japanese companies have been good at managing their businesses and profit and loss accounts, but less effective at managing balance sheets. However, improvements are slowly drifting through and share buybacks, for example, are up about 20% year-on-year.
This improving picture at the company level is clearly very welcome and supported by a generally positive macro backdrop. In particular, employment conditions are strong and the recent pickup in wage growth is supportive of Japan's move towards reflation. We are also seeing signs of the government gradually relaxing restrictions on foreign workers in Japan, which can create stockpicking opportunities.
Inbound tourism has also been growing about 15-20% over the last couple of years, mainly due to Chinese tourists taking advantage of more relaxed visa regulations, which is helping to sustain consumer spending. This looks set to continue with Japan hosting the Rugby World Cup in 2019 and the 2020 Olympics, so, barring an external shock, Japan’s economy is reasonably underpinned going forward.
Fidelity Japan Trust PLC
The Trust recorded NAV returns of 31.0% over the 12 months to June 2018, outperforming the reference index, which returned 10.6%. The discount to NAV narrowed over the same period and the Trust’s share price returned 30.4%. Strong stock selection in the services, electric appliances and real estate sectors was a key contributor to returns over the 12-month period. The underweight allocation to banks also paid off. Conversely, holdings in consumer-related companies that experienced a deceleration in earnings growth detracted from returns. Over the past three months, the manager has selectively increased positions in services companies operating in growth markets such as recruitment and e-commerce. Conversely, he took profits in strong performers in domestic-oriented sectors, and sold materials and industrial stocks where the risk/reward balance had deteriorated.
A stockpickers delight?
While Fidelity Japan Trust PLC is really built from the bottom-up - and doesn’t digest any macro effects as a primary process - this should provide a decent environment for companies to grow and prosper, particularly in areas like services where I am finding several opportunities.
Examples here include Recruit Holdings, the number one online job site in Japan which also owns Indeed, its UK equivalent, which is showing strong growth. There’s also Makita, which is one of the largest power tool manufacturers in the world. It’s currently expanding into the gardening market and working on increasing environmentally-friendly tools with greater battery capacity. It’s a good story as it’s a move that can increase Makita’s market penetration by 50%-60% over the medium-term. Another company in the portfolio is ‘no brand quality goods’ label Muji which is a company I’ve been following for 20 years and is expanding globally, including into China.
Outside of these larger and relatively well-known names, I also see a lot of potential among smaller and medium-sized companies. This is an interesting part of the market and being on-the-ground has huge advantages in terms of the company selection process. As almost half of the companies in the mid and small-cap space are not covered by analysts, there’s a huge opportunity to turn over stones in order to discover those hidden Japanese investment pearls.
Glossary:
Price Earnings (P/E): A valuation ratio of a company's current share price compared to its per-share earnings.
Share buybacks: The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. A share buyback allows companies to invest in themselves. By reducing the number of shares outstanding on the market, buybacks increase the proportion of shares a company owns.
Nicholas Price
Portfolio Manager, Fidelity Japan Trust PLC
Nicholas Price has over 20 years of investment experience in Japanese equities, having joined Fidelity’s Tokyo office in 1993 as a research analyst before becoming a portfolio manager in 1999. He currently manages a number of Japanese equity portfolios for both retail and institutional clients, including the Fidelity Japan Aggressive Fund. More recently, he has been appointed to take over as portfolio management of Fidelity Japan Trust PLC with effect from 1 September 2015.
Important information
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
This section is sponsored. Interactive Investor does not endorse any particular product. If you are unsure about whether an investment is suitable for you please seek advice from a financial adviser.