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A good year for JPMorgan Japan Smaller Companies

JPMorgan Japan Smaller Companies’ undiluted total return on net assets, net of fees and expenses (or portfolio return) for the year ended 31st March 2016, was 13.9%, versus 6.9% for the benchmark. The company’s diluted return on net assets, which assumes that all of the subscription shares in issue were exercised at the rate of 243 pence per share, was 12.2%. The share price total return was 7.8%. In local currency terms, the portfolio’s diluted total return on net assets was 1.8% versus -3.0% for the benchmark.

Looking at the drivers of this outperformance, approximately three quarters of the excess return was attributable to stock selection and the remainder is explained by sector allocation. Stocks that contributed most positively to the excess return included Peptidream (pharmaceuticals, biotechnology & life sciences), GMO Payment Gateway (software & services), Invincible Investment Corp. (real estate), Anicom Holdings (insurance) and Sohgo Security Services (commercial & professional services).

  • Peptidream is a biotechnology company. Using its proprietary technology platform, pharmaceutical companies attempt to discover peptide drugs for various diseases. Since the end of 2014, the company has signed seven new licensing contracts with drug companies. It has partnerships with global mega pharmaceutical companies including AstraZeneca, Novartis, Bristol-Myers Squibb, Amgen and GSK.
  • GMO Payment Gateway provides a payment processing service, with a primary focus on credit card payments for online shopping. It is dominant amongst small merchandisers and has grown strongly on the back of increasing diffusion of e-commerce. It is diversifying: (1) its customer base to cover larger firms and public entities; (2) into overseas markets; and (3) into new lines of business. They believe the company can continue to grow earnings by 2030% per annum over the medium term.
  • Invincible Investment Corporation is a REIT that has increased exposure to hotels through acquisitions. The REIT performed strongly, supported by rising hotel revenues. The hospitality industry is enjoying strong demand from an increasing number of inbound tourists, in particular from Asia. The REIT sector is likely to benefit from increasing demand from financial institutions in the negative interest rate environment.
  • Anicom provides pet insurance, a market which is still in its infancy in Japan and is continuing to grow strongly. The ageing population acts as a tailwind for the company as an increasing number of elderly people live with pets and have a high propensity to spend on them.
  • Sohgo Security Services is the second-largest operator of home and office security services in Japan after Secom. The company has grown strongly over the last few years, under the new management team that took charge in 2012, following many years of stagnation. Its profit margin still lags that of Secom and they believe there is further scope for the company to expand its margins and therefore its profits.

On the other hand, Dowa Holdings (materials), Taiheiyo Cement (materials) and Aida Engineering (capital goods) were among stocks that detracted most from performance.

  • Dowa Holdings is a diversified industrials company whose businesses range from industrial waste management, to niche electronics materials, to auto parts. Its earnings have been under downward pressure because falling commodity prices have depressed the profit from the sale of recycled precious metals.
  • Taiheiyo Cement is the largest producer of cement in Japan with operations in the US, ASEAN and China. The company’s short-term earnings outlook deteriorated throughout the year due to poorer-than-expected demand in Japan.
  • Aida Engineering manufactures press machines for the auto industry. It is the second largest manufacturer of its kind globally and has enjoyed strong order growth as the manufacturing process becomes increasingly complex. They believe that the poor performance is attributable to concerns about the global economic outlook in general and the auto industry capital expenditures in particular.

In each of the above cases, they believe that this is a short-term cyclical setback and that their investment cases are intact. As such, they have maintained the positions.

With respect to sector allocation, the top contributors include software & services (overweight), banks (underweight) and insurance (overweight). The level of gearing fell from 10.3% at the end of March 2015 to 5.2% in March 2016 primarily as a result of their bottom-up investment decisions.

There are broadly two subsets within the software & services sector: domestic-oriented service companies, which tend to be defensive in terms of both their earnings and share price performance; and internet companies. The former performed better than the broader market in the volatile environment, and internet companies in general performed well in line with their strong earnings growth.

Banks underperformed significantly after the introduction of negative interest rates in January.  The insurance sector performed strongly thanks to the largest constituent Anicom.

JPS : A good year for JPMorgan Japan Smaller Companies

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