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JPMorgan Japan Smaller lags benchmark by 8.4%

JPMorgan Japan Smaller Companies Trust reports that its NAV return for the half year ended 30th September 2016, was 14.1% (15.4% adjusting for the effect of the subscription shares), versus 22.5% for the benchmark. The share price total return was 16.5%.

The Board was notified during the period of Naohiro Ozawa’s decision to resign from JPMorgan. Mr Ozawa acted as co-manager of the portfolio alongside Nicholas Weindling and Shoichi Mizusawa, the lead manager. Mr Ozawa has been replaced by Eiji Saito, an experienced portfolio manager and a Japan specialist within JPMorgan’s Emerging Markets and Asia Pacific equities team. Mr Saito joined JPMorgan in 2004 from Nikko Asset Management, Co. Ltd., where he spent eight years, initially responsible for managing Asian equities funds and latterly for Japanese mid to small-cap equity funds. Mr Saito is based in Tokyo.

The attribution analysis shows that both the sector allocation and stock selection detracted from performance. The largest detractors with respect to the sector allocation were insurance (in which the portfolio was overweight), cash (the portfolio was geared in a falling market in yen terms), and food, beverage & tobacco (in which the portfolio was underweight). The performance of the insurance sector is dictated by the biggest constituent Anicom. Food, beverage & tobacco outperformed during September as many stocks in the sector recovered from the summer sell-off. Despite this the portfolio stayed underweight the sector as they considered many stocks in the sector unattractive either because of poor long-term fundamentals, unattractive valuations, or a combination of both. The negative contribution from the above items was partially offset by a positive contribution from health care equipment & services (in which the portfolio was overweight) and transportation (in which the portfolio had no holding).

Approximately 60% of the underperformance is attributable to stock selection. Stocks that contributed most negatively included Invincible Investment Corp. (real estate), GMO Payment Gateway (software & services), Anicom (insurance), Casio Computer (consumer durables & apparel) and Wellnet (software & services). Invincible Investment Corp., GMO Payment Gateway and Anicom were among the five most significant contributors to performance during the year ended March 2016, and all of them fell on profit taking.

Invincible Investment Corp. is a listed real estate investment trust (REIT) that specialises in hotels. After a very strong run to the end of March, the shares fell on the back of a stronger yen, which is negative for inbound tourism. We started to reduce the position in February and continued to take it down during the review period.

GMO Payment Gateway provides a payment processing service, with primary focus on credit card payments for online shopping. It is dominant for small merchandisers and has grown strongly on the back of increasing diffusion of e-commerce. It is diversifying its customer base to larger firms and public entities as well as into overseas markets; and into new lines of businesses. We believe the company can continue to grow earnings by 2030% per annum over the medium term, and therefore maintained the position.

Anicom provides pet insurance, a market which is still in its infancy in Japan and continuing to grow strongly. The ageing population is a tailwind for the company as an increasing number of elderly people live with pets and they have a high propensity to spend on them. We maintained the position.

Casio Computer sells watches and other digital devices, and is known for the G-SHOCK brand. The stock fell due to concerns that a stronger yen will adversely impact its exports. A stronger yen also makes it more expensive for foreign tourists to visit Japan. We sold the entire position in July after the company announced a disappointing set of results for fiscal year 2015 and profit guidance for 2016.

Wellnet operates online payment systems. It enables cash payments for those who either do not wish to, or are unable to, pay by credit card. The stock fell sharply in August after the company announced that its profits would fall by as much as 50% in the new fiscal year. We sold the entire position in October. We concluded that the long-term investment case was invalidated as the pricing pressure was substantially greater than we originally anticipated.

On the positive side, M3 (health care equipment & services), SMS (software & services) and Seria (retailing) delivered strong performance.

M3 operates the websites used by doctors and helps pharmaceutical companies to reduce their marketing expenses. It is the number one site in Japan and the United Kingdom amongst other regions. As required by the Company’s Investment Policy, the portfolio’s interest in M3 was sold in July after its market capitalisation rose to one of the top 100. This follows Sysmex (medical equipment) that we sold in March 2015 when its market capitalisation also rose to one of the top 100. We owned both M3 and Sysmex for a significant period of time and rode the volatility in share price in the interim period with strong conviction on their long-term growth outlook. We hope to repeat the same with many other holdings in the portfolio.

SMS provides cloud-based business management solutions for nursing care operators. It also operates a staffing service specialising in nursing and medical care services by leveraging its social network site for medical and nursing professionals. As the population ages, the supply of nursing professionals is experiencing a serious shortage, the company is therefore well positioned to grow over the longer term. Its shares rose as the concern about dilutive equity finance receded after they secured long-term debt to finance part of their overseas acquisition.

Seria operates 100-yen shops throughout the nation, and is steadily gaining share at the expense of ailing competition.

JPS : JPMorgan Japan Smaller lags benchmark by 8.4%

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