Aberdeen Japan held back by currency hedge as the Yen soared by 16% against Sterling following the Brexit vote. On a total returns basis, the net asset value returned 20.5%, underperforming the benchmark by 12.5%. The hedge accounted for 7.0% of this underperformance. The share price’s total return was 23.5% and the discount to NAV per Ordinary share narrowed over the year from 12.5% to 10.5% as at 31 March 2017.
The hedge was introduced as part of the new investment mandate approved by the shareholders in October 2013. The hedge, in isolation, has continued to do its job of smoothing currency gains and losses in sterling terms. Overall since inception to the end of April 2017, the hedge is showing a net NAV loss of around 3.5% reflecting the cumulative fall of approximately 7.5% in sterling against the yen over this period. From the inception of the new mandate, the yen initially weakened and the hedge produced an NAV gain in sterling of about 8.5% to the end of 2014. In the next 18 month period up to the Brexit Referendum, this gain was gradually eroded to close to zero but the fall in sterling following the Referendum led to a further reduction of NAV of about 6.0% by the end of the financial year. The Board, in consultation with the Manager, keeps the appropriate level of the sterling hedge under review in the light of the underlying yen exposure in the portfolio and at the year end this stood at approximately 50%. The Board will review the operation of the hedge in the light of the experience so far, to ensure its continuing suitability.
43% increase in dividend
Dividend income from Japanese companies continued to strengthen. After taking the weakness in sterling into account, the revenue return for the financial year reached 7.27p (2016 – 5.67p). The Board aims to maintain a stable dividend paying not less than the amount required to maintain investment trust status. Based on this policy the Board is recommending a final dividend of 6.0p, a 43% increase on the 4.2p paid in relation to 2016.
Extract from the manager’s report
“The underperformance of the equity portfolio to the index of 4.8% for the year under review largely accounted for the balance of the under-performance. A major reason for the equity holdings’ underperformance was the Trust’s substantial weighting in the consumer sectors. The Trust’s consumer holdings performed well in absolute terms but lagged relative to the broader Topix index. Japan Tobacco’s share price was weighed down by worries that its market share was being eroded by competitors’ new offerings in the rapidly expanding novel nicotine product category. Nevertheless, the company retains the lion’s share in terms of overall domestic cigarette sales. It also aims to start selling its Ploom TECH electronic cigarettes across Japan soon. Retail conglomerate Seven & i continued to face rising wage costs and a struggling department store business. However, the company’s long-term fundamentals remain solid. Management is taking steps to restructure the business, including divesting loss-making stores. Its annual results met our expectations, with the core convenience store business continuing to deliver results and the Ito-Yokado supermarkets returning to profitability.
The underweight to the financial sector also weighed on relative performance. The sector rallied on the back of hopes that President Trump’s proposed economic stimulus measures would help raise long-term rates in Japan and elsewhere, and benefit banking-sector profits in turn. Not holding mega bank Mitsubishi UFJ Financial detracted from portfolio performance. As for our holding in Aeon Financial Service, the share price lagged on disappointment over management’s decision to raise funds and pare debt via the issue of Yen34 billion in new shares and Yen30 billion in convertible bonds. The move was an issue that we engaged management with, given that it would dilute the stake of existing shareholders. Nonetheless, we like the company’s track record and remain sanguine about its prospects, supported by resilient earnings and stable non-performing loans.
Also detracting from performance was resort developer Resorttrust, which sustained high development costs for new resorts that have yet to be covered by membership sales. We think it is only a matter of time before sales eventually catch up, given the wealthy elderly population who favour such facilities and are the company’s main customers.
On a positive note, the Trust’s holdings in the basic materials sector contributed to relative return. Shin-Etsu Chemical’s shares rallied on speculation that demand for its polyvinyl chloride products would improve on potentially higher infrastructure spending in the US. Tighter market conditions also raised the prospect of better pricing for its semiconductor wafer products. Both Kansai Paint and Nippon Paint gained from lower raw material costs. Additionally, Kansai Paint benefited from good contributions from its Indian subsidiary, while Nippon Paint saw demand recovery in China, one of its key markets.
The Trust’s industrial holdings also outperformed. Keyence continued to see healthy demand for its sensor products, buttressed by a sales approach that encompasses on-site consultancy to offer the best solutions to customers. Increased capital expenditure from automobile companies helped support Fanuc. A series of investments, such as two new research centres near its headquarters and increasing the headcount of engineers, should ensure the company remains at the forefront of robotics machinery. Nabtesco rallied on robust demand for its hydraulics equipment, notably from China’s construction industry, while its precision equipment business stayed resilient.
As mentioned in the half-year report, we introduced SCSK early in the review period. The systems integrator provides solutions to the financial, manufacturing and distribution sectors, and we like its sturdy balance sheet, stable cash flow generation and long-term growth potential. New orders continue to grow. More recently, we divested both Canon and Unicharm. For disposable hygiene products maker Unicharm, valuations had started to appear rich relative to its fundamentals following a sharp rally in its share price. While its domestic presence remains solid, we think its overseas outlook has deteriorated amid rising competition. Canon is also facing diminishing prospects on a combination of the weak macro environment, intense competition and pricing pressures, which have hurt margins. The camera and printer maker has struggled to assess changing market trends and we feel the outlook will not improve soon.”
AJIT : Aberdeen Japan held back by currency hedge