Over CC Japan Income & Growth’s (CCJI) annual results period to 31 October 2019, the company delivered a total NAV return of 9.9% in sterling total return terms while the sterling total return of the Tokyo Stock Exchange (Topix) was up by 7.2%. CCJI says it has recorded a 69.7% NAV total return since listing in December 2015 until the recent financial year end, while the Topix delivered 58.5% over the same period.
Manager’s review
Richard Aston, the trust’s manager, noted the following: “Concerns about the slowing global economy and ongoing political tensions have been prominent features during the year and resulted in a delay to monetary policy normalisation in the major economic regions. Lower interest rates were consequently a factor in the strong performance of the real estate investment trust holdings (REIT) held by the company. Invesco Office J-REIT, Invincible Investment Corp, Japan Hotel REIT and MCUBS Mid City Investment were all amongst the top contributors to the performance in the fiscal year. This reflects the attractiveness of their yields which have been further enhanced by strong underlying operating fundamentals of the Japanese real estate market. The operating environment for financial companies, such as banks and leasing companies, undoubtedly becomes more challenging while interest rates are low and yield curves flat. The likes of Sumitomo Mitsui Financial Group, Mitsubishi UFJ Holdings, Resona Bank and Tokyo Century consequently suffered from share price weakness although from a shareholder return perspective, financials delivered attractive year on year increases and continue to offer significant potential for further improvement when the economic backdrop improves.
The arguments for maintaining holdings in world leading companies through an industry cycle are based on their increasing commitment to shareholders’ interests and progressive dividend policies. This is evident in the performance of Tokyo Electron (semiconductor equipment) and Shin-Etsu Chemical (silicon wafers and PVC) which have been major positive contributors to performance despite weaker short term operating trends. The performance of a number of the smaller capitalisation companies in the portfolio has been disappointing in recent months after prior strong contributions. Yamada Consulting (business succession planning), Gakkyusha (educational services) and Pola Orbis (skincare) have all encountered share price sell offs as their business momentum has temporarily slowed in each case. These shares were the primary negative contributors in the fiscal year but each has delivered satisfactory shareholder returns and we believe will continue to reward investors consistently as business conditions improve.
We believe that maintaining extensive and regular contact with company management as part of our investment process will ensure that we are able to identify companies that offer attractive shareholder returns. We are encouraged that a number of companies have raised their dividend assumptions for the full year ending in March 2020 – Shoei, Noevir, Mitsubishi Corp, Hikari Tsushin, Inpex and Tokio Marine Holdings will all be paying larger distributions than originally expected, while significant share buyback programmes have been announced by a broad range of companies. This includes Toyota Motor (2.94% of outstanding shares), Tokio Marine Holdings (1.8%), Kakaku.com (1.8%) and Mitsubishi Corp (7.5%).”
Outlook statement from chairman Harry Wells
“On 20 November 2019, Shinzo Abe became the longest serving Prime Minister in Japan’s history. This is notable not just because of the length of his service but also the stability this has offered during a period of an increasingly uncertain political environment around the world and also Japan’s recent history which saw six Prime Ministers in as many years prior to his appointment in December 2012.
While the jury will remain out for some time on the ultimate success of his Abenomics policy initiatives to reinvigorate and reform the economy, the significant progress in the areas of capital efficiency, corporate governance and shareholder return should be highlighted. These trends are particularly relevant to the philosophy of the Investment Manager and the investment case for Japanese equities. There are quantifiable improvements. Return on Equity (“ROE”) has doubled for all listed constituents from under 5% to 10.8% between FY12 and FY18. The percentage of Tokyo Stock Exchange 1st Section companies appointing outside independent directors is now 93%, up from 17% in 2012. There is a consistent increase in the total dividends paid from Y6.8 trillion in FY2013 to Y15.0 trillion in FY2019. The corporate sector in Japan has aggregate cash balances of Y240 trillion (US$ 2.2 trillion), which underscores the potential.
Japan’s Stewardship Code was adopted in 2014 and revised in 2017, while their Corporate Governance Code was adopted in 2015 and revised in 2018. These initiatives have been integral to the positive developments by encouraging dialogue between investors and corporate managers that were not previously evident and is continuing to reap benefits. Cross-shareholdings continue to fall and there has been an acceleration in the unwinding of the parent/subsidiary listing relationship through consolidation or sale, which enhances business focus, decision making and capital allocation.
The clear conclusion from these initiatives and the ongoing discussions is that these improvements are here to stay and have established a foundation for the next leg of progress. The recent slowing of economic growth has not tempered the enthusiasm for change. It is particularly encouraging that corporate managers are demonstrating a commitment to the stability of dividends over time despite earnings volatility and also demonstrating a more flexible approach to share buybacks in order to achieve greater capital efficiencies. The increase in share buybacks over the last twelve months (almost 100% year-on-year, as equity valuations have fallen), is a notable feature of recent market dynamics and a commendable response to any weakness in share prices.
These improvements will feature prominently amongst Prime Minister Abe’s legacy achievements. The framework created through the introduction of the codes of behaviour, market index creation and law revisions will ensure that the improvements will be maintained well beyond his tenure. The Investment Manager believes that the favourable characteristics will continue to be recognised by domestic and international investors and should ensure that they are able to differentiate between long term investment opportunities and short term market trends.
Some disquiet has arisen as a result of recent moves to restrict stock activists. Private equity firms have been very busy in Japan. The Japanese parliament (Diet) has amended the Foreign Exchange and Foreign Trade Act (FEFTA) to introduce pre-filing requirements for foreign investors wishing to purchase stakes in certain business sectors deemed of “national security”. The Government Pension Fund has also announced that it will cease its stock lending programme which as a major holder of equities will curtail the activities of short sellers. These moves may have affected sentiment but are largely irrelevant to our Investment Manager in the execution of our investment process.
Perhaps the 2020 Tokyo Olympics will act as a catalyst for investor interest in Japan. Additional fiscal stimulus announced in December 2019 is positive and more than offsets the apparently negligible effects of the increase in the Government Sales Tax. Recently, foreign investors have turned net buyers of Japanese equities after nearly two years of net selling. It seems bizarre that domestic savings continue to have an obsessive appetite for foreign high yield products with inherent currency risk, when it is possible to invest in a basket of leading domestic companies offering yields of over 4%. Indeed, the yield on the Topix exceeds that of the S&P 500.
A US – Iranian war would undermine confidence in world equity markets, besides driving oil prices higher, in itself a negative for Japan as an oil importer. We must hope that diplomatic efforts to calm a dangerously unstable Middle Eastern situation will prevail. Any improvement in China / US trade relations would be a positive catalyst for Japanese equities but, irrespective of developments on that score, our manager remains alert to manifold opportunities in a fertile income landscape.”
CCJI: CC Japan Income & Growth reports annual results as Shinzo Abe’s record tenure brings stability