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Disappointing year for Schroder Japan Growth

Over Schroder Japan Growth’s (SJG) annual results period to 31 July 2020, it delivered a total NAV return of -11.7%, which compares with -6.1% by the benchmark. In the manager’s report, it was noted that the company’s bottom-up stock picking approach typically results in a moderate bias towards an overall ‘value’ style. This generated a headwind for SJG relative performance over the year. This was especially the case during the market sell-off in the first quarter of 2020.

The manager’s report section of the results noted: “There was also negative contributions from both sector allocation and stock selection, but there were few large stock contributions. Instead, the bulk of the underperformance was generated from small negative contributions from a wide range of stocks, reflecting our view that style characteristics, rather than stock-specific factors, have continued to have a disproportionate influence on relative performance in this period. Elsewhere in the market, a relatively narrow range of stocks continued to see strong momentum, which has pushed valuations to further extremes.

Among individual stocks in the portfolio, the largest negative contribution came from Sankyu, a specialist in logistics and plant engineering. The stock underperformed from February to end-July, on fears that order flow from industrial clients could decline in the short term due to the sudden economic slowdown. Mitsui Fudosan, a major property developer, also had a negative impact on performance but, in this case, the underperformance was more concentrated in March as investors moved to discount the impact of COVID-19 related social restrictions on the company’s hotel and leasing businesses.

The strong momentum seen in a relatively narrow range of stocks continues to generate unusual attribution results for the portfolio, with relatively large contributions coming from stocks that are not held. This was again evident in the 12 months to July, with both Sony and Keyence among the largest negative contributors, despite not being held in the company. While we recognize the quality in these stocks we do not believe their current valuations justifies inclusion in the company.

More of the same from Yoshihide Suga

The manager notes that “Shinzo Abe announced his resignation as prime minister of Japan on 30 August, due to the resurgence of a long-standing health problem, just four days after he recorded the longest continuous term of any Japanese prime minister. Although Mr Abe’s health has clearly deteriorated, his popularity has also recently declined, primarily due to his handling of Japan’s response to the pandemic. As a result, the approval rate for the current cabinet had fallen to 35%, the lowest level since Mr Abe came to power in 2012, although still above the 30% level at which Japanese leaders generally become untenable.

Despite the public’s very poor perception of the authorities’ response, Japan’s virus data, both in terms of incidence and mortality, remains significantly better than most other developed countries. In recent weeks, an uptick in new infections cases, albeit from a very low base, has led to further criticism of perceived policy inconsistencies. Even prior to Mr Abe’s announcement, expectations on the political timetable were already complicated by the pandemic and the postponement of the Tokyo Olympics to July/August 2021, just ahead of the next general election which is due in October 2021. Nevertheless, the precise timing of the announcement surprised us.

In the event, the LDP opted for the simplest method to elect their next party president. Yoshihide Suga, the Chief Cabinet Secretary,  duly won the leadership election on 14 September. His position as the new prime minister was then confirmed in a special Diet session on 16 September. We recognise that the change in political leadership may cause some short-term nervousness in financial markets, especially among foreign investors, as Mr Abe has been so closely identified with his government’s economic plans under the banner of “Abenomics”. There may be additional uncertainty if Mr Suga decides to call an early general election to reinforce his position with a stronger mandate. 

In reality, since Mr Suga has been a staunch supporter of Mr Abe throughout his tenure, and since the LDP remains the dominant party, we would expect little to change. In fact, this may be a good opportunity for a new leader to refresh the cabinet and refocus the pandemic response. Mr Suga may provide some differences in emphasis on the various structural reform programmes underway but, overall, we would expect continuity of fiscal policy. This is particularly true at present since fiscal policy remains at the forefront of the pandemic response for all countries. We would also expect that monetary policy, under the Bank of Japan Governor Haruhiko Kuroda, will continue unchanged. However, we must acknowledge that the close association between Mr Abe and Mr Kuroda, and the consequent policy coordination, may be harder to replicate for any new prime minister.

One other feature of Mr Abe’s tenure has been a relatively stable relationship with the current leaders of both the US and China, despite the escalating tension between those two countries. We will watch closely whether Mr Suga can adopt a similar stance, especially as we approach the US presidential election Overall, we feel that the departure of Mr Abe should not distract investors from other positive factors, including structural improvements in corporate governance, profitability and return on equity. Japan has outperformed many other countries in dealing with the virus so far, but in our view, these positives are yet to be reflected in share prices. However, with equity market valuations at reasonable levels, short-term sentiment could still be driven primarily by data on domestic and global virus incidence, and any renewed restrictions on economic activity.”

Conditional Tender Offer

In his statement, SJG chairman, Anja Balfour, said: “The board has reviewed the company’s performance, and the share price discount to NAV, and has consulted with the Company’s advisers and its largest shareholders. The directors believe that the long-term outlook for Japan is favourable, and that the Manager has the resources to deliver favourable outperformance against the company’s benchmark in view of its deep resources in both London and Japan. Whilst the manager’s investment style has been out of favour, the directors do not believe that it would be appropriate to change this style to a material degree at this point in the cycle. However, the board feels that it is also important to support investors with a structure that allows for a partial return of capital in the event that performance falls short of expectations over the next few years.

Accordingly, the directors have agreed that, should the company not deliver net asset value total return performance of at least 2% per annum above the benchmark over the next four financial years, starting on 1 August 2020 and ending on 31 July 2024, the board will put forward to shareholders proposals for a tender offer of up to 25% of the issued share capital at a price equal to the then prevailing net asset value less costs. This would be contingent upon the next continuation vote of the company, at the AGM in November 2024, being successful.”

SJG: Disappointing year for Schroder Japan Growth

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