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Reflections from JPMorgan Japan Small Cap Growth and Income following strong year

JPMorgan Japan AGM 2018

JPMorgan Japan Small Cap Growth and Income (JSGI) reported its annual results to 31 March 2021, with the 42.5% return in total NAV terms representing a significant outperformance of the company’s Japan SmallCap net return index benchmark index (up by 21.7% over the same period). The broader TOPIX index advanced 39.3% in Japanese yen terms over the twelve months to end March 2021.

JSGI’s total shareholder return came to 47.9%, as the discount tightened. Performance was strongest over the first half of the company’s financial year when the quality and growth stocks favoured by the managers outperformed the company’s benchmark. JSGI notes that over the second half, as cyclical and value stocks outpaced growth and quality stocks, both the share price and NAV per share fell marginally.

BASE, Bengo4.com, and Taiyo Yuden drive performance

JSGI’s managers, Eiji Saito, Naohiro Ozawa, and Michiko Sakai, had this to say on the backdrop to the year’s performance and the main drivers and detractors:

“The market spent last summer recovering much of the ground lost in February and March 2020, when the COVID-19 pandemic spread rapidly around the world and sent equity markets into steep decline. This recovery received fresh impetus in November with the arrival of several vaccines, which fuelled hopes of a global economic recovery in 2021. The Japanese market rose sharply over the remainder of 2020 and the first quarter of 2021, reaching a 30-year high by end-March.

However, the positive vaccine news prompted some notable shifts in equity market drivers. High-value technology and other growth and quality stocks led the market during the first six months of the review period, while more economically sensitive businesses that were hardest hit by lockdowns, lagged. Once investors became more confident that these cyclical and value stocks would survive the pandemic, they began to outperform and continued to outpace growth and quality stocks over the remainder of the review period. In addition, the improvement in the economic outlook, combined with further aggressive US fiscal stimulus implemented by the new Biden administration, sparked concerns about inflation and rising interest rates. The valuations of some stocks, especially high-value growth names, were reassessed accordingly, contributing to their underperformance of cyclical and value names over the latter six months of the review period.

During the twelve months under review, both stock selection and sector allocation had positive impacts on performance. Given our bias towards quality and growth stocks, most of the year’s gains were made in the first half of the period, when these stocks performed more strongly than poorer quality, cyclical names.

Stocks that contributed most significantly to returns included BASE, Bengo4.com and Taiyo Yuden. The pandemic has accelerated trends toward technological innovation and the digitalisation of many commercial, personal and government services. These names are all particularly well-placed to take advantage of these trends and their prospects for strong earnings growth have improved accordingly.

  • BASE provides an e-commerce platform for smaller companies and individuals. It helps users set up online stores very quickly and easily, without incurring fees. E-commerce market penetration is still low in Japan, compared to many other developed countries and China. However, growth in this sector has accelerated as lockdown restrictions have driven many retail businesses online. Base is ideally positioned to meet the rising demand for online retail platforms.
  • Bengo4.com is an online portal for lawyers. The company has a dominant market position, and it is at the forefront of the digitalisation of legal work in Japan, including the provision of a cloud-based digital contracts service called Cloudsign, that replaces Japan’s traditional personal signature stamps. Cloudsign has the largest number of registered users in Japan and should continue to benefit as the adoption of such digital services becomes more widespread.
  • Taiyo Yuden manufactures electronic components, including multi-layer ceramic capacitors (MLCCs), which are in increasing demand in the automotive industry. The pace of technological innovation in the auto sector is very rapid, driven by the race to develop electric and autonomous driving vehicles. Demand for these vehicles will translate into huge potential markets for several Japanese manufacturers, including those, like Taiyo Yuden, that provide high quality MLCCs.

Negative contributors to relative performance over the review period included Star Mica Holdings, a real estate services company, Yappli, a smartphone app development platform, and Medley, which provides recruitment services to the healthcare sector. However, despite their short-term share price weakness, in our view, each of these companies possesses competitive advantages that will drive growth over the long term, so we have maintained our exposure.

With respect to sector allocation, top contributors to relative performance included our overweight positions in semiconductors & semiconductor equipment and software & related services. Portfolio gearing also had a positive impact. The main detractors from performance at the sectoral level included overweights to insurance and household & personal products.”

Looking forward

“COVID-19 and its aftermath have cast a shadow over Japan’s economic outlook. Vaccination programmes are gathering momentum in Japan and around the world, and the global economy is beginning to recover from the devastating effects of the pandemic. However, successive waves of the virus and new variants are generating ongoing uncertainties and delaying the resumption of international travel to many regions. At present, the Japanese government has maintained that the Tokyo Olympics will proceed, but spectators from abroad will not be allowed to minimize the risk of infection. We believe that these decisions should have no impact on our portfolio which focuses on longer-term growth opportunities. We also believe that the pandemic is likely to leave significant and lasting positive changes in its wake, including industry consolidations, supply chain diversification and productivity gains from flexible working practices and the more intensive use of information technologies.

Looking further ahead, Japan remains set on its long-term goals – to achieve sustainable, broadly-based growth, driven by digitalisation, the government’s reforms to corporate governance and by free trade. Japan’s efforts to boost trade with its regional neighbours in coming decades were greatly enhanced when it became a signatory to the Regional Comprehensive Economic Partnership (RECP), in November 2020. This is a free trade agreement between 15 Asia-Pacific member states, including China, Korea, Indonesia, Singapore and Australia. Member countries represent 30% of the world’s population and 30% of global GDP, making it the world’s largest trade bloc. The agreement will reduce trade tariffs by 90% over the next 20 years, lower costs and foster deeper co-operation on all aspects of trade across the region. Moreover, average valuations of Japanese companies remain reasonable, both lower than historical averages and below those of most other major markets. In sharp contrast to other developed economies, Japan’s smaller and more entrepreneurial companies are at the forefront of innovation, ideally positioned to prosper over the long term.”

JSGI: Reflections from JPMorgan Japan Small Cap Growth and Income following strong year

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