Fidelity Japan to seek shareholder approval to invest in more unlisted companies – Fidelity Japan (FJV) has posted its final results for the year to 31 December 2021. During this time, its NAV per share increased by 1.8% in sterling terms and the share price rose by 3.9%. In comparison, the Reference Index returned 2.0%.
The start of 2022 saw weakness across all markets amidst fears that new COVID variants may stall the global economic recovery as well as concerns of growing inflationary pressure and the need for interest rates to rise. This has been exacerbated in recent weeks by the Russian invasion of Ukraine and the resulting volatility in global markets and concerns that the conflict and sanctions imposed on Russia will have a significant impact on energy and commodity prices. This has seen FJV’s NAV fall more than the market index as growth stocks have suffered the most over this period.
However, the standout contributor to the performance over the period was Mitsui High-tec, now a top 10 holding, which dominates nearly 70% of the global motor core market, an essential component of power-train motors in electric vehicles (EV) and hybrid vehicles. The manager said the company’s strength lies in its ultra-precision machining and die technology which is used to create high-quality motor cores and machine tools.
Another company tied to secular growth trends (factory automation (FA)) that made a material contribution to performance is MISUMI Group, a manufacturer and distributor of FA and metal die components. The manager said the company’s distinctive business model (it provides customised products with short delivery times) and sophisticated production system, allied with its e-commerce platform, are conducive to sustainable growth. Against a backdrop of accelerating automation demand globally and persistent supply constraints, the company delivered earnings results that exceeded market expectations.
At present, FJV is permitted to invest up to 10% of the portfolio in unlisted companies. As the opportunities for investment in unlisted companies is expected to grow, the board is seeking shareholder approval at the Annual General Meeting on 17 May 2022 to increase the limit of the company’s assets in unlisted companies from 10% to 20%.
There were 125 initial public offerings (IPOs) in calendar year 2021, marking the highest number of listings since 2006. Six companies listed directly on the TSE First Section, and around three-quarters of the IPOs were on the TSE Mothers market, an exchange for emerging companies with high growth potential. Around 70% of the IPOs were for companies in the Information & Communication and Services sectors, reflecting growth trends in areas such as artificial intelligence, digital transformation and SaaS.
[This is an exciting but unsurprising development from Fidelity Japan. The trust fared well from the IPO of Raksul in 2018 and this time last year, the IPO of Coconala (which saw its valuation increase by 351%) gave the trust a significant boost. As the manager notes, 2021 saw the highest number of listings in Japan since 2006 while Prime Minister Kishida has highlighted the country’s start-up market as an area in need of support and that change could be on the way. Furthermore, Fidelity has both experience and a successful history of investing in unlisted companies not just within FJV, but also Fidelity China Special Situations, which is well-known for benefiting from the IPO of Alibaba back in 2014. Last year, FCSS increased its unlisted exposure from 10% to 15%.]
Statement from the manager:
So far 2022 has brought with it an extreme style rotation that has led to the outperformance of value names and sharp declines for growth stocks. This was most evident in the buying of low price-to-book (PB) names and the selling of high PB stocks. This has occurred as accelerating rate hike expectations have driven up real interest rates in the US. The stock market has started to price in these developments, which has seen, for example, Banks and Insurance stocks outperform quite strongly over the year-to-date period. Conversely, growth-oriented sectors such as Precision Instruments, Services and Electric Appliances have been the most significant underperformers. Given the rising momentum for US rate hikes, further volatility is possible in the near-term.
In this environment, holdings in mid/small-cap growth stocks in the Information & Communication sector have been among the most significant detractors from performance. In particular, SaaS related names have corrected sharply since the previous quarter. At the same time, companies tied to secular growth trends such as factory automation (FA) and electric vehicles (EV) that did well last year have been subject to profit taking over the year-to-date period. Given the market trends described above, the underweight exposure to traditional value sectors such as Banks and Automobiles has also worked against performance.
Another factor of the recent market phase that has generated headwinds for performance is the narrowness of price movements. This has produced strong intra-sector divergences and as a result, natural hedges have not worked. For example, shares in Toyota Motor (an underweight position in the Company) are up versus TOPIX over the year-to-date period, but group company Toyota Tsusho (an overweight holding in the Company) is down in relative terms. Given the extreme nature of these movements, we expect them to correct at some point.
I have been taking some profits in stocks that have performed well and those that have been relatively insulated from the recent correction. At the same time, I have been gradually adding on weakness where valuations are looking more attractive on a mid-term view. As a result, there has not been a significant change in terms of key holdings in the Company’s portfolio.
The price-to-earnings ratio (PER) of the portfolio has come down quite considerably, to a level closer to the market average, though the estimated earnings growth is far higher. The portfolio PER estimate for 2022 still shows a premium versus the index as some of the COVID reopening plays have yet to recover fully. However, the estimate for 2023 multiple is pretty much in line and with a significantly higher rate of earnings growth and returns.
The sharp correction in high valuation and high-growth stocks that has been driving the value rally is unlikely to go much further given the scale of the moves so far, though the buying of value names that have yet to fully participate may continue. While the correction in valuations has largely played out for now (the convergence or crossover of value and growth valuations generally indicates that we are close to a bottom), the unwinding of global monetary easing will accentuate the importance of bottom-up stock picking and a keen focus on companies that can continue to grow earnings over the mid-term.
With this in mind, I am focusing on companies that are long-term winners with sustainable growth prospects and differentiated products in growing markets. In particular, I like companies that are efficiency enablers in both the Manufacturing (FA) and Software (Digitalisation) sectors. Over the longer-term, I am looking at companies that can contribute to and support Japan’s energy transition and requirements for energy efficiency (green energy, factory automation and EV components, etc.). As always, we continue to evaluate new and under-covered opportunities, while focusing on companies that can continue to grow through 2022/23 and exceed market expectations over the mid-term.
FJV : Fidelity Japan to seek shareholder approval to invest in more unlisted companies