JPMorgan Japanese (JFJ) has published its interim results for the six-months ended 31 March 2022. The period is one that has seen investors rotate away from the kind of high quality and high growth companies that JFJ focuses on (its manager runs a high conviction, unconstrained approach focused on finding the best investment ideas in Japan) towards cyclical and value companies. This is reflected in its performance relative to the Tokyo Stock Exchange (TOPIX) Index. During the period, JFJ provided an NAV total return of -24.2% and a share price total return of -23.4%. In comparison, the TOPIX provided a total return of -8.7% (all in sterling terms).
JFJ’s managers, Nicholas Weindling and Miyako Urabe, say that, while this near-term performance is disappointing, it is the result of the same quality and growth focus in its holdings that has underpinned JFJ’s long-term record of strong absolute returns and outperformance. They highlight that, over the ten years to end-March 2022, JFJ delivered an annualised return of 12.1% (on an NAV basis), decisively outpacing the benchmark’s annualised total return of 8.5%. The Company’s long-term share price performance has been even stronger.
Managers’ comments on significant contributors and detractors to performance
“Our focus on quality and growth companies took a short-term toll on the Company’s performance in the six months to end-March 2022. Our Japanese growth holdings were subject to the same revaluation pressures as their counterparts in other markets, even though we do not expect significantly higher interest rates in Japan, and despite the fact that the long-term outlook for these companies has not deteriorated. Indeed, as discussed above, their prospects are improving materially as a result of the long-term structural shifts underway across the Japanese economy.
“Just as we view the sell-off in Japanese growth stocks as unjustified, we also believe the outperformance of Japanese banks is not supported by fundamentals. With economic growth set to remain modest, a significant pick-up in loan demand seems unlikely. Furthermore, Japan’s banking sector remains highly competitive, while returns on equity are low (currently 6%) and look set to remain so.
“Portfolio holdings worst hit by market revaluations over the review period include Keyence, along with Benefit One and Recruit which both provide employment and business services. These are all Premium rated companies that continue to post strong results, so we expect their recent sell-offs to prove transitory, and all remain in the portfolio.
“Our holdings in other quality growth names such as Lasertec, a semiconductor producer also hurt performance, while Nihon M&A Center detracted for stock-specific reasons. This company provides mergers and acquisition-related services to companies in Japan and globally. Its share price fell sharply late last year after it announced an investigation into some accounting irregularities over the last few years, which had the effect of artificially enhancing sales revenues in some periods. The issue has now been resolved and the company has announced measures to prevent a re-occurrence of this problem. While growth may be somewhat lower in the future, in our view the company’s long-term opportunities remain positive. We continue to hold the stock.
“At the end of the review period, gearing stood at 12.5%, lower than the average level of 13.6% over the review period. This reflects our conviction in the near-term outlook for the market and portfolio. However, gearing detracted from performance during the review period.
“The detrimental performance impact of these developments was partially offset by positive contributions from several holdings, including Nintendo and Tokyo Electron, which benefited from a particularly strong set of results. MonotaRO also enhanced returns after it announced a significant expansion in capacity. We have since taken some profits on our positions in both Tokyo Electron and MonotaRO.”
Managers’ comments on portfolio activity
“The recent sell-off in growth names has generated opportunities to increase our exposure to some Premium and Quality rated names at more attractive levels. For example, we have opened a position in Nippon Sanso, Japan’s leading provider of industrial gases. We expect an improvement in this company’s profitability thanks to a new management team at its parent company, Mitsubishi Chemical. We added exposures to Nippon Paint – the number one consumer paint company in Japan and China – and to JSR, a specialist chemicals producer which is the world leader in a range of electronic materials. We bought Kissei Pharmaceutical, a small company with three new drugs approaching approval and a very strong balance sheet, along with Tokio Marine Holdings, Japan’s number one property and casualty insurance company. Tokio has a large US business and an attractive dividend policy.
“In addition to these new acquisitions, we also added to existing positions in Shin-Etsu Chemical, as the company announced a significant improvement in its dividend pay-out policy. We also like the fact that this company has the pricing power to pass on higher costs to customers.
“These acquisitions were funded by a number of partial sales, including profit-taking on Tokyo Electron and MonotaRO (mentioned above). We also took some profits on positions in Recruit, Lasertec and M3, a provider of online medical information, which had all risen substantially in value since acquisition.
“We also closed a number of positions, including exposures to several companies facing increased competition. For instance, we sold Hennge, a software infrastructure supplier, Giftee, an online gifting company, and Pigeon, a provider of mother and baby products facing increasing competition in its key China business. We also exited positions in Mercari, a consumer-to-consumer e-commerce site, due to rising competition in the US and slowing domestic growth, and in Modalis Therapeutics, due to disappointing progress with the development of its drug pipeline.
“With some regret we also sold Renova, a leading player in Japan’s renewable energy market, following its failure to secure an offshore wind contract in circumstances where price competition raised serious questions about the viability of the sector.
“In all, portfolio turnover at end-March 2022 was 18% on an annualised basis, with over 50% of the portfolio held continuously for over five years. At the end of the review period, the portfolio held 60 stocks, compared to 63 at 30th September 2021. None of the Company’s portfolio holdings had significant exposure to either Russia or Ukraine.”
Managers’ outlook
“Japan’s post pandemic recovery is likely to remain relatively subdued compared to other major economies. The war in Ukraine will have an inevitable adverse impact on activity. Japan procures less than 10% of its liquefied natural gas imports from Russia, so it is better placed in terms of energy security than many European countries that rely heavily on Russian oil and gas. Japan also has little other direct trade with Russia and Ukraine. Consumers will, however, feel the indirect effects, especially through rising energy prices, as Japan has almost no gas, oil or coal of its own, and the production of energy from renewable sources such as solar and wind remains in its infancy. Import price rises will be compounded by the weaker yen, although on the positive side, the lower yen will boost export receipts.
“But unlike the case in most other major nations, inflation should not be a significant concern in Japan. Although prices have begun to rise due to rising energy and material costs, there has been no significant increase in property rents, and despite a tight labour market, wage growth remains low. In this environment, rises in energy and other prices may prove to be mostly one-offs, that do not feed through into higher wage demands and long-term inflation expectations.
“Despite some inevitable short-term uncertainties, we are positive about the longer-term outlook for Japan. The country is in the process of a major technological transformation that should deliver growth and substantial productivity gains over time. Moreover, Japan’s Prime Minister Fumio Kishida, who was elected in September 2021, remains very popular and we expect Japan’s political landscape to remain stable for the foreseeable future, while improvements in Japan’s corporate governance continue.
“We therefore maintain our positive view on the long-term prospects for Japanese growth stocks and the themes that guide our investment decisions. Indeed, just as Covid accelerated the pace of change in some areas, such as e-commerce and digitalisation, so too have recent developments accelerated other trends. For example, energy price rises have made the transition to renewable energy more urgent, while mounting wage pressures have in some major economies boosted the demand for automation.
“This is an ideal environment for Japan’s many dynamic, innovative, quality businesses, especially those in the small and mid-cap space. We seek out the very best of these investment opportunities, at the heart of Japan’s new growth. The recent market sell-off has made many of these opportunities available at more attractive prices. We have therefore increased the combined weight of Premium and Quality stocks to reflect this. The high quality companies we own have strong balance sheets, leading competitive positions and are often number one in their respective industries, in Japan or internationally. They have demonstrated pricing power over many years, and we believe they are capable of prospering, over the long-term, regardless of the macroeconomic environment.
“Our approach means the portfolio typically has a high active share which means it often looks very different to the benchmark. This inevitably leads to some volatility in relative performance, as we have seen over the review period. However, over the last ten years, the strategy has generated returns well in excess of the benchmark, and we remain confident in the portfolio’s ability to continue to outperform the benchmark over the long-term.”