JPMorgan Japanese (JFJ) has published its annual results for the year ended 30 September 2024, during which it provided NAV and share price total returns of 24.2% and 22.4% respectively, both comfortably outperforming its TOPIX benchmark index, which provided a total return of +10.3%. The managers say that part of the outperformance reflects their success in capturing the benefits of some of the recent corporate reforms. Japanese equity markets rose strongly during the financial year and both the Nikkei 225 and the TOPIX finally both hit all-time highs in July, almost 35 years after their previous peaks. JFJ’s chair, Stephen Cohen, says that the most positive influence on Japanese equities over the past year has been the authorities’ ongoing efforts to promote corporate reform, which has enhanced shareholder returns thanks to higher dividends, share buybacks and better capital allocation. He adds that this captured the attention of foreign investors, who reduced their underweighting in Japanese stocks.
JFJ’s board proposes to pay a final dividend of 6.75p per share, an increase of 3.8 (2023: 6.50p). This increase in dividend follows last year’s 4.8% increase. JFJ repurchased a total of 7,680,000 shares (5.4% of shares in issue), almost double the number it purchased during the previous financial year (2023: 3,870,000 shares).
Merger with JSGI completed post period end
Post the year end, JFJ completed its merger with JPMorgan Japan Small Cap Growth & Income (JSGI). This transaction completed on 25th October 2024 and resulted in a post combination company with approximately £1bm of net assets, which Cohen says gives “it a leadership position within the Japanese investment trust sector”. Following the combination, JFJ will benefit from a new, fee arrangement and the ongoing charges ratio is expected to be significantly lower, estimated to be around 0.62% for the period to 30 September 2025, as compared with 0.73% for the period to 30 September 2024.
Gearing
JFJ’s board believes that gearing can benefit performance and sets the overall strategic gearing policy and guidelines and reviews them at each board meeting. The portfolio managers then manage gearing within the agreed limits of 5% net cash to 20% geared in normal market conditions. As at 30 September 2024, gearing was equivalent to 10.5% (2023: 13.7%) of net assets and at the time its annual report was written, the gearing had increased to 14.0%.
As mentioned in its interim report, JFJ did not renew its loan with Mizuho Bank Ltd, and this was repaid by the company. Along with the short-term revolving facility of JPY 10 billion with Industrial and Commercial Bank of China Limited, London Branch, the company also has long-term fixed rate debt in place. The company has, post year-end, started using Contracts for Difference (CFDs) as an alternative means of implementing gearing.
Revenues and dividends
Income received during the year ended 30 September 2024 fell this year, with earnings per share for the full year of 7.37p (2023: 7.46p). This small decrease is a result of lower income received from portfolio companies and from stock lending.
The board’s dividend policy is to pay out the majority of revenue available each year. The board therefore proposes, subject to shareholders’ approval at the Annual General Meeting to be held on 22nd January 2025, to pay a final dividend of 6.75p per share (2023: 6.50p) on 12th February 2025 to shareholders on the register at the close of business on 27th December 2024 (ex-dividend date 24th December 2024). This increase in dividend follows last year’s 4.8% increase.
JFJ’s board says that, as part of the combination with JSGI, it undertook to review JFJ’s dividend policy, including speaking with the trust’s major shareholders (many of whom were also shareholders in JSGI). JFJ’s investment objective is to seek capital growth from a portfolio of investment in Japanese companies. It invests primarily in growth companies which often have relatively low dividend yields, not least because they are likely to reinvest excess cash in their businesses and/or buy back their shares rather than increase dividends. At present, JFJ pays out the majority of revenue available each year as a final dividend. Having now completed its review of the company’s dividend policy, the board has concluded that JFJ’s dividend policy should remain unchanged. The board hopes to increase the dividend year on year, as has been possible since 2020.
Investment manager’s comments on performance
“We are very pleased to report that the strong absolute and relative performance we saw in the first half of the financial year continued into the second half. For the year ended 30th September 2024, the Company’s total return NAV with debt at fair value was +24.2% in sterling terms, outpacing the benchmark return of +10.3% by +13.9%, in sterling terms.
“We focus on quality and growth stocks, yet the strong returns realised over the past year were achieved during a period when Japanese value stocks in general – unlike their US counterparts – outperformed the growth and quality names we prefer for most of the period. We attribute this achievement to three factors. Firstly, we increased our focus on companies embracing governance change and improving the efficiency of their balance sheets. Secondly, the last two months of the financial year did finally see a change in the style environment away from value names, in favour of more growth-oriented stocks, when the yen began to appreciate. Thirdly, ASICS, the specialist running shoe manufacturer, made a significant contribution to returns over the period.
“The robust returns registered over the past year have boosted the Company’s performance over the long term. The annualised NAV total return with debt at fair value over the three year period was -4.4%, versus the benchmark return of +2.9%. However, the long-term absolute and relative performance has strengthened. In the ten years to end September 2024, the Company made an annualised NAV total return of +10.5%, ahead of the benchmark return of +8.4%.”
Investment manager’s comments on performance attribution for the year ended 30th September 2024
Investment manager’s comments on Economic and market background
“The Japanese market has returned to the limelight over the past 18 months, after a long period of being unloved and under-owned by international investors. The Company’s benchmark, the TOPIX, delivered a total return of 12.8% during calendar year 2023, and has continued to rise this year, reaching a record high in July 2024. Japan’s bellwether Nikkei 225 also hit a fresh all-time high in the same month. Much of the inflows have apparently come from global equity portfolio managers increasing their allocation to Japan. They buy a relatively small number of the larger cap stocks so the market rally has been quite focused in this area.
“The main reason for these gains is global investors’ positive reaction to corporate governance reforms and shareholder friendly policies currently underway in Japan. The authorities are encouraging businesses to improve the transparency and independence of their boards, and to raise shareholder returns by returning their large cash reserves to shareholders, in the form of higher dividend payments and share buybacks. At the same time, shareholder activism is increasing, and Japanese pension funds have been publicising their voting positions on corporate actions – actions which enhance market information for all participants.
“Investors have also welcomed signs of improvement in Japan’s domestic economy, after years of stagnation and deflation. Most significantly, the spring wage negotiations, known as the shunto, agreed a 5.3% wage increase, the highest in 33 years and substantially ahead of the rate of inflation, which is currently running at 3.0% pa. This rise in real wages may boost consumer sentiment and support domestic demand.
“On the monetary policy front, the Bank of Japan (BoJ) has begun to raise interest rates for the first time in 17 years. This is partly an effort to stabilise the yen, as its depreciation is driving up the cost of essential imports like energy and food, which, in turn, is eroding consumer confidence. The BoJ has lifted rates twice since March 2024 and the key policy rate now stands at 0.25%. However, monetary settings are still relatively loose, as the central bank remains committed to bolstering liquidity and stimulating growth, and this should be positive for the market in the near term.
“The divergence between interest rates in Japan and the US and other major economies remains significant even after the BoJ’s recent hikes and the US Federal Reserve’s rate cuts, and this gap has seen the yen weaken dramatically over the past two years. Although the yen strengthened somewhat since the BoJ’s second rate hike in late July this year, which was followed weeks later by a larger than expected rate cut by the Fed, it remains near multi-year lows versus the USD. Japanese exporters such as automakers and industrials have benefited accordingly, although the yen’s partial recovery in September saw market leadership switch away from exporters, towards other areas of the market, including domestic sectors such as retail and services.
“We believe that private equity investors are increasingly active in Japanese businesses. One important development that may be encouraging this trend has been the establishment last year of Japan’s takeover code, which is intended to spur industry consolidation and boost competitiveness. The code also ensures the market is now informed of all such bids, which helps draw attention to undervalued companies and could foster competition for assets amongst competing bidders.
“Two of the Company’s portfolio holdings have been impacted by these developments. One holding, Benefit One, a provider of staffing and employment services and benefits, was subject to a hostile takeover by a very traditional life insurance Japanese company, a highly unusual occurrence in Japan. Of even greater significance, another holding, Seven & I Holdings, the world’s largest operator of convenience stores, is currently the subject of a bid from its global rival, Canada’s Alimentation Couche-Tard, which operates Circle K convenience stores. We believe this transaction will have long-lasting consequences. We have never seen inbound M&A on this scale. The bid means that we can now start to consider other possible Japanese candidates for M&A activity by overseas investors, particularly in cases where the potential target is trading at a discount to its global peers, as is the case with many Japanese companies.
“Japanese equity markets experienced a bout of volatility in August, sparked by the BoJ’s policy action and associated hawkish commentary on the potential for further hikes, combined with a run of weaker than expected US economic data. The fall was exacerbated by a partial unwind of the yen carry trade, in which investors borrow cheap yen to buy overseas assets. The market has since regained most of those losses.
“On the political front, in September Shigeru Ishiba became Prime Minister following the resignation of Mr Kishida, whose popularity had fallen precipitously. Kishida’s demise was partly the result of a scandal in the ruling Liberal Democratic Party (‘LDP’), as well as growing dissatisfaction within the electorate about deteriorating living standards, as yen weakness has raised the price of key imports such as food and energy. However, this change of leadership is unlikely to have a significant impact on policy direction. Although the LDP suffered significant losses in the October election, we still expect Mr. Ishiba to maintain all the key policies of his predecessor.
“Elsewhere in the region, the Chinese authorities, in response to economic weakness and deflation, announced a major stimulus package in September, which sparked a significant rally in the Chinese market. We hold some companies that should benefit from an uptick in Chinese consumption, including ASICS, Fast Retailing, owner of the Uniqlo clothing brand and Shimano, a supplier of bicycle parts, amongst others. However, generally we remain cautious about companies that compete against local Chinese businesses.”
Investment manager’s comments on portfolio themes
“The portfolio is constructed entirely on a stock-by-stock basis as we seek out the best, most attractive companies, regardless of the economic cycle. Nonetheless, many portfolio holdings offer exposure to key structural themes that should drive growth over the medium term. These companies are also well-placed to take advantage of recent developments in the corporate governance landscape. While they are outstanding businesses poised to compound earnings growth for many years, they often have sub-optimal capital allocation policies which have, historically, encouraged high cash balances and cross shareholdings. Unwinding these creates scope for significant improvements in shareholder returns.
“Another theme is digitisation and the adoption of technological innovation. Japan remains well behind most other advanced economies in areas such as online shopping, digital services and cloud computing, and this leaves plenty of scope for such trends to continue developing over coming years. For example, the penetration of e-commerce within the Japanese retail market is just over 10% which remains much lower than in China, the UK, South Korea or the US. In addition, many companies across the economy still use inefficient internally developed software systems which will need to change as the developers of these bespoke systems retire. OBIC, a leading provider of IT services for small and mid-sized companies, is one business benefiting from the standardisation of business software. It has operating margins over 60%. It also has a significant and growing net cash position, as well as a portfolio of shareholdings which are depressing its return on equity. We are engaging with the company to encourage it to improve its capital allocation.
“De-globalisation is another trend gathering momentum. The pandemic, and subsequent events such as widespread supply chain shortages, the conflict in Ukraine and simmering Sino/US geo-political tensions, have increased companies’ desire to move production nearer to end customers, including to Japan. For example, TSMC, the Taiwanese semiconductor producer, is building plants in Japan. Our portfolio holding in Japan Material, which installs and services infrastructure for semiconductor factories, is benefitting. With wage inflation now an issue in the US and other markets, businesses establishing new production plants and warehouses have a stronger incentive to incorporate factory automation into these facilities wherever feasible. Japan is fortunate to be home to some of the world’s leading automation specialists, several of which are held in our portfolio, including Keyence. This long-held Premium rated company not only has a dominant market share and high profitability, but also significant potential for improved shareholder returns.
“Japan is home to many global leading consumer brands such as Fast Retailing and computer games companies such as Sony and Nintendo. As in other sectors, we can find companies that combine long-term structural growth with significant potential from improved governance. Nintendo, which owns some of the sector’s most valuable intellectual property, with characters such as Super Mario and Pokemon, has roughly a quarter of its market cap in net cash and could do much more in terms of shareholder returns. Meanwhile, Shimano, which commands more than 75% of the market in bike parts, will benefit from the surge in popularity of cycling as an alternative to driving. The company also holds close to a quarter of its market cap in net cash.
“Japan also hosts many world-leading hardware technology companies, some of which are dominant in their niche markets. One such example is Quality-rated chip tester Advantest. Chip testing used to be a fragmented market with many competitors, but it has become a duopoly over time, with Advantest winning considerable market share. One of its key customers is Nvidia, the US producer of the most advanced chips. Similarly, Premium-rated and long held HOYA is the leading global manufacturer of glass substrate for hard disk drives.
“While exposure to key structural themes underpins the investment case for many portfolio holdings, other portfolio companies have very specific drivers. Secom is Japan’s number one security company. Following a change in management last year, we saw the company undertake its first share buyback for over 20 years, accompanied by a price hike. Elsewhere, there are substantial opportunities in small stocks which generally have low levels of sell-side (investment bank analyst) coverage. One such example within the medical technology field is Osaka Soda, which is the leading global supplier of a key ingredient in anti-obesity drugs, yet it is has a low level of analyst coverage. We expect Osaka Soda’s profits to grow rapidly due to the huge popularity of these drugs. This company is also making improvements to its balance sheet structure, to improve capital efficiency. It has a strong net cash position, so it is likely to deliver the same improvements in shareholder returns we are seeing across the market.”
Investment manager’s comments on significant contributors and detractors to performance
“The most significant contributors to returns over the financial year ended 30th September 2024 included several stocks we rate as Quality and one Premium rated name. The Quality-rated names included ASICS, a leading brand of running shoes. This business experienced a difficult period between 2016 and 2020, when it attempted to compete with Nike and Adidas in the market for casual trainers. However, more recently it has delivered strong results following its decision to focus on its core, specialist, running shoe product. Another key contributor, Hitachi, is a Quality rated conglomerate that is a major supplier of cabling for power grids, as well as other businesses. The company has dramatically changed its business portfolio over the last few years and several of its businesses are global market leaders in their respective fields. Its results remain strong. The shares of Tokio Marine, a Quality-rated non-life insurer, benefited after management announced a plan to speed up the sale of its shareholdings in other companies and distribute the proceeds to shareholders. Performance was also enhanced by gains in Recruit, a provider of human resources technology and other business solutions. This Premium-rated business continued to do well, thanks in large part to its ownership of the world’s largest job search website. The company also announced a Y600 billion (US$4 billion) buyback programme, which will boost shareholder returns. Itochu is a Standard rated import/export conglomerate trading in a variety of goods. Like other significant contributors to performance, its share price has been supported over the past year by continued strong results and improving shareholder returns.
“The main detractors from performance over the period included Nakanishi, Japan’s leading dental equipment producer. This Quality-rated business recently acquired DCI, a maker of dental chairs, but DCI’s performance since acquisition has been weaker than expected. Japan Material is both an installer of infrastructure for semiconductor factories, and a provider of after sales servicing. This makes the company a convenient, ‘one-stop shop’ for its clientele. The company is Quality-rated but earnings growth has slowed as the business invests for the future. OBIC, a Premium-rated IT services business, saw its shares de-rate over the year, unjustifiably in our view, as we see no deterioration in the investment case and management continues to execute well. Daikin, which produces air conditioners, is Quality-rated. However, demand has been weaker than expected in China and the United States. Additionally, the European take-up of heat pumps has been slower than forecast. This recent disappointing performance prompted us to close this position. Our decision not to own Standard-rated Mitsubishi Heavy Industries also detracted from returns. The shares performed well following the Japanese government’s announcement of plans to increase defence spending, one of the company’s key exposures.”
Investment manager’s comments on portfolio activity
“Corporate governance reforms, including business re-organisation, are increasing the number of companies we may, in future, deem to be Premium- or Quality-rated, and this has created many more opportunities for us to invest in the kind of businesses we favour. Over the past year we added several new stocks to the portfolio. The most significant acquisitions included:
“Advantest – This Quality-rated business is the global leader in semiconductor chip testing. Demand from its key customer, Nvidia, and other major clients, is driving earnings growth.
“Softbank Group – The group listed its Quality-rated subsidiary ARM, a chipmaker, in the US last year. This has greatly improved visibility regarding the value of the whole group, which in our assessment is trading at a wide, and appealing, discount to NAV.
“Kao – During the past year, this leading, Quality-rated maker of consumer goods announced a plan to improve profitability, including focusing on a smaller number of brands. We believe this plan is likely to be effective in lifting performance.
“Suzuki Motor – This Standard-rated business trades at a big discount to the value of its stake in Maruti Suzuki, India’s leading car manufacturer. Furthermore, Suzuki has a very strong balance sheet, and we believe there is potential to substantially improve capital allocation.
“Denso is one of the world’s top auto component makers, focused on hybrid and electric vehicles, as well as advanced driving systems. The company is significantly reducing its cross-shareholdings and improving its capital allocation. We upgraded the strategic classification to Quality and bought the shares at an attractive valuation.
“In the last six months we also established new positions in Kinden, an electrical engineering company, Lifedrink, which bottles soft drinks to be sold as own-label products, Toei Animation, a creator of anime content, Nichias, a supplier of thermal insulation, whose new president is focused on profitability, and Yamato Kogyo, a steelmaker. All these acquisitions were motivated by the prospect of improving shareholder returns, attractive valuations and appealing growth characteristics.
“These purchases were funded by the sale of several holdings including Daikin, mentioned above, and Nippon Telegraph and Telephone. We sold this Standard-rated stock due to worsening competitive dynamics in the telecom industry. In the last six months we also exited Zozo, an internet retailer, Ibiden, which makes electronic and ceramic parts, and several other names due to deterioration in their investment cases, better opportunities elsewhere, or high valuations. We also trimmed a position in Sony, a Quality-rated gaming and consumer electronics company, to fund the purchase of Advantest. We took some profits on ASICS and Recruit after their strong share price rises.
“It is worth noting that, as highlighted in the Chairman’s Statement, since the financial year end, we introduced CFDs into the portfolio. This move aims to enhance our gearing strategy by making it more efficient and cost-effective.”
Investment manager’s comments on outlook
“The transformation underway in Japan has, in our view, only just begun. The gains to be realised from corporate governance reforms and other structural changes will be much more significant than those we have seen to date. The most important positive influence on the outlook for Japanese equities remains the ongoing reform of the corporate sector. With the encouragement of the government, regulators and shareholders, Japanese companies are adopting ever higher standards of independence and transparency and implementing best practices in their capital allocation decisions. Shareholder returns are increasing due to the resultant share buybacks and higher dividends, and we expect dividend payout ratios to continue to rise. These developments have the potential to lift the whole market, including the Company’s holdings, to a higher valuation.
“But there are several other reasons to be positive about the outlook for Japanese equities. For one, Japan is at a very early stage in the digitisation process compared to the rest of the world, and this, combined with the trend towards industrial automation, has the potential to help drive significant growth and/or productivity gains over the medium term. Deglobalisation, the transition to renewable energy and developments in medical technology are also contributing to rapid structural change – an ideal environment for the dynamic, quality businesses we want to own.
“Japan’s labour market is also changing. Increasing wages is one indicator of the extremely tight conditions in this market, and the supply of labour is set to contract further as the country’s aging workforce retires. However, this situation has one major potential upside. Traditionally, Japan’s labour market has been characterised by a rigid mentality. But there are now signs that the high demand for labour is making workers bolder in their employment choices, with many more inclined to change jobs in pursuit of higher income. If this trend gains further traction, the resulting improvement in labour market flexibility should have a favourable effect on overall productivity and the long-term future of Japan’s corporate sector.
“Increased demand from foreign investors also looks set to provide further support for the market. Many global investors are underweight Japanese equities. However, they are beginning to recognise the opportunities on offer in this market, especially since valuations, while not cheap, are still relatively attractive. At the end of September 2024, the market was priced at 14x earnings on a forward price to earnings basis and at 1.5x book value (in trailing price to book terms). With inflation now positive, and an enhanced Nippon Investment Savings Account (NISA) providing a greater incentive to invest, there are also signs that domestic retail investors are taking more interest in their home market.
“Now that the BoJ has begun to raise rates, the yen has risen slightly from its mid-year lows of around 160 yen to the US dollar, and 200 yen to the pound. While the yen is still undoubtedly weak on an historical basis, and therefore potentially attractive, the recent victory by Donald Trump in the US election may yet cause the US dollar to strengthen further, as tariffs on imports may mean US inflation is higher and interest rates remain relatively elevated.
“So, even though the Japanese market has had a very strong run over the past 18 months, this combination of corporate governance reforms, structural transformation and appealing valuations should help sustain and encourage investors’ appetite for Japan stocks. It will also generate many exciting investment opportunities, regardless of the economic backdrop.
“We believe that our experienced team, based on the ground in Tokyo, means we are ideally placed to identify these opportunities, and capitalise on them. Japan is one of the world’s three largest equity markets. It is very deep, broad and liquid. Yet, large areas of the market have relatively low levels of sell-side analyst coverage. This leaves the way open for locally based investors such as us to identify potential winners that most other investors simply miss. Furthermore, in addition to our extensive Tokyo-based team, we also benefit from our global team of investment professionals, who help us identify new trends and opportunities, as well as confirm investment themes and competitive positioning.
“In summary, there are many good reasons for our optimism regarding the Japanese market, and hence the long-term prospects of the portfolio’s holdings. We are therefore confident of the Company’s ability to continue delivering capital growth, and outperformance, to shareholders over the long term.”
