The managers of the JP Morgan Japan Smaller Companies Trust – Shoichi Mizusawa, Nicholas Weindling and Naohiro Ozawa – are “constructive” on the outlook for Japanese equities in 2014.
They cite positive factors such as strong political leadership, changing inflation expectations, improving investor sentiment, strong corporate earnings prospects, Japanese yen weakness and attractive valuations. “Although there has been little progress in structural reforms, we continue to give the Abe administration the benefit of the doubt. We believe that the effects of improved corporate profitability will be keenly felt in the domestic economy through rising incomes,” says Mr Weindling.
This view is reflected in the portfolio’s current positioning in favour of domestic sectors. It has a focus on financials, including real estate, and firms likely to benefit from an improving Japanese economy, notably retail, general services and internet-related sectors.
The managers emphasise, however, that the long-term themes in the portfolio – such as the ageing population, factory automation, greater use of mobile devices, retail consolidation and the growth of e-commerce – remain unchanged.
The trust aims to generate long-term capital growth through investment in small and medium-sized Japanese companies. It excludes the top-200 companies ranked by market capitalisation, updated on a quarterly basis.
The investment trust’s process of bottom-up, research-driven stock selection has remained unchanged since its launch in 2000. The managers explain that macroeconomic factors are reflected in this process.
At the beginning of 2013, the team increased the trust’s gearing and added money to stocks that they believed would benefit from domestic reflation, such as real estate and financials. This decision followed the Liberal Democratic Party’s (LDP) landslide election victory in December 2012 with a mandate to push through “largely market and business-friendly policies”.
Mr Weindling explains: “The improved macro outlook and the substantially weaker Japanese yen will be a boost to exporters. Similarly, the pressure on the Bank of Japan to target higher inflation is positive for risk assets in Japan. Bold fiscal and monetary policy action in Japan concurrent with the steady recovery path in the US should prompt expectations of an improvement in both the economy and corporate earnings.”
Performance of the trust has been somewhat patchy, with its three- and five-year total returns to February 25 both severely lagging the AIC Japanese Smaller Companies sector. Recent performance has picked up, as in 2013 the trust produced a return of 40.31 per cent, outperforming the sector average of 37.98 per cent, for the first time since 2008.
The manager explains that the portfolio’s bias towards domestic stocks worked particularly well because of the improvement in fundamentals over 2013. In the real estate sector, the team highlights the trust’s holding of Tokyo Tatemono, one of the major office and condominium real-estate developers in Japan. It benefited from the improving economic environment, with rents starting to increase as vacancy rates fell. Another strong performer was Don Quijote, a major discount store operator in Japan. Among the portfolio’s internet-related stocks, strong performers include Cookpad, an online recipe company and Cyberagent, a blog, games and internet-advertising agency. These stocks benefited from “stronger top-line growth driven by higher smartphone penetration and rise in e-commerce”.
