AVI Japan Opportunity 04 December 2019

AVI Japan Opportunity (AJOT) invests in Japanese small-cap stocks. The investment strategy aims to generate strong long-term returns through investment in companies which are both extremely cheap, and which retain significant excess cash and listed equity investments on their balance sheet. The trust uses shareholder activism to persuade management to make shareholder-friendly changes to governance in order to boost returns.

The trust was launched in October 2018 and is managed by Joe Bauernfreund, also manager of the £1.05 bn AVI Global Trust. AVI launched AJOT specifically to access a particular opportunity set arising from changes in the regulatory approach to corporate governance in Japan, which they believe can catalyse a valuation re-rating amongst a group of very cheap stocks.

AJOT is activist in its approach, and seeks to constructively deal with company management to improve shareholder returns. In this regard, they increasingly believe they are pushing on an open door. Not only have market regulators and the Japanese government (via the ‘third arrow’ of Abenomics) strongly encouraged businesses to reform in this manner, but, increasingly, huge institutional mandates in Japan are doing so as well.

The portfolio itself trades on a discount to the wider Japanese small-cap market, which itself trades at a discount to other global markets. This is before balance sheets are made more efficient. Greater balance sheet efficiency would further increase the valuation opportunity, and AVI have opted for a closed-ended investment structure in order to best capture this opportunity. Further details of the valuation opportunity can be found in the Portfolio section.

Having consistently traded at a premium since launch, the current AJOT premium stands at around 0.5% (as of 8 November 2019). Strong investor demand and the relatively small size of the portfolio have contributed to the persistence of the premium. AJOT operates a discount control mechanism, with significant capacity to buy back shares, and offers investors the opportunity to realise their position at NAV after four years have passed since launch.

AJOT has a clear vision and objective, with a coherent strategy and strong structure. While historically Japanese businesses have displayed a general aversion to activist engagement, AJOT has powerful allies, in particular the Japanese government, and there are signs that corporate governance reform is taking hold. There is some evidence that, in any event, the universe of comparable companies (those with over 30% of their market cap held in cash or other securities on the balance sheet, among other factors) has outperformed in its own right. Were this to continue, activist successes could be seen as a bonus, and not a necessity.

The balance sheet factor means these companies tend to offer relative security, while typically the AJOT managers avoid cyclically exposed companies. However, the trust’s focus on small-cap stocks, often poorly covered and illiquid, means that adverse market conditions or a slowing global economy can prove a short-term headwind. The closed-ended structure, giving a fixed capital pool as well as an ability and willingness to gear, could offer additional tactical opportunities for the managers to lean into such conditions. Indeed they have tried to take advantages of the inefficiencies of their markets.

Overall AJOT is a strong product with much to commend it for long-term investors.