AVI Japan Opportunity 10 April 2019

AVI Japan Opportunity (AJOT) invests in Japanese small-cap stocks, aiming to generate high long-term returns by taking advantage of extremely cheap valuations in that part of the market but also using shareholder activism to supercharge returns.

The £78m trust, launched in October 2018, is run by Joe Bauernfreund, also manager of the £900m British Empire Trust. Joe looks for asset-backed companies on low valuations where he can see a catalyst for a re-rating. In small cap Japan he has found what he believes is an outstanding opportunity. On a look-through basis, the companies in the portfolio have 78% of their market cap in cash or transferrable securities and are trading on 3.9 times EV/EBIT, compared to 8.7 times on the MSCI Japan Small Cap and 18.5 times on the S&P 1500 all-cap index.

AJOT is an activist investor and aims to take advantage of the political and regulatory pressure on Japanese companies to increase the efficiency of their balance sheets. One of the “three arrows” of Abenomics is policies for growth, and in part this means a determined push to put idle corporate cash and cross-shareholdings to more productive use and thereby boost shareholder returns.

In their view, AVI is therefore increasingly pushing on an open door. In the first six months of the trust’s life it has seen nine of its 29 portfolio companies make shareholder friendly moves, be that paying or increasing a dividend, buying back shares or other measures. NAV performance has also been solid, with the trust up 0.3% compared to a 1.6% loss for the MSCI Japan Small Cap index, to the end of March. Although it was aided by it not being fully invested during the global market downturn in November and December, most of the outperformance came when it was fully invested, illustrating the success of the stock-picking.

Following the encouraging start, and to take full advantage of the current opportunity, the company drew down £10.4m in borrowings in April 2019, amounting to gearing of 12.5% of NAV.

The trust has been trading on a premium since launch, in part helped by not being fully invested in the Q4 2018 market slump. The trust is now on a 3.2% premium. The board is yet to seek to address this, but the prospectus does allow for further share issuance if the trust is trading above NAV. AJOT will offer a liquidity option after four years and every two years thereafter, meaning that if returns are disappointing investors can redeem at close to NAV.

There is no specific income objective. However, AJOT’s portfolio currently yields 2.1% (at NAV) and, to retain investment trust status, the board will have to pay out 85% of that after costs. Through 100% charging costs to capital, the majority of the portfolio yield will flow through to shareholders as dividends.

The first six months of the trust’s life have been hugely encouraging from a corporate governance point of view, and prove that there is a real trend towards governing in shareholders’ interests rather than those of management in Japan. Should this trend continue, we believe it could be the impetus that prompts a re-rating of Japan in general and AJOT’s portfolio more specifically. As we highlight below, the trust owns high-quality businesses trading on depressed valuations, each with a specific catalyst that could lead to a re-rating. We therefore believe this trust should be attractive to investors looking for a strategy with high return potential after a decade-long bull market in global equities. Early performance has also been encouraging, with the trust’s stocks outperforming the market in a rough period for Japanese small caps, illustrating the benefits of a value approach.