Baillie Gifford Japan 20 November 2024
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This is a non-independent marketing communication commissioned by Baillie Gifford. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Baillie Gifford Japan (BGFD) is seeing its largest positions perform well as the Japanese market environment seems to be shifting back in its favour. BGFD is a long-term strong performer which has had a weak period of performance as the developed world struggled with inflation after the pandemic and interest rates rocketed higher. Over the last 12 months performance has been positive, and marginally ahead of the index, and both SoftBank and Rakuten, which together make up over 11% of the portfolio, have performed particularly well (see Portfolio).
BGFD is managed by Matthew Brett who aims to identify the best long-term growth opportunities in Japan, looking to find companies he believes can return at least 100% over five years. Turnover is low as Matthew invests for the long term, but in recent months he has been finding a number of new opportunities in secular, ‘Warren Buffet’ growth stories which have fallen onto highly attractive valuations amidst a period in which growth investing has been out of favour.
Matthew’s conviction is demonstrated by the significant Gearing level he has been running for some time, and this stood at 15% on a net basis as of the end of September. In his view, the economic environment in Japan is likely to remain conducive to growth investing over the long run, with inflation and interest rates low and demographics forcing the country to generate productivity advancements to grow. While a lot of attention has been on the corporate governance story over the past two years, Matthew argues that this often leads to one-off or short-term boosts to company performance, and the more attractive stocks are those that can compound earnings growth over the long run thanks to innovation.
BGFD’s shares trade on a wide Discount to NAV of 10.8% at the time of writing.
A number of environmental factors seem to be turning in BGFD’s favour. Japanese inflation has come down over the past year, meaning that rising rates in the country seem less likely, while rates in other developed markets are falling. The global GDP outlook has slowed, meaning that company-level earnings growth is arguably more attractive, while technology has reemerged as the main driver of productivity growth and innovation in stock markets. However, we think the most encouraging developments over the past year are at the stock level, with some of BGFD’s largest and longest-held positions performing well operationally and in share price terms, having weighed on performance in 2022 and early 2023. Given how active BGFD is versus the index, and that it is relatively concentrated at the top of the portfolio, single stock factors are important to the outlook. In that light, SoftBank’s return to form and heavy investment in the AI industry is particularly promising.
We think there are clear signs that a period of poor performance is over, and the trust has the potential to perform very well again in the future, while the shares trade on a wide discount. That said, BGFD is clearly a risky proposition due to its strong style bias, active nature, and significant gearing, and we think investors should consider these risks carefully.
Bull
- Strong long-term track record
- Highly active approach which brings outperformance potential
- Low OCF relative to peers
Bear
- Active share increases underperformance potential as well as outperformance
- Gearing can amplify losses on the downside and volatility
- Economic conditions could lead to the growth style remaining out of favour