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Kepler Trust Intelligence
Updated 18 May 2021
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by JPMorgan Japan Small Cap Growth & Income. 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.

Investing for income is a common goal among UK investors. In a country known for its status as a dividend haven, generating income from investments in stocks comes naturally.

Traditionally, most UK investors have turned to funds focused on well-known UK dividend-paying stocks, such as BT, Associated British Foods and Royal Dutch Shell. However, an increasingly concentrated number of FTSE 100 companies have been responsible for the vast majority of its dividend pay outs. In December 2019, prior to the pandemic, ten stocks alone accounted for 50% of the FTSE All Share Index’s yield.

The risks of this concentration were laid bare in 2020. According to the LINK Group’s dividend report published in the first quarter of 2021, UK companies cut their dividends by 44% between the second and fourth quarters of 2020. LINK has now warned investors that UK dividends are unlikely to recover to 2019 levels for another four years.

At the same time, these companies offer very limited growth for their investors. Combined, all of this has demonstrated the risk of being too focused on the UK and on its larger-cap companies when hunting for income. By looking further afield, investors could find diversified sources of income – and more opportunity for growth.

Welcome to Japan

One market less known for income generation is the Japanese stock market, with its smaller companies in particular providing very little income. True, the majority of the companies operating in Japan would be classified as ‘growth’ stocks. Yet, the unique nature of the investment trust structure means that Japan-focused investment trusts, such as JPMorgan Japan Small Cap Growth & Income (JSGI), can offer investors an income alongside tapping into this growth.  

Investment trusts are able to pay any proportion of their income from capital. This means using some of the capital profits from their investments to bolster their own dividend pay outs to investors, rather than relying on the dividends received from their underlying investments.

In practice, for JSGI this enables the management team, Eiji Saito, Naohiro Ozawa and Michiko Sakai, to access the best of the growth opportunities in a growth-oriented market, while still offering investors a yield – in this trust’s case a dividend equivalent to 1% of NAV at the end of each quarter, which in recent times has made it the highest yielding trust in both the AIC Japan and AIC Japanese Smaller Companies sectors.

While sourcing such an income is usually associated with forgoing growth, this is not the case for JSGI, which is the second-highest performing AIC Japanese Smaller Companies trust over one, five and ten years. This strong performance is the result of an unconstrained investment approach, which allows the managers to look at the full spectrum of Japanese companies (bar, of course, its largest 200 companies) to find interesting investment opportunities.

Buying the future

One key aspect of JSGI’s investment process is its focus on holding stocks for a long time. Indeed, at the point of purchase, the team value stocks on the basis of their five-year projection for returns, a valuable time horizon for smaller companies that may take some time to build momentum in their markets.

One trend to which this time horizon certainly applies is the growing role of sustainability in Japan. Japan’s sustainability track record has been gradually improving recently. The country has long led the way in terms of recycling and producing environmentally efficient cars – the Toyota Prius was one of the most widely-adopted early hybrid vehicles globally. However, some industries have lagged behind their peers in other markets.

In 2019, 97% of Japan’s companies reported sustainability initiatives, according to a study by KPMG Azsa. Eiji and his team believe that this is reflective of the tide turning in Japan towards a more uniform commitment to sustainability.

As a result, they have recently added companies such as Nittoku, which provides wiring for electric vehicles, and Iriso Electronics, which provides connectors for the same subsector. Equivalent companies listed in the US and UK are currently sitting at very elevated valuations, demonstrating another benefit of diversifying a portfolio into new markets: accessing equivalent technologies at a more attractive price.  

The investment trust structure enables investors to source an income in markets where this is not the norm – without missing out on the growth these markets can offer. By looking to new markets like Japan as a source of income, UK investors should mitigate some of the risks of being overexposed to UK dividend payers. With a trust like JSGI paying c. 4% of NAV as income annually, investors need not sacrifice their income goals in a bid to access diversified, differentiated opportunities.

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