AVI Japan Opportunity (AJOT) offers investors a highly differentiated approach to Japanese small-cap investing. The management team led by Joe Bauernfreund aim to generate long-term performance through a portfolio of high-quality companies bought at attractive valuations. What sets AJOT apart is the strategy of active engagement, whereby the managers target companies with inefficient balance sheets and corporate structures in an attempt to convince management to address those issues and increase shareholder returns as a result.
Company management has proved very responsive since AJOT launched thanks to a strong regulatory and political push towards improving corporate governance in Japan, which forms the third arrow of ‘Abenomics’. While COVID-19 delayed some of AJOT’s engagement plans, 2021 looks to be a promising year with the advent of major policy change to both governance codes and index construction. The team have already prepared numerous engagement campaigns, with 11 of their 27 holdings already in the pipeline for some form of active engagement over the year. In order to be sufficiently resourced to deal with the volume of work, the AJOT team have been significantly expanded with the inclusion of four new Japanese-speaking team members.
AJOT’s performance has been in line with its benchmark since its inception in 2018, despite its value-tilted approach being out of favour and the turmoil in markets due to the pandemic. However, on a fundamental level the portfolio remains strong, with the team reporting a V-shaped recovery in sales and profits while the portfolio trades on a highly attractive 4.5x EV/EBIT valuation. With the dichotomy between price and fundamentals, coupled with an active upcoming AGM season, the team are increasingly bullish going into 2021. AJOT trades on a 0.6% premium to NAV.
Joe and the team at AVI have identified a clear and differentiated source of alpha in the push for corporate governance reform in Japan. When the trust was launched in late 2018 some may have doubted that the reforms would bear fruit but events have validated the thesis, with plenty of activist ‘wins’ in the AJOT portfolio and in the broader Japanese market, and a growing recognition by other investors of the opportunity.
We think the incoming policy changes to Japan’s corporate governance code and index construction (see the Portfolio section) show that the opportunity has not passed and that 2021 is likely to present new opportunities. While AJOT has underperformed in the aftermath of the pandemic, its large pipeline of engagement activity for the coming year indicates that there is plenty of scope for it to generate outperformance in a more normalised, post-pandemic environment.
AJOT also offers one of the few true value propositions in a region so often dominated by growth-focussed strategies. We agree with the notion that AJOT has substantial optionality in it, whereby its portfolio of high-quality companies are in unto themselves attractive business opportunities and so therefore the team’s active engagement is a mechanism through which AJOT offers substantial alpha potential rather than it being the predominant source of return.
We think the differentiated source of alpha the trust offers is likely why AJOT continues to trade on a slight premium, as it has for most of the time since it was launched.
|Potential for increased shareholder returns through corporate governance reforms
||Lower exposure to broader tech-related growth trends in Japan
|Unique, highly active approach to investing
||Gearing can exacerbate losses during a market rout
|Underlying portfolio has shown great resilience in sales and profits during COVID-19 crisis
||Possibility that engagement campaigns may not succeed