AVI Japan Opportunity 13 April 2023

AVI Japan Opportunity (LON:AJOT) takes an activist approach to investing in a market with some of the most lowly-valued companies in the world. Japanese small caps are under researched and, due to a variety of reasons, often have exceptionally high amounts of cash and low valuations, even when the underlying businesses are operationally strong. AVI, the manager of AJOT, aims to identify those companies in this universe which have high-quality underlying businesses and scope for engagement to rectify undervaluations.

AJOT was launched in late 2018 and has performed very well since, being almost the top-performing of any Japanese trust over this period (see Performance). Returns have been driven by some exceptional single-stock gains, as engagement has been met with action by company management teams and as valuations have expanded.

The management team, led by Joe Bauernfreund, have gradually increased the concentration of the portfolio over the years, aiming to ensure their engagement efforts will have a meaningful impact on NAV when successful, justifying the intensive work they put into each engagement. Engagement is increasingly on the operational side, rather than only focussing on agitating for dividends and buybacks. This shows management teams that AVI is a genuine long-term investor and ensures the returns are potentially even higher over the long run, if operational improvements work alongside valuation uplifts to drive the shares. To the same end, the quality of the portfolio has improved over time. Joe and the team think there is huge upside in many stocks in the portfolio, even for those which have already produced excellent outperformance (see Portfolio).

Joe’s optimism on the opportunity set means that he is comfortable with increasing gearing above current levels (see Gearing), but the trust has been raising cash through issuing shares and recently sold some positions, and the managers are sticking to their discipline of being highly selective regarding new entrants to the portfolio.

We think the fact that AJOT has traded close to, or above, par since launch is testament to the trust being a premium product. It has a clear and differentiated strategy, which has worked just as intended, since launch. The team have shown their ability to generate alpha and their thesis has been proven, as companies in Japan have responded to government and regulatory intervention positively, with a revolution in corporate governance underway.

In our view, AJOT would be a worthy addition to many portfolios, thanks to the differentiated source of returns in a market to which many investors are likely to have little exposure. Additionally, we think it is worth bearing in mind that the good performance, so far, has come during a period in which Japan has been out of favour with foreign investors, small-cap companies have underperformed and the Japanese yen has been weak. However, the outlook for Japan is, arguably, more positive than it has been for some time. Inflation in Japan has been modestly above target and the central bank has gingerly begun to tighten monetary policy. With the potential for the US and other developed countries to loosen later in the year, there is a positive backdrop for the currency. And with Japan having only recently released the last pandemic restriction, there is likely to be a spurt of domestic economic activity. A return of confidence and foreign inflows to Japan could provide further impetus for good AJOT returns.