AVI Japan Opportunity 02 October 2024

AVI Japan Opportunity (AJOT) has had another successful year as corporate governance reform continues to drive returns in Japan, while AJOT’s constructivist approach has also borne fruit. The trust’s strategy is designed to capitalise on a concerted effort by Japanese authorities to push companies to improve shareholder returns. A series of reforms have increased pressure on company management teams to boost their valuations and return on equity, as well as to release excess cash and investment securities held on the balance sheet.

As we discuss under Performance, AJOT has consistently had success with its approach since its 2018 launch. Last year, 2023, was particularly strong, and this led to several positions being realised. Manager Joe Bauernfreund and the team have reinvested this cash in a number of small positions, with 12 new additions to the portfolio in 2024, three of which are currently top ten positions. Pleasingly, some of these new ideas are amongst the strongest performers in 2024.

Another common theme in the year has been takeovers, with three portfolio companies being subject to takeover bids and privatised, while a fourth received an unsolicited partial tender offer. The takeover of NC Holdings typifies how the managers have been able to create significant value through taking large positions in small companies and creating the catalyst for unlocking value themselves. The team tell us they see buyouts and privatisations becoming increasingly accepted in Japan. This exciting trend for activist investors illustrates how corporate governance reform continues to revolutionise the Japanese market.

Since inception AJOT has typically traded on a premium and issued new shares, including in 2023 when global markets were weak for much of the year. In 2024, AJOT has slipped onto a discount, which is 1% at the time of writing.

Lots of things in markets are cyclical, but – at least in the short term – government policy is not one of them. The corporate governance reform story in Japan has only become more entrenched over time and is resulting in transformations in the operations, governance and valuations of companies across its markets. The trend only seems to be gathering pace, and with 3,000 smaller Japanese companies still under-researched and overwhelmingly cheap, the outlook for AJOT’s strategy continues to look compelling in our view. While performance has been good in 2024, and even better in yen terms, AJOT has been trading on a small discount in recent months. We think this presents an attractive entry opportunity given the strong outlook and the trust’s history of trading on a premium.

One reason for the discount might be wariness after the market wobble in August, which saw an almost 20% fall in AJOT’s NAV in a couple of days that was almost all immediately regained. This seems to have been a liquidity event, in which investors panic-sold Japanese assets due to currency issues – essentially due to an unwind of the ‘carry trade’, which sees investors borrow in yen and invest in other currencies. The proximal cause of the unwind was the Bank of Japan’s decision to increase its benchmark interest rate, which was made in light of the strength of the Japanese economy amidst sustained inflation and rising wages. This is positive for the outlook for Japanese companies’ earnings. Similarly, if yen rates were to rise, then this should see an inflow of capital into Japan. As such, we think the macro picture is actually improving, with the short-term volatility over the summer a reflection of leverage, complacency and short-termism.