Baillie Gifford Shin Nippon 12 May 2021

Baillie Gifford Shin Nippon (BGS) is a small-cap Japanese equity strategy, giving investors access to rapidly growing companies. Lead by Praveen Kumar, BGS’s strategy is to take a highly active, long-term view to bottom-up investing. This involves identifying companies which are able to either disrupt incumbent industries or offer solutions to many of the problems facing Japan, with many of BGS’s investments being held for over a decade. While the investment process is flexible, as we outline in the Portfolio section, the team places the greatest weight on management quality and sales growth, with investments ideally returning at least 100% over five years.

The team’s strategy has clearly been successful, given BGS’s sector-leading performance. Over the last five years the strategy has generated returns that easily outperform both its benchmark and peers, as we detail in the Performance section. 2020 was also an exceptionally strong year for the trust thanks to the tailwinds from COVID-19, with six of its holdings generating returns of over 100% during the year.

While there have clearly been near-term headwinds for BGS thanks to the vaccine recovery-led rotation into value stocks, the trust’s portfolio is overwhelmingly driven by stock-specific risk, with Praveen commenting that his companies ‘live or die’ on the decisions of their management.

Perhaps thanks to its market-leading return, BGS’s shares have traded at a premium to NAV for the majority of the last five years, and the premium is currently 2.7%. BGS also has the lowest OCF in the sector, thanks to its tiered management fee structure and large market cap. Being a total-return-focussed strategy, BGS does not pay a dividend.

Under the management of Praveen and the wider Japanese equity team, BGS has clearly been successful in delivering an attractive level of total return to its investors, especially when compared to its peers and benchmark. The small-cap space is in fact one of the best sectors for managers to add value, especially in Japan given the acute lack of analyst coverage. The team have taken full advantage of this, as shown by the high alpha generated over the last five years.

While investing in small-cap growth can enhance the risk investors face, we believe that the team’s dedication to identifying the most aggressively growing companies is justified. Thanks to the ample opportunities presented by the demographic and thematic issues facing Japan and the current lack of solutions, even small-cap companies can become market leaders, as has been made evident by some of BGS’s holdings.

We believe that BGS would be an excellent choice for any long-term investor looking to gain exposure to the domestic Japanese economy, or simply for those looking to add diversification to their growth allocation, thanks to the team’s successful approach to small-cap investing and the unique sectoral tailwinds underpinning BGS’s portfolio. A long holding period may be necessary for this strategy, given its enhanced volatility. However, investors with a more cautious risk profile may find BGS unpalatable due to its above-market volatility (although in the past this has been more than compensated for by its returns) and clear growth style bias.