Fidelity Japan 28 February 2024

Nicholas Price has managed the Fidelity Japan Trust (FJV) since September 2015, consistently employing a GARP (growth at a reasonable price) approach. He targets companies with steady earnings growth, but whose shares can be bought at a lower price than the earnings potential suggests they should be, essentially aiming to capitalise when the market is mispricing growth (see Portfolio).

A key aspect of Nicholas’ strategy is focusing on small and mid-cap growth businesses, which he believes are often overlooked and under-researched. He targets those which have the potential for significant growth over time, favouring businesses in which he can see material change that has not yet been incorporated into the stock price, such as a shift in the company’s operating environment or general market sentiment. Over FJV’s latest financial year ending December 2023, several mid-cap names, such as Harmonic Drive Systems and Taiyo Yuden, were added to the portfolio due to attractive valuations on a trough-to-peak view and strong mid-term growth prospects. Additionally, Nicholas invests in unlisted companies, accounting for roughly 6% of the portfolio, with notable changes over the year including Innophys, which was redeemed via a share repurchase, and a new investment in taxi app company GO Inc.

FJV’s allocation to small and mid-cap growth businesses hindered performance at times, particularly during periods of significant outperformance of value over growth stocks. However, Nicholas argues these businesses offer stronger alpha potential compared to their larger counterparts and have proven integral to FJV’s long-term outperformance of the TOPIX under his tenure (see Performance). Moving forward, he sees several potential catalysts for a pickup in performance over 2024, including the governance reforms spreading out through the small and mid-cap companies he invests in.

FJV’s Discount is currently wider than its own five-year average, trading at 11.3%.

A distinct part of Nicholas’ strategy is exposure to small and mid-cap growth businesses. He points out that only a fraction of the c. 3,800 Japanese companies are well covered by sell-side analysts meaning there are plenty of lesser-known businesses that hold significant long-term growth potential. Being locally based and fluent in Japanese, along with the support from a team of dedicated analysts in Japan (see Management), provides Nicholas valuable insight into company management and the domestic market, an advantage in stock selection in our view. We also think this bolsters his expertise in unlisted companies. Whilst only a small portion of the trust, we think exposure to this part of the market gives the team a greater view of emerging trends and competitors than other peers in the Japan sector, bringing high return potential and a differentiated source of returns to the table (see Portfolio).

Whilst these exposures have driven strong returns versus the index at times, they also entail risks, including heightened sensitivity to domestic factors, style rotations, and the nature of some unlisted businesses which have higher failure rates. That said, the reverse is also true and when in vogue contribute well to returns, as evidenced by Osaka Soda’s recent run of Performance.

We think this is a higher-risk, higher-reward strategy that benefits from the steady hand of a longstanding manager who has been tested through multiple market cycles. The outlook for Japan moving forward is one of optimism driven by the emergence from a deflationary environment and the positive impact of corporate governance reforms. We believe Nicholas’ focus on small- and mid-cap growth stocks, exposure to unlisted companies, and consistent levels of Gearing, position the trust to capitalise on these changes. Combined with a double-digit Discount which is wider than its own five-year average, we think this also presents a compelling opportunity for investors seeking exposure to the under-researched world of Japanese equities.