Updated 21 Jan 2022
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by CC Japan Income & Growth. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Back in 1988, in the midst of Japan’s meteoric economic growth, American political commentator Paul Harvey complained the US was facing an “economic Pearl Harbour” from its ostensible ally across the Pacific.

His comments reflected a widespread fear that Asia’s then-largest economy would soon surpass the US as the world’s wealthiest nation and emerge as a global superpower.

As most investors today know, that didn’t happen. A crash in asset prices started only a couple of years after Harvey made his hyperbolic claims and Japan has not been in a position to challenge the United States’ hegemony since.

Japan’s GDP remains lower than it was in 1995 and the TOPIX, an index of companies on the Tokyo Stock Exchange, is below the all-time high it hit in 1989, with the country’s ageing population and high level of public debt continuing to weigh on investors’ enthusiasm for the country’s stocks.

It’s not (just) the economy, stupid…

But just as markets were overly optimistic about Japan’s prospects 30 years ago, the tendency to see things through the prism of its subsequent macroeconomic profile means investors can end up missing out on the opportunities that Japanese equities may offer.

In sterling terms, the TOPIX delivered compound annual returns of just under 10% in the decade up to January 2022. Aside from the S&P 500, not many indices produced these sorts of returns over the same period.

Several factors likely contributed to that stellar performance. On a simple level, Japanese stocks had been pushed down to low valuations, which some investors clearly believed didn’t reflect their true worth.

There was also a change in attitude following Shinzo Abe’s election in 2012, with the former prime minister’s economic reform program, ‘Abenomics’, encouraging firms to raise profitability and resulting in regulatory reforms that allowed shareholders to put greater pressure on management when seeking changes in company policy.

Most notably, businesses were encouraged to appoint independent directors to their boards and there was a greater focus on delivering strong return on equity to shareholders.

What does the Japanese market look like?

Japan’s stock market gives investors access to a broad range of sectors. The TOPIX contains companies in everything from fishing and ceramics to financial services and shipbuilding.
Semiconductor producer Tokyo Electron, Uniqlo owner Fast Retailing, and investment group Softbank, provide simple examples of the firms available to investors.
The Japanese economy remains heavily tied to the US and China, with the latter being both the biggest source of its imports and exports. But other East Asian economies, such as Taiwan, South Korea, and Thailand, are still major trade partners. Of course, listed companies in Japan also have substantial exposure to the domestic economy as well.

The strong ties to the US and China mean that Japanese stocks have tended to experience the same sort of major shocks that listed companies in those countries have experienced over the past couple of decades.
Having said that, Japan’s economy has far greater ties to East Asia than the UK or US does, making it a diversifier for investors looking to have exposure outside of those regions.

Why it’s hard to invest directly in Japanese stocks

Anyone who finds these stats appealing and is looking at how to invest in Japanese stocks may realise it’s a little trickier than accessing other markets outside the UK.

A basic problem is many investment platforms simply don’t offer access to Japanese equities. Those that do often have large minimum order sizes and hefty dealing fees, as well as a fairly small selection of stocks.

Aside from these hurdles, individual investors also have to contend with some of the idiosyncrasies of Japanese corporate life.

About half of small and mid-cap Japanese stocks have one or no analyst covering them. Compounding this is the fact that many of these companies don’t release financial reports or trading updates in English.

Along with a dearth of third-party English-language information, this makes it difficult to evaluate prospective investments. Active investors are thus left with something of an uphill battle if they want to invest in Japanese stocks.

Why investment trusts can be the best way to get exposure to Japan

Japan-focused investment trusts provide a way around these problems. As London-listed funds, they’re easily accessible to individual investors but still provide exposure to Japanese shares, without any outsized dealing fees or high minimum order sizes.

They are also likely to have a team of equity analysts with strong expert knowledge. This arguably means they’re better able to capture the nuances of the local market and identify promising investment opportunities than an individual struggling to run a company’s Q1 results through Google translate.

And that points to another strength, which is that investment trusts can take an active approach to the market. Like any other country, Japan has companies from a range of sectors that offer opportunities to both value and growth investors.

Investment trusts can take a broad or more refined approach to this by focusing on a particular area of the market. Their smaller size, along with that local expertise, also means they can move down the market cap scale to get exposure to companies that large funds may be unable to touch.

Case study: CC Japan Income & Growth

Company: Coupland Cardiff Asset Management LLP (Coupland Cardiff)

Launched: December 2015

Manager: Richard Aston

Ongoing charges: 1.04%1

Investment policy: The investment trust aims to provide investors with dividend income and capital growth via investment in Japanese equities.

Comparative Index: TOPIX

Investors looking for exposure to Japanese equities may want to consider CC Japan Income & Growth (CCJI). Launched in 2015 by Coupland Cardiff, a specialist asset manager focused on Asia, the investment trust aims to deliver income and capital growth to shareholders by investing in Japanese equities.

CCJI tends to invest in three different sets of companies. There are those that look capable of paying a growing dividend, others that can pay a consistent dividend above the market average, and, lastly, companies that look like they’re undergoing a turnaround in attitude towards shareholders.

The investment trust does use gearing to enhance returns. It may also invest up to 20% of its assets in exchange-traded funds to gain exposure to certain companies.

Historically, CCJI has managed to outperform its benchmark, although there have been some periods of relative underperformance. Despite this, the investment trust has often traded at a discount to its net asset value.

1) What is the investment trust’s goal?

CCJI places a strong emphasis on delivering income to shareholders by investing in Japanese equities, though it also aims to provide capital growth as well.

2) What kind of stocks do the managers like?

CCJI’s investment process is driven more by the income and growth opportunities a company provides, as opposed to a particular macroeconomic theme or belief in a certain sector. The investment trust is diversified across a range of industries as a result, with no one sector holding sway over the portfolio. The investment trust is also prohibited from having one stock make up more than 10% of its holdings.

The bulk of the portfolio is made up of companies that have demonstrated consistent growth in their dividend payment over time. The remainder of the portfolio is allocated to stocks paying a stable yield above the market average and to companies undergoing some form of turnaround – acting as a catalyst for a change in dividend policy.

3) Are investment decisions driven by a particular investment style?

Income remains the core goal of CCJI but this is also balanced against capital growth. As a result, portfolio manager Richard Aston tends to sift through thousands of companies in order to find those that can provide some assurance of paying income to shareholders but which still offer growth potential to investors. The need to balance these factors means there is typically only a small set of companies that the investment trust managers are happy to invest in.

4) How many stocks does the investment trust typically hold?

CCJI usually holds a relatively small number of stocks compared to other trusts. At the time of writing the trust holds 42 stocks. This number is not fixed and can change over time but it is typically between 30 and 40 stocks.

5) What is the investment trust’s dividend policy?

Although the investment trust is focused on providing income to shareholders, it does not have a specific yield target. At the time of writing, it has, however, managed to increase dividend payments to shareholders every year since inception. This is not a guarantee of future returns.

6) What are the investment trust’s ongoing charges?

The investment trust’s ongoing charges are 1.04%.

7) Does the investment trust have performance fees?

The investment trust does not have performance fees.

8) How much attention do the managers pay to the index, and to what extent are absolute returns important?

The investment trust is not restrained in any way by the index and does not make investment decisions based on it.

9) How much does the investment trust deviate from the index?

The investment trust tends to deviate strongly from the index as it looks for opportunities outside of the larger stocks found within it. At the end of November 2021 the active share of its portfolio was 82%. This approach has paid off as CCJI has historically outperformed the index.

10) Does the investment trust use gearing and if so is it structural or opportunity led?

CCJI uses structural gearing to enhance growth and income opportunities in the portfolio. Gearing is undertaken through long only contracts for difference (‘CFDs’) and equity swaps.

The Japanese investment trust sector

At the time of writing (November 2021) there are 11 investment trusts focused specifically on Japan. Six of these cover larger quoted companies and the remaining five invest more in small-cap stocks.

Across both sectors, ongoing charges range from 0.62% to 1.58%. Investors should also be aware of the currency risks they can be exposed to given that the investment trusts’ underlying assets are denominated in Yen, not sterling.

The investment trusts are also managed in different ways. For instance, Baillie Gifford runs two Japan-focused investment trusts from its Edinburgh headquarters with no full time ‘desk presence’ in Japan itself, whereas Schroders operates its Japan Growth fund using a fund manager based in London and a team of local analysts in Japan.

There are also stylistic differences across both the small-cap and large-cap focused investment trusts. Fidelity’s Japan Trust, for example, takes a very growth-oriented approach to the market. In contrast, the CC Japan Growth & Income Trust places a much greater emphasis on delivering income to shareholders.

A similar mix of management practices and investment styles exists in the open-ended fund space. Japanese focused investment trusts have, however, historically outperformed their open-ended peers.

Over the past decade2, shares in large-cap and small-cap focused Japanese investment trusts have delivered total returns of 340.6% and 336.8% respectively. Open-ended funds delivered returns of 173.3% and 261.6% during the same period.

That may be the result of structural benefits that investment trusts have. Open-ended funds typically hold more cash than investment trusts as they need to ensure they can remain liquid enough to meet redemption requests, which acts as a drag on performance.

Redemptions also tend to hit open-ended funds when a fund isn’t performing well. Conversely, investment trusts have a closed pool of capital, meaning they are arguably better able to ride out rough patches in the market.

Investment trusts can also use gearing - borrowed money - to enhance returns, although this can also lead to greater losses if markets move against them.

1 Source: Morningstar as at 18/01/2022

2 Past performance is not a reliable indicator of future returns. Source: FE, 29 November 2011 - 29 November 2021
Basis: bid-bid in GBP share price terms.

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