David Kimberley
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Updated 08 Mar 2024
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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.

Japan’s stock market has proven to be one of the few bright spots for investors over the last couple of years. Given there is often some scepticism regarding the country’s economic prospects, that may come as something of a surprise to some investors.

But the reality is Japan’s stock market has delivered strong performance over the last decade.

In fact, the last two years seem to have been more the result of investors realising that and the potential the country offers. That Warren Buffett has taken several large positions in firms based in the country has probably helped improved sentiment as well.

However, investing in Japan directly isn’t a straightforward process for UK investors. That’s why investment trusts are arguably a superior means by which to do so.

Investing in Japan

Before looking at why that’s the case, it’s worth examining why Japan has reemerged as an attractive place to invest.

For a long time the country was viewed as being stuck in the doldrums. Partly that’s due to the country’s demography and its knock-on effect on the economy.

Japan has a famously low birth rate and shrinking population. The country’s GDP, which is lower today than it was almost three decades ago, provides a simple illustration of the problems that has led to.

Investors have also been wary of Japan because of the asset bubbles the country experienced in the 1980s. Real estate and stock market valuations soared to eye watering levels, largely based on overly optimistic views about Japan’s future prospects.

The bursting of these bubbles in the late 1980s and early 1990s had a long-lasting impact. The Nikkei 225, a Japanese stock market index, has only just reached the same all time high it was trading at in 1989.

Finally, Japanese corporate governance standards meant that many firms would retain earnings but not reinvest or pay dividends. They also had cross-holdings designed to prevent corporate takeovers and reduce the influence of ‘outsider’ shareholders.

What has changed?

Despite these problems, many of which were more sentiment-driven, Japan has still been a good place to invest long-term.

For example, in the decade up until the end of January 2024, the Tokyo Stock Price Index (TOPIX) delivered annualised total returns, in sterling terms, of just under 9%. This was behind the S&P 500 but ahead of comparable UK, European, Asia ex-Japan, and emerging market indices.

In part that’s because the last decade has seen a slow shift in both sentiment towards Japan and regulatory changes that have strongly impacted corporate governance standards.

With regard to the former, Japan is a world leader in many industries and even if its domestic economy has problems, that doesn’t mean publicly-traded companies can’t deliver growth globally.

For example, about half of the world’s industrial robots are produced in the country. As you might expect given that stat, the country is a global leader in robotics and automation systems.

Other publicly-traded companies share that role in their respective fields and have continued to deliver impressive growth over the last two decades.

Sony and Nintendo, for example, are both among the 10 largest video game companies in the world by revenues. Similarly, Uniqlo’s parent company Fast Retailing has delivered share price returns and earnings growth over the last decade that would not look out of place among the US tech giants.

As noted, there have also been numerous changes to Japan’s corporate governance standards since former prime minister Shinzo Abe assumed power in 2013.

These have often been enforced indirectly via reforms to stock market listing rules. They typically mean that a company wanting to achieve a top-tier ‘Prime’ listing on the Tokyo Stock Exchange must adhere to a number of new rules.

For example, companies must have independent board directors if they want ‘Prime’ status. The result has been that over 90% of companies listed on the Tokyo Stock Exchange now have independent directors, up from only 6.4% when reforms were introduced in 2014.

Similarly, companies must now declare cross-shareholdings and annually assess whether they are appropriate. Another significant rule change requires firms trading below book value to make reforms that will increase that amount and disclose what those are publicly. Failure to do so means losing a prime rating or even delisting.

The goal here is to encourage firms that often sit on large cash piles to either reinvest that money or return it to shareholders via dividends and/or share buybacks. This has already borne fruit. For example, watch manufacturer and designer Citizen Watch bought back almost a quarter of its outstanding shares in early 2023 in response to these reforms.

Why it’s hard to invest directly in Japanese stocks

Any UK investor who finds these stats appealing and is looking at how to invest in Japanese stocks may realise it’s trickier than accessing some other foreign markets, like Europe or the US.

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 limiting their offering to large caps.

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, although this is changing.

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 directly.

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 actively managed, with a portfolio manager, perhaps backed by 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 be selective. 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 closed-ended nature, 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 (CCJI)

Company: Chikara Investments LLP

Launched: December 2015

Manager: Richard Aston

Ongoing charges: 1.06%

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 consider CC Japan Income & Growth (CCJI). Launched in 2015 by Chikara Investments, a specialist asset manager focused on Asia and emerging markets, 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 uses gearing to enhance returns. This is achieved by using contracts for difference (CFDs) and an overdraft facility.

CCJI has managed to outperform its benchmark since launch. 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 aims to deliver a total return to shareholders by investing in Japanese equities. The investment trust places a strong emphasis on generating income as well as providing capital growth.

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. This investment trust is 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?

CCJI is managed for total return and can be described as a ‘core’ strategy. Income and capital growth are both important goals for the investment trust. 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. As at 31/01/2024, the trust held 40 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, CCJI 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 1.06%.

7) Does the investment trust have performance fees?

CCJI 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. As at 31/01/2024 the active share of its portfolio was 80.4%. 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.

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