JPMorgan Japan Small Cap Growth & Income 05 February 2020

JPMorgan Japan Smaller Companies Trust (JPS) looks to deliver capital growth through investment in small and mid-cap Japanese companies, excluding the largest 200 Japanese companies by market capitalisation. The investment managers, Eiji Saito, Naohiro Ozawa and Michiko Sakai, seek to identify the best growth opportunities in high-quality companies within the Japanese market.

Since April 2018, it has been a policy of the trust’s board to distribute dividends totalling 1% of NAV (as measured at the end of the quarter) on a quarterly basis. This was instituted to broaden the trust’s appeal to investors seeking yield, with the view that this will ultimately help the share price trade closer to NAV.

Importantly, this change does not impact the investment strategy of the trust, which has historically delivered outperformance of the benchmark. This strategy follows the stock-analysis framework of the wider JPMorgan Japanese equity team, a well-resourced and deep pool of analysts and portfolio managers based in Japan.

With a wide pool of under-researched stocks amongst the roughly 4,000 listed companies in Japan, the managers believe this level of resource gives them an advantage in identifying market pricing inefficiencies. The process seeks the best growth opportunities available in the Japanese small-cap market, places emphasis on understanding management strategy and the operational environment of the underlying business, and incorporates certain thematic considerations around the Japanese economy and market.

As at 30/01/2020, JPS’s shares traded on a discount to NAV of c. 6.0%; as a result of the new dividend policy, they yield c. 4.3%.

The Japanese small- and mid-cap markets offer a plethora of companies with little or no broker research, increasing the likelihood of pricing inefficiencies and potential stock-picking opportunities. Coupled with the ongoing positive effect of gradual adjustments to corporate governance, in our view this gives significant opportunities to active managers seeking to generate long-term outperformance from Japanese small and mid-caps. We think the highly active portfolio within JPS, with high differentiation from the benchmark index, improves the chances of stock-picking materially benefitting performance.

These are all attractive attributes from a relative returns outlook. However, the discount has remained somewhat intractable over the long term, and it remains to be seen whether the new dividend policy will entice sufficient interest to alleviate this. Whilst the portfolio has strong, long-term structural drivers, the unashamed growth nature of the portfolio means it is likely to be negatively impacted at periods of market inflection or reversal, exacerbating downside risks. Japanese companies are generally perceived to carry greater exposure to the global economic cycle.

This notwithstanding, we think the geared exposure to the strong growth credentials of the underlying portfolio, combined with a c. 4% dividend, mean the shares will be attractive to certain investors looking for an active manager in a market which offers significant opportunities to active managers.