Results analysis: JPMorgan Japan Small Cap Growth & Income

• JPMorgan Japan Small Cap Growth and Income (JSGI) has reported its final results the year ending 31 March 2021. Over that period JSGI generated a NAV total return of 42.4% and a share price return of 47.9%, beating the 21.7% return of its benchmark, the S&P Japan Small Cap Net Return Index.
  
  
• JSGI continues to offer investors a competitive yield despite investing in a portfolio of Japanese small caps, which are not traditionally hunting grounds for income investors. This is due to the board’s policy of paying out 1% of its NAV each quarter, from capital if necessary. JSGI currently has a dividend yield of 4.3% (as of 17/06/2021).
  
  
• While the pandemic has brought about a number of challenges, JSGI’s focus on quality growth has allowed it to generate very competitive returns, helped by the strong performance over the first half of its financial year. JSGI’s team also make heavy use of thematic investing, often capitalizing on the themes underpinning ‘New Japan’. We think this means JSGI continues to offer a compelling long-term story.
  
  
• Over the financial year JSGI’s discount continued to narrow, from 11.9% to 8.7%. We believe this is the result of not just JSGI’s impressive performance but also the rare combination of small-cap quality growth investing and a strong yield, which offers a rare source of diversification to income investors. JSGI currently trades on around a 5.0% discount.

Kepler View

While Japan has been able to avoid the worst of the pandemic it has still been caught up in the broader swings of the global equity market. However, over its financial year (ending 31 March 2021), JPMorgan Japan Small Cap Growth and Income (JSGI) has been able to deliver enviable returns. JSGI has generated a 12 month NAV total return of 42.4%, and a share price return of 47.9%, far in excess of the 24.4% of its benchmark, the S&P Japan Small Cap Net Return Index.

JSGI’s performance also stacks up well against Japanese large caps, with the TOPIX having returned 22.3% over the 12 months, and broader global equities, with the MSCI ACWI returning 38.9%. While JSGI’s total return is certainly impressive we believe that of equal, if not greater, importance is JSGI’s income profile. The trust pays a quarterly dividend equal to 1% of the NAV at the end of the previous quarter, out of capital if necessary, meaning  JSGI offers the rare combination of Japanese small cap exposure and a competitive yield and making it a source of potential diversification for income seeking investors. It should be noted the JSGI was geared through its entire financial year, in a range from 6.1% to 10.4%, which was an overall positive contributor to performance. JSGI currently has an 8.6% level of net gearing.

The three strong team behind JSGI, Eiji Saito, Naohiro Ozawa and Michiko Sakai, follow a process which has a clear focus on identifying the best quality growth opportunities within Japan; companies which are characterized by their higher return on equity and earnings growth than the market, albeit commanding a higher premium. Stock selection has been the primary contributor to the financial year returns, but beyond bottom up the team rely heavily on their understanding of the trends underpinning Japan economy, often focussing on companies exposed to the ‘New Japan’. Given the nature of quality growth stocks over the last 12 months, much of JSGI’s return came in the first half of its financial year, a period which heavily favoured quality and growth factors above all others; as investors placed a premium on strong companies which could maintain their growth trajectories during the pandemic.

These themes encompass a broad range of topics, including Japan’s digital transformation, changing demographics, corporate governance reforms and de-carbonisation. These are all themes with room to run and in our view this means that even though JSGI has been able to generate attractive short-term returns, it retains a clear trajectory for future growth.

The pandemic has ultimately done little to impact the strategy of the team, given their discipled long-term view to investing. It may have, if anything, accelerated the adoption of these themes by encouraging greater use of technology, improved productivity and corporate consolidation. The team remark that Japan’s recent signing of the Regional Comprehensive Economic Partnership in November 2020 may enhance the opportunities within their ‘overseas demand’ theme, as it lowers the tariffs Japan faces when trading with the Asia-Pacific region, which represents 30% of both global population and GDP.

While the near term market environment remains one of uncertainty, as the clear ‘winners’ of the pandemic recovery become harder to identify and Japan lags behind its developed peers in the vaccine rollout, the JSGI team remain unruffled. They believe that Japan remains determined to achieve its long-term goals; sustainable and broad-based growth driven by digitalisation, improving corporate governance and increased access to free trade. Ultimately the team’s long-term approach to thematic investing means they should be undeterred by near-term noise. This long-term approach to investing, coupled with the trust’s attractive income, has been increasingly rewarded by the market, as over the financial year JSGI’s discount narrowed from 11.9% to 8.7%, with JSGI currently trading on around a 5.0% discount (as at 17/06/2021) and we would not be surprised to see this interest in the trust sustained.

The trust’s appeal as a long term play for investors seeking well managed exposure to the growth generated by Japanese smaller companies, with the benefit of a differentiated yield, remains clear.

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