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Thomas McMahon
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Updated 02 Oct 2023
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Schroder Japan. 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.

  • Schroder Japan Trust (SJG) has reported strong absolute and relative returns for the year ending 31/07/2023, with a NAV total return of 11.7%, well ahead of the 9.4% total return of the benchmark. The share price total return was 18.7%, as the discount narrowed. It was the third consecutive year the trust has outperformed the Topix Index benchmark.
  • The trust is therefore substantially ahead of its tender performance target. This is to outperform the index by 2% a year over the four years from 01/08/2020. With one year left, the manager has delivered c. 4% of annualised outperformance so far.
  • During the year, the trust’s name was changed, with the board dropping ‘Growth’ in order to ‘reflect more accurately the investment approach of the manager’.
  • Manager Masaki Taketsume’s investment strategy sees him place importance on valuation, and this was helpful during the year as value outperformed growth in Japan. There were strong returns from financials and some idiosyncratic stories where the manager identified short-term over-reaction in strong companies. Gearing also contributed positively to returns during the year.
  • In order to lower the costs of gearing, the board is asking for shareholder approval to allow the manager to use contracts for difference in addition to bank borrowings.
  • Revenue during the year increased from 4.97p to 5.41p per share, allowing the board to declare a final dividend for the year of 5.40p per share, representing an increase of 10% over the final dividend paid in 2022. At the time of writing, this would amount to a yield of 2.3% on the current share price.
  • Chairman of the board Philip Kay said: “My fellow directors and I continue to be excited about the company’s prospects, because we see two major developments which should continue to drive equity performance over the medium to long term. Firstly, corporate governance and stock market reforms in recent years have stimulated a tectonic shift in the attitude of many Japanese companies towards improving returns for shareholders. Secondly, the reappearance of inflation could signal the end of the deflationary spiral which has, for example, constrained consumer spending in Japan over the last two decades. ... Against this macroeconomic background, there remain significant opportunities for our high conviction, bottom-up strategy to identify and exploit market opportunities and drive positive relative performance.”

These are excellent results from Schroder Japan Trust (SJG) which show shareholders have been rewarded for remaining invested while sentiment towards the global economy has been negative. To some extent the trust’s sturdy total returns reflect that Japan has been at a different point in the cycle from its developed world peers. It only lifted its last pandemic-era restrictions in Q4 2022, and so there has been a rise in domestic economic activity and tourism in 2023, with the end of China’s zero-COVID policy late last year also providing visitors and demand for goods and services. This is one of the reasons for growing investor interest in the country this year.

However, we think the more important, and potentially longer-term, reason is the one highlighted by the chairman in his comments: corporate governance reform is only gathering pace and momentum, and encouraging more efficient use of cash in Japanese businesses, either to generate growth or to distribute to shareholders. We think this could lead to the valuation gap Japanese equities trade on versus their international peers to close, which means opportunity at the index level. Crucially, it is also creating great opportunity at the stock-specific level, rewarding investors with a local presence (like Schroders) who can identify those company management teams committed to significant change that can lead to individual stock re-ratings.

Masaki’s strategy is to find high quality companies whose value is not reflected in the current share price. Returns over the last year show how this can generate returns from multiple sources. Financial positions performed well as Japan inched towards tightening monetary policy, raising the possibility it would escape the deflationary environment which has limited economic growth over many years. More interesting are the idiosyncratic positions such as Ibiden. Ibiden is a small cap electronic component manufacturer whose products are critical for CPUs and GPUs. Masaki built a position last year on weakness and was rewarded this year when AI-linked stocks rallied sharply. Similarly Disco Corporation has a strong market share in providing equipment for integrated circuit packaging, used in the semi-conductor industry. It also contributed strongly to returns over the period. We think these examples illustrate Japan has many interesting technology companies flying under the radar of most global investors.

We think it is intriguing to note that Japanese equities remain cheaper than many international peers while there are many companies trading below book value, even though the Topix hit all-time highs over the year in question. An example of the latter is mid-cap Mitsui Chemicals, which Masaki bought for Schroder Japan Trust in the 2023 financial year. Management have a plan to transform the company operationally which has seen it deliver resilient earnings even as demand slows, Masaki arguing that this indicates the transformation is already bearing fruit and this has not been reflected in the share price.

All told, low valuations, a cyclical boost from the reopening and the long-term trend of improved corporate governance create an exciting environment to be investing in Japan, and in our view Schroder Japan Trust has shown its valuation-sensitive stock-picking strategy has the potential to add value in such an environment.

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