“The Japanese small-cap market is a rich hunting ground for entrepreneurial companies,” says Shinji Higaki, portfolio manager of the Fidelity Japanese Values investment trust.
“And yet, research coverage remains patchy. This means that a lot of growth opportunities have yet to be reflected in share prices.”
The trust seeks to provide investors with exposure to fast-growing Japanese mid and smaller companies that will generate significant returns over the long term. It aims to outperform its benchmark, the Russell/Nomura Mid Small Cap index. Mr Higaki focuses on first-hand, detailed analysis of corporate fundamentals and builds the portfolio through bottom-up stock selection, taking account of market trends, but not being driven by them. To generate investment ideas, Mr Higaki draws on Fidelity’s internal research and external brokers. Company visits, he says, are “a critical element of the investment process to uncover under-researched, undervalued stocks”.
In 2013, the portfolio maintained a balance between domestic consumer services and pro-cyclical manufacturers. As the market rallied, the manager trimmed positions where share price valuations had already discounted foreseeable growth and recycled into new stocks with reasonable valuations. The portfolio remains underweight in low-growth, defensive stocks in food, power utilities, pharmaceuticals and railway sectors.
In consumer services, the manager has retained relatively large overweight positions in internet-based service companies, such as M3 and Kakaku.com. Business models that have been added include solar power integration, leisure & entertainment and recruitment.
The manager added Sanix in March 2013; though its mainstay business is termite extermination, it has transformed itself into a solar power integrator that installs small-scale solar panels. Other new holdings include Tosho, an operator of sports club facilities and hotels, which has strong earnings momentum, and Round One, which operates bowling alleys and video game arcades.
In 2013, the performance picked up compared with the AIC Japanese Smaller Companies sector average, having underperformed its peer group for the previous four years. Last year the trust produced a return of 39.45 per cent, outperforming the sector average of 37.98 per cent, according to data from FE Analytics. Longer-term performance is more disappointing with a return of 135.53 per cent for the five years to February 25 2014, lagging the sector average of 164.27 per cent.
The manager notes that in 2013 three of its top 10 contributors were online businesses, including Kakaku.com; Wirelessgate, which provides high-speed wireless broadband services; and M3, which offers web-based support services for pharmaceutical companies and doctors. Both Kakaku.com and M3 are long-term holdings, which have consistently added value since they were initiated in 2007, says Mr Higaki.
Three businesses that are well positioned to benefit from prime minister Abe’s growth strategy – the so-called ’Third Arrow’ – have also performed strongly. JP-Holdings, a nursery school operator, stands to benefit from government plans to increase the number of private nursery schools. Government initiatives to accelerate new drug development are favourable for Medrx, a pharmaceutical company, while homebuilders and housing-related materials makers have been buoyed by expectations of domestic reflation.
Detractors included Odelic and Endo Lighting, LED lighting makers, which fell on short-term earnings weakness, though the manager maintains their overweight positions, believing they will benefit from growth in energy saving in Japan.
Looking ahead, Mr Higaki suggests valuations are not stretched because earnings growth has accelerated. Of this year’s correction, he says: “The indiscriminate selling has created opportunities to invest in attractive businesses at a cheaper price.” Moreover, he is encouraged by the buoyancy of last year’s 54 initial public offerings (IPOs): “These new companies often have characteristics that we look for in our investment process – innovative business models that are changing existing business practices in their own areas and gaining share from the incumbent.”
EXPERT VIEW
Rob Morgan, pensions and investment analyst, Charles Stanley Direct
VERDICT
“The discount has narrowed substantially on this trust. It could have been bought at a discount of 20 per cent last year but is now at a less-interesting 10 per cent. With investor interest in Japan seemingly firmly reignited, this opportunity seems to have passed. In addition, the portfolio has shown some decent form recently in performance terms, harnessing the sharp rebound in the sector well. So shareholders are probably pretty happy with manager Shinji Higaki who was appointed in 2007. However, on the downside, the fees are expensive, and it is highly geared at 16 per cent so it will typically be a volatile ride.”
