InvestmentsJan 19 2015

Fund Review: Fidelity Japanese Values

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The £94m Fidelity Japanese Values investment trust recently passed its 20th anniversary in November and has been managed by Shinji Higaki since September 2007.

Its aim is to achieve long term capital growth from an actively managed portfolio of securities primarily of small and medium sized Japanese companies listed or traded on Japanese stock markets.

The manager notes: “The investment process has never changed during my tenure. I follow a bottom-up stock picking approach to build a portfolio. Stock selection is based on details analysis of individual companies’ fundamentals and share price valuations.”

He explains the portfolio, which is benchmarked against the Russell/Nomura Mid Small Cap Price index, focuses on stocks with the potential for strong and sustained profit growth over the mid-to-long term. “Smaller companies, being relatively young and dynamic, are often able to create their own niche market and may therefore be capable of expanding their business regardless of the external economic environment. Management’s track record in raising shareholder returns is also a key consideration,” he adds.

While the manager acknowledges the need to be aware of macroeconomic trends he points out “neither negative nor positive macro factors will be a primary trigger for an investment decision”.

Instead he says he adds value by “identifying mis-pricings on a company by company basis, with no competitive advantage forecasting macro variables or constructing portfolios primarily on the back of those variables. This methodology has contributed to the number of stocks in my portfolio”.

The investment process is based firmly on Fidelity’s internal research capabilities to produce a “diversified portfolio with balanced exposure to companies benefiting from global growth and those leveraging a shift in consumer behaviour in the domestic market”.

For the five years to January 6 2015 the investment trust’s total return of 45.7 per cent has significantly lagged the AIC IT Japanese Smaller Companies sector average of 81.49 per cent, according to FE Analytics data.

In 2014 the trust performed inline with the sector breaking even, while in 2013 it edged ahead of its peers with a return of 39.45 per cent.

In terms of the portfolio Mr Higaki notes: “While I avoid the clearest of headwinds, such as much domestic consumption, I find interesting opportunities in companies benefiting from a broad shift towards internet-based consumer services. I also avoid the low quality (e.g. weak balance sheet) stocks.”

The main focus is on companies with healthy earnings growth momentum, as the manager explains that while there are concerns about the macroeconomic situation in terms of weak GDP and wage growth, Japanese companies’ earnings results have highlighted solid fundamentals in the corporate sector.

“In addition to the benefits of a weaker yen, restructuring and cost-saving measures have contributed to the improvement in earnings,” says Mr Higaki.

As a result the manager notes while the trust maintained a large overweight exposure to domestic consumer service providers with multi-year growth drivers, he has added positions in yen-sensitive cyclicals in the technology hardware sector. In the meantime, he has also actively trimmed positions where the investment thesis had played out, including construction materials producers, some electronic component makers, and retailers.

Reviewing the performance in 2014 he adds: “An impending consumption tax hike increased uncertainty. As a result, holdings in the retail trade sector detracted from performance, while stock selection in the wholesale trade sector added value. Technology exporters, which are beneficiaries of a weaker yen, also performed well.”

Looking ahead the manager notes prime minister Shinzo Abe’s decision at the end of last year, to postpone a second increase in the consumption tax, is growth-positive for the country.

He adds: “Meanwhile, corporate tax reform and asset re-allocation at the Government Pension Investment Fund (GPIF) will be key market events going forward. At the micro-level, structural reforms are happening but we believe they will take place at a slower pace in 2015.

“As corporate earnings continue to grow and companies become more focused on capital efficiency, we expect to see further improvements in shareholder value and returns on equity. Considering the fundamental changes in corporate policy and historically low valuation multiples, Japanese equities look attractive on a mid-term view.”

EXPERT VIEW

Rob Morgan, pensions and investment analyst, Charles Stanley Direct

VERDICT

There is a bias to companies with healthy earnings growth momentum, competent management and attractive valuations. In the present portfolio there is a large overweight in domestic consumer service providers as well as yen-sensitive cyclicals in the technology hardware sector. Since Mr Higaki started managing the trust around six years ago it has underperformed its benchmark , the Russell/Nomura Mid Small Cap Price Index, though some of this can be explained by gearing; the present level being around 20 per cent. Historically, it tends to outperform in strong markets, and this has certainly been the case in the past few years. The trust may be attractive to investors who already have large-cap Japan funds and now seek aggressive exposure to smaller companies and are happy with the additional volatility of a geared investment trust.