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First State pair cut back on cyclicals following yen rally

First State pair cut back on cyclicals following yen rally
Sophia Li: Last year’s appreciation in the yen was “difficult” to ignore

First State Stewart Asia managers Martin Lau and Sophia Li are backing Japanese domestic industry consolidators after the strength of the yen prompted them to cut back on cyclical holdings last year.

The managers, who run the firm’s Japan Focus fund, admitted that a renewed surge in the country’s currency had prompted them to reposition their portfolio slightly to focus on more defensive names.

The yen strengthened by 3.2 per cent against the US dollar in 2016, despite the latter’s own rise against various currencies, data from FE Analytics shows. The yen also gained 23 per cent against sterling.

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While the duo typically ignore currency movements in conventional times, the sharper-than-usual appreciation in the yen made it “difficult” to ignore, Ms Li said. As a result, the managers “significantly” cut exposure to cyclicals as the currency gained momentum, selling out of holdings such as SMC Pneumatics.

However, Ms Li said the pair had been responding to an unpredictable macro backdrop by focusing on secular growth stories, including cases of industry consolidation. 

They have been adding in particular to pharmaceutical company Tsuruha, which made up 4.1 per cent of the fund at the end of February. The manager described the industry as “fragmented” and said the top-five names in the sector had a market share of just 35 per cent. 

“The population is ageing and it’s an increasingly strong health consumer market,” she said. 

“People are encouraged to take over-the-counter drugs, but prefer a one-stop shopping experience.

“I think this will be one of the growing industries in the next three to five years.  [Tsuruha] is taking market share in the food segment with [food retailers that also sell over-the-counter drugs]. Those businesses are run by people who are going to retire soon. They can’t find successors so they have to exit the industry and sell.”

The managers have also been topping up a position in furnishing and interiors name Nitori, which sits in the fund’s top 10, in the hope that it will be another winner from market consolidation.

Ms Li explained: “Nitori is similar to Ikea: it has a vertically integrated business model. The industry in Japan has no growth, but the company has years of growth. It has also innovated with products, such as a mattress with a self-warming function.”

Another favoured name is Koito, which produces headlights and is expected to benefit as part of a shift from halogen to LED bulbs. “The penetration [of LED] is pretty low at about 20 per cent,” Ms Li said.

Not all of this consumer-facing exposure is turned towards Japan’s domestic market. 

In early 2017, 48 per cent of the fund was invested in firms that received more than 50 per cent of their revenue from overseas markets, despite the effects a stronger yen would have had on these holdings. One such name is Keyence, which makes factory automation sensors and other related products. 

Ms Li noted that demand for such offerings could come from further afield. “Japan has been strong at factory automation and robotics,” she said.