Nicholas Price, Portfolio Manager of Fidelity Japan Trust PLC, discusses recent key political and economic developments in Japan. He outlines how an increased focus on digital transformation is impacting the landscape and creating new opportunities across both public and private markets.
Japanese equities are second only to the US in posting the highest returns of any major region since 2012, but still remain significantly under-owned by international investors. This is mainly due to the commonly held view of Japan’s economy as stagnant and low growth.
On the political front, however, the country has managed a smooth transition to a new leader and key economic policies are largely a continuation of the supportive stance pursued by the previous administration. In an uncertain world, with its wealth of under-researched companies, Japan represents a significant source of potential alpha (excess return relative to its benchmark) for long-term investors.
One of the biggest changes that we’ve seen over recent months has been the move to online and digitalisation - a trend seen globally. However, this shift is significant in Japan as Japanese companies have long been laggards in e-commerce and digitalisation. The current crisis has highlighted the need to be much more resilient and corporates are now rapidly increasing their spend on digital transformation initiatives. We are also seeing a big push from the government, with major policy initiatives in this area. For instance, newly appointed Prime Minister Yoshihide Suga has pledged to establish a new agency tasked with handling digital transformation policies.
Against this backdrop, we believe that companies that can supply some of the services to facilitate corporate Japan’s digital transformation offer attractive growth opportunities. Additionally, companies in areas such as online services, e-commerce and educational software that can benefit from changes in the way we work, shop and play look interesting.
Buying the dip
We had anticipated that the shift online would accelerate and that stocks in this area could potentially see a lot of upside. As a result, in the early stages of the pandemic when many of these stocks - especially in the small-cap software as a service (SAAS) area - were oversold, we considered this to be a unique buying opportunity.
We also looked at companies with strong balance sheets that were temporarily hurt by the spread of the Covid-19 pandemic, but that are well positioned to recover and grow their businesses as restrictions are lifted. Key examples here are domestic services companies, particularly in leisure industries.
During the crisis, we also increased the level of gearing as we wanted to take advantage of stocks that were oversold when compared to their long-term growth prospects. Having said that, I do not expect gearing to increase further and as stocks approach their target prices, this gearing level will decline over time.
The trust has the ability to invest up to 10% of the portfolio in unlisted companies, and we continue to look for early stage ideas, particularly among fast-growing services and internet-based companies, as well as innovative medtech names. One such unlisted name offers an online consumer to consumer (C2C) platform where users can buy and sell knowledge, skills and experience from those who are willing to teach these activities for a fee. This company has seen enormous growth as people are finding second jobs and working from home, so we see this as an area that will benefit considerably in the medium-term.
The above examples highlight to good effect the size and diversity of the opportunity set on offer in Japan. Notably, just over one-third of the 3,800 listed companies are not well covered by sell-side analysts, especially in the mid to small-cap space. Being on-the-ground means that we see a lot of the new ideas and business models that are coming to market first-hand.
This creates opportunities for bottom-up managers like me, who are willing to do the leg work and identify the most attractive investment cases. It is pleasing that we have managed to capture this potential for investors over my first five years in charge of the trust, delivering a share price return double that of the index.
During my five year tenure as portfolio manager, we have seen two major challenging periods. The period following the US election in 2016 and more recently the Covid-19 crisis when the market moved temporarily away from small-cap growth stocks.
Going forward, the key issues will be the speed with which we exit from the current crisis, the extent of the cyclical recovery, and finally the mid-term inflationary outlook due to the scale of monetary and fiscal stimulus globally.
We believe volatility may continue in the near term, but this is also allowing us to invest in strong growth companies at very attractive valuations, and we remain positive on the medium-term for growth stocks in Japan.
The Trust will continue to be driven by bottom-up stock picking to identify, ahead of most other investors, the next generation of great growth companies in Japan.
Performance overview of Fidelity Japan Trust PLC
|Sep 15 - Sep 16||Sep 16 - Sep 17||Sep 17 - Sep 18||Sep 18 - Sep 19||Sep 19 - Sep 20||PM tenure|
|Fidelity Japan Trust NAV||35.9||21.7||26.7||-3.9||23.5||18.4|
|Fidelity Japan Trust Share Price||29.9||28.7||28.4||-3.7||25.9||20.3|
Past performance is not a guide to the future.
Source: Fidelity International, Morningstar, 30 September 2020. Basis: bid-bid with income reinvested, in GBP, net of fees. Index: Tokyo Stock Exchange TOPIX Total Return Index. Tenure: 5 years annualised %
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