Article from Investment Trust Newsletter October 2024. For full access to all articles and back copies, please SUBSCRIBE HERE.
SCHRODER JAPAN TRUST
(SJG, 252.5p)
After a strong start to the year the Nikkei 225 Index has settled back and fallen by 6% over the last six months, potentially offering another entry point into a promising equity story. The path of Schroder Japan Trust shares has followed a similar path, initially rising after our ISA recommendation in March before retreating to much the same level. We caught up with the trust’s Tokyo-based manager Masaki Taketsume after the trust’s full year results were released last week.
The results, first of all, reflected another good year for this all-cap trust that uses bottom-up stock selection to construct a portfolio of 60-70 high quality stocks. In the year to 31st July the trust produced a NAV total return of 21%, ahead of the benchmark return of 16.4% and marking a fourth consecutive year of outperformance. We have no reason to doubt the quality of the management here. The net asset value has since fallen back marginally from 299p per share to 296p though as the Tokyo equity market has run into some profit-taking, digested a severe bout of market volatility, and adjusted to a rise in interest rates. The macroeconomic backdrop has been a little mixed.
Masaki told us that he sees two prime drivers for the market, the first being inflation, which is much more welcome in Japan after a lengthy period of deflation than it is here. He says that whilst inflation is slowing down to 2% thanks to a fall in commodity prices, domestic wage growth continues to underpin inflation and the argument that Japan can begin a new virtuous cycle of inflationary growth remains intact. Masaki has said before there is a strong correlation between nominal GDP and stock market performance. One factor that we felt might be important in the mix for both growth and inflation is the exchange rate, which has been highly volatile of late and may perhaps have changed direction. After a long period of yen weakness stretching back at least four years, the decision by the Bank of Japan to raise interest rates to 0.25% on July 30th caused ructions in the foreign exchange markets and sent the yen sharply higher for a short while at least. There does not seem to have been very much follow-through though, so it is far from clear that any fundamental shift has taken place. A stronger yen could be a useful tailwind for sterling investors, although less helpful for inflation or for Japanese exporters, so any change is far from a simple positive or negative in any event. We hear repeatedly from managers that they are not currency forecasters but for what it is worth Masaki feels the yen may be fairly stable around the current level for the time being, and thus not central to his decision-making. Nor did that short burst of volatility around the interest rate decision trigger any short-term trading for SJG, which is focused on longer-term trends. The episode may have been useful though for clearing out some speculative positions.
The second major trend that Masaki sees as a driver for equity markets is corporate change, which is a continuing narrative in Japan. Companies are improving governance practices, focusing more on shareholder value and more efficient capital allocation. Masaki says he is seeing “a steady increase in dividends, a steady increase in share buyback announcements, and also steady progress in disclosing cross-shareholder ownership” and that these improvements continue to have a positive impact on the overall valuation and return on equity.
The trust’s portfolio has a bias towards domestic companies because the managers have a positive outlook for the Japanese economy, and that is reflected as well in the gearing level, which is steady at around 13%-14%, although using CFDs now rather than bank borrowings. There are no large bets on particular sectors because the bottom-up process here is much more focused on individual stock selection, looking for internal change and market misperceptions, particularly in the mid and small cap space. Recent strong performers in the portfolio include Fujikura and Hitachi, whilst some semiconductor and component companies have underperformed. Overall, Masaki expects steady earnings growth and continues to see good value in the Japanese market, on a large discount in valuation terms to the US.
One final note, on the dividend, is that SJG pays an ‘enhanced’ dividend that is funded largely from capital, which is not generally something we like to see. It is not a reflection of the income generated by the trust, but the trust will be paying out 10.81p per share in the final quarter. The shares will go ex-dividend on 7th November and pay the dividend on 13th December.
We were reassured by this discussion and continue to feel that SJG offers good broad exposure to Japan. The shares offer good value in our opinion on a discount of 14.8% and we are content to stand by our BUY rating. The twelve-month discount range is between -0.4% and -15.6%, so the current rating is very much at the cheap end of the range, offering investors a second bite of the cherry here. Amongst mainstream Japanese trusts, SJG remains our choice, and we think most investors should have exposure to Japan at a time when geographic diversification looks sensible. Many European economies have debt issues to work through and highly valued US stock markets may be vulnerable to setbacks during a period of political uncertainty.
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