Liontrust Japan Equity Fund: Q1 2022 review

The Fund’s equity portfolio outperformed due its overweight exposure to some more cyclical areas such as the energy, industrials, and materials as well as being underweight in the consumer related, healthcare, information technology and communications sectors. In addition, the Fund’s overall return was hindered by holding no utilities or telecoms stocks.

For the third quarter in a row, the larger and mid cap stocks held up better by falling only -1.7% and – 2.6% respectively. Again, it was the smaller category Mothers and JASDAQ indices that lagged, falling by -20.0% and -6.6%. In turn largely because of the threat from higher interest rates which impacts longer duration investment assets such as growth stocks.

TOPIX, having closed 2021 at the 1992 level, almost reached 2,050 before hitting its low of 1,755 on the 9^th of March after successive declines due firstly to general rising inflation and interest rate concerns and then the start of Russia’s Ukraine invasion at the end of February. Then, despite the oil price’s sharp concurrent share price rise to above $120 per barrel, TOPIX regained its composure, rallying to close to 2,000 before ending the month at just below 1,950 as the fallout from the war in the Ukraine did not turn out to be as expected.

As usual, individual stocks showed disparate performance often strongly contrary to the underlying sector’s returns. For instance, consumer staples in aggregate fell by -2.9% with Seven & I, the convenience store operator, rose by 15.9% on a total returns basis.

Similarly, relative outperformance within the virtually unchanged industrials sector was shown by Mitsubishi Heavy Industry that rose +52.6% upon management announcing restructuring plans and in the materials sector JFE, the steel producer, rising by 21.9% on news of successful product price hikes.

By contrast in industrials, Daikin (air conditioning), a big gainer the previous quarter, declined by -13.8% on profit taking whilst Fanuc, the leading automation and robotics firm, fell -10.5% after machine tool orders were deemed to have likely peaked for this cycle. Likewise in materials, Sumco, the ultra-pure Silicon supplier to the global semiconductor industry, declined by -13.5% on expectations that demand may have peaked and Kansai Paint dropped -20.6% on higher input costs (oil) and therefore compressed profit margins.

Financials overall gain of 9.1% for the quarter saw our holding in the property firm Mitsui Fudosan climb by 16.2%, whist our monies invested in JAFCO, a venture capital firm, depreciated by -13.2% given the current global uncertainties and likely interest rate rises would lessen both the opportunity and the valuation of any firms that it tried to list upon the public markets.

As previously stated, our investment thesis remains that we expect Japanese equities to do relatively well based on their balance sheets and balance of operations tilted towards the non-OECD and the more cyclical sectors. We expect inflation’s stickiness to become more apparent and force central banks to raise rates further and faster than generally expected. As a result, given the generally no/low debt condition of most Japanese firms and given increased tax burdens are likely to be imposed on US firms, the relative improvement in profitability should encourage investment into the Japanese stock market.

Also, the emerging trends of near-shoring and de-globalisation have already been embraced by Japanese firms who began to de-emphasise their Chinese operations and relocated elsewhere should place them at a structural competitive advantage. The renewed demand for capital equipment should also benefit the many Japanese firms in these sectors.

In the meantime, the government, having approved in December a record for the new financial year as well as restated its intention to keep Japanese interest rates at their current levels whilst other OECD nations raise theirs, suggests the yen will succumb to widening interest rate differentials and will help underwrite a multi-year recovery in Japanese corporate profits. As such, the Fund will remain overweight in large, well-financed, industry dominant Japanese multinationals that are set to benefit most from the currency’s likely weakening.

Discrete years’ performance (%)**, to previous quarter-end: