The Baillie Gifford Japan Trust has come a long way since its 1981 foundation. Manager Matthew Brett suggests technological progress and rising dividends mean there is further to go.
As we celebrate 40 years of The Baillie Gifford Japan Trust, it is tempting to dwell on a record that gave shareholders far more to celebrate than had they simply invested in the wider Japanese stock market.
But those four decades are now in the past. Today’s shareholders consider what the future may hold. So with another decade till the half century, I’m going to make a few predictions about what the future might hold. As the saying goes: ‘It’s tough to make predictions, especially about the future,’ but I hope the following will give shareholders something to mull. Here goes:
1. Technological progress will drive returns
2. Japan will continue be a decent place to invest
3. Taking a long view will deliver better outcomes
4. The journey won’t be smooth
5. We will focus on delivering value to shareholders after fees
6. Dividends should grow significantly
Let’s take these one by one:
Technological progress will drive returns
Baillie Gifford has been clear on this point for some years now. Moore’s law suggests exponential growth in computing power, 5G creates far better connectivity and, within a decade, routine deployment of machine learning and AI is quite plausible. Inevitably this creates a world where many things will be different. Exponential progress implies that, although next year will be similar to now, the situation in a decade won’t simply be the sum of ten single years. To quote Bill Gates:
“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten”.
Within The Baillie Gifford Japan Trust there are many internet-type businesses that we hope will benefit from disruptive technology, ranging from Softbank (now described as “vision capitalists” by Masayoshi Son) to Rakuten who have progressed from being an ecommerce business to directly challenging the telecoms companies with its own network roll-out. But an additional benefit is that we also access Japan’s excellent manufacturing companies, which we believe could experience rapid growth as the increases in computing power create opportunities in automation: whether that is FANUC with its green-painted collaborative robots or Kubota increasingly looking for opportunities to automate agricultural mechanisation.
Conversely, history is littered with examples of companies that have become irrelevant over time. Yet stock markets continue to make progress, because the winners add more value than the losers subtract. Our task is clear. We need to focus on identifying as many big winners as we can. Given the acceleration of technological progress, this will be even more important over the next decade than in the last.
Japan will be a decent place to invest
It seems highly likely that Japan will continue to provide the strong foundations on which businesses can prosper. It is a well-established, liberal democracy that respects the rule of law, and the concept of societal harmony is deeply embedded. Following significant reform in the last decade, through the introduction of its Stewardship Code and its Corporate Governance Code, Japan now has some of the strongest protections for shareholders globally. For example, in Japan it is possible to remove a company president through a simple majority shareholder vote. Successful entrepreneurs are increasingly celebrated in Japan. It is perhaps one of the few countries around the world to be moving in directions generally helpful to stock market investors.
Today’s Japanese stock market is well placed to deliver for shareholders. The major index constituents are increasingly technology focused and Japan’s legendary manufacturing prowess means that roughly half of the major global robotics companies are listed in Japan. This compares favourably to the large bank and old conglomerate domination of a decade ago. Additionally, and completely differently from the late 1980s, the overall price of the market does not seem in any way excessive.
Taking a long view will likely deliver better outcomes
A core mistake of many who use the stock market is to focus on share price fluctuations rather than what a share price means. Shares are simply a fractional ownership of a real business. In the long run some businesses succeed, others don’t. Unsurprisingly, because shares represent fractional ownership, those that do succeed have share prices that increase over the long term. But this says nothing about why prices fluctuate in the short term, which can be for any number of reasons. By trying to always focus on the long-term (by which we mean looking at five years and beyond) we increase the probability of backing the right businesses.
Few investors admit in their marketing materials to having a short-term time horizon and to focusing on the ups and downs of share prices. But there is an easy way to check who is genuinely taking the long-term view and, therefore, whose results will be driven by the long-term performance of the underlying businesses: Look at turnover. A lower number means that stocks are being held for longer. For The Baillie Gifford Japan Trust, turnover over the last decade has averaged 9 per cent, which we believe is without parallel among investment trusts with a Japan focus. This approach should also encourage our shareholders to consider what we hold in the portfolio today – it’s not likely to change in a hurry.
The journey won’t be smooth
It is important that we’re transparent: sometimes our investments don’t show the growth we hoped for. Sometimes we will make a less obvious but probably more important error: not buying something that goes on to deliver exceptional growth. But we will continue to try to find businesses with a large growth opportunity ahead of them, and the competitive advantages to profit from it. By being open and honest about mistakes being inevitable we can focus our energies on optimistically seeking successful investments. Because one successful investment can deliver a return many times more than one mistake, we think that being opportunity-focused is the right thing to continue to do.
It would be lovely if we could deliver a good outcome for shareholders in a neat straight-line but it’s never going to happen. Looking back over the past 40 years there have been six occasions when the share price has declined by over 30 per cent, so it shouldn’t be a huge surprise if another such dip was to happen over the next decade. The returns that are available to shareholders from long-term investment in good quality companies are only available at the price of toleration of shorter-term volatility. We hope all shareholders are forearmed with the knowledge that setbacks will happen and will be able to steel themselves to continue to the next peak and beyond.
We will focus on delivering value to shareholders after fees
The principle of putting our clients’ interests ahead of our own will continue to guide our actions. Our primary aim is to find attractive growth businesses, invest your money in them, and patiently to benefit from their growth over time. If we can do this well, we believe we can compound your wealth over time. Additionally, we try to keep costs down. Ongoing charges fell from 1.27 per cent to 0.66 per cent over the past decade*, mainly due to fee reductions and the trust’s increasing scale, which means that shareholders keep more of the return. When the shares have traded at a premium to the asset value the board has been prepared to issue shares and, on the rare occasions they have fallen to a meaningful discount, have been prepared to buy them back. Both actions help enhance shareholder value over time.
By being open and honest about mistakes being inevitable we can focus our energies on optimistically seeking successful investments.
Dividends should grow significantly
Attitudes towards shareholders have changed markedly in Japan over the decades. The combined effect of the Japan Corporate Governance Code and Japan Stewardship Code is to make boards much more thoughtful about traditional practices such as crossholdings and large cash holdings, and they are significantly more likely to pay a dividend based on a percentage of profits. However, given the large amounts of cash still on Japanese balance sheets, it is highly likely that dividend growth can outpace profit growth over the next decade.
Although rare in a global context, many Japanese internet businesses pay good dividends. Two examples from the trust’s top 10 holdings are GMO Internet (hosting, payments, and other services) which has a forward yield of 1.6 per cent, and SBI (online brokerage and financial services) which has a forward yield of 4 per cent. The Baillie Gifford Japan Trust paid its first dividend for many years in 2018 and it has increased every year since. While our focus remains on capital growth, we think it inevitable that dividends per share will be significantly higher in a decade’s time.
Conclusion
Having delivered a NAV total return of 10.6 per cent per annum for the first 40 years, over double the 4.7 per cent of the TOPIX Total Return Index, it might be tempting to wonder whether the best years of The Baillie Gifford Japan Trust have already happened. But we believe that the most fertile ground for growth investment in Japanese companies still lies ahead of us. We encourage shareholders to look to the long-term, and show fortitude during the inevitable setbacks, so that the long-term rewards can be theirs to enjoy.