A Cheap Way To Invest In Japan

Out of all the major developed markets the one that tends to get the least attention is Japan, which is perhaps understandable given the persistent deflationary environment and low investment returns. However, it finally looks as though things might be changing with inflation having risen to around four percent in recent months.

For a hitherto moribund economy, this might be enough toencourage greater consumption and investment, which could be a catalyst for increased innovation and productivity. The big unknown is how the incoming governor of the bank of Japan will react, although the indications suggest that he will maintain interest rates at their current low level for the immediate future.

A full unwinding of pandemic-related restrictions has unleashed pent-up demand for consumer spending, thereby benefitting the domestic economy. Real GDP growth is expected to return to positive territory in 2023, which will probably allow the Yen to appreciate and improve the returns for UK-based investors.

Attractive Way To Access The Market

One of the more unusual funds investing in the country is the £168m AVI Japan Opportunity Trust (LON: AJOT), which the broker Numis describe as an attractive way to access the Japanese market. It follows an activist approach that seeks to unlock value from businesses that the manager believes suffer from weak corporate governance and capital misallocation.

AJOT invests in a focused 27-stock portfolio of quality small and mid-cap listed companies that have a large portion of their market capitalisation in cash or realisable assets. It has built up a strong track record since inception in October 2018, with NAV total returns of 28.8% compared to 12.7% for the MSCI Japan Small Cap index.

At the end of December, its latest reporting date, the underlying portfolio had net cash as a percentage of its market cap of 41.9%. The net financial value − which consists of cash and investment securities on the balance sheet, less any debt − was 63%, with the remaining 37% representing the value attributed to the core operating businesses.

Writing in the recent accounts, manager Joe Bauernfreund, said that the portfolio: “is positioned for several potential idiosyncratic events with upsides of 50-100%. Combined with a cheap Yen and an increasingly supportive macro environment, we are optimistic about prospective returns.”

Evolving Strategy

The strategy has evolved over the years with the manager emphasising the importance of avoiding the numerous value traps that exist in the Japanese market. As a result, the fund has a greater exposure to higher quality, growing companies that are trading at attractive valuations, which means that it is likely to be ‘paid to wait’ to realise the valuation opportunity.

One example is TSI Holdings, a major purchase in 2022, that has a bloated balance sheet with net cash, investment securities and real-estate accounting for 176% of its market cap. Bauernfreund believes that by managing its clothing brands more efficiently the company will be able to unlock the value from its lowly rating.

The other significant acquisition last year was the medical equipment manufacturer, Nihon Kohden, which is undervalued relative to its peers. A number of improvement measures have been identified with a view to double the share price, including improving margins, something the company president has agreed is achievable.

AVI Japan Opportunity Trust offers a different exposure to more mainstream Japanese funds with the performance largely driven by stock specific events, although it would still benefit from the more helpful macro environment. The shares tend to trade close to NAV.