Buying opportunity for the Baillie Gifford Japan Trust

Baillie Gifford Japan has an excellent long-term track record, but the recent pullback provides an ideal entry point for this growth-oriented trust.

The one billion pound Baillie Gifford Japan Trust (LON: BGFD) provides exposure to medium to smaller sized Japanese companies that are believed to have above average prospects for growth. It typically owns 40–70 stocks that are held on a three to five year view and differs substantially from the TOPIX benchmark.

It is an approach that has yielded astonishing results with an annualised NAV total return of 10.6% versus the 4.7% achieved by the index over the 40 years since it was launched. In the last few weeks however the shares have fallen back by about 11% and are currently available at a small discount to NAV rather than the normal premium.

I recently wrote about Japan’s struggle to get out of the spiral of low growth and deflation that has lasted for years and suggested that the return of inflation in the west could be the catalyst to rejuvenate the market. If this turns out to be the case then Baillie Gifford Japan could be one of the big winners.

A unique portfolio

Manager Matt Brett invests in quality growth companies that can be divided into four distinct categories. His disciplined approach ensures that each individual holding is generally kept to less than five percent of the assets.

The largest group at 47% of the portfolio are the secular growth stocks that have the highest potential, albeit with the greatest uncertainty given that they are operating in rapidly evolving markets. This part of the fund includes most of the internet and factory automation businesses where the manager has found some exceptional long-term investments.

They are followed by the cyclical growth stocks that make up 25% of the assets. These are companies where the earnings will not rise every year, but where the manager expects them to be higher from one cycle to the next.

Next come the special situations, which are stocks where there is a reason to believe that improvements are underway following a period of disappointing performance. They are complimented by the growth stalwarts, where growth is more predictable, yet less rapid.

A mixed year

In the financial year to the end of August the shareholder total return was 25.7% versus the 16.3% achieved by the index. Much of the outperformance came from physical-world businesses as they recovered from the pandemic, whereas the internet stocks that had done well in the past acted as a drag.

There have been several recent additions to the portfolio that all share the common feature of having significant inside ownership. Brett and his team have long believed that where the management have a material stake in the business it helps to ensure that shareholder interests are high up the priority list, which is often not the case with Japanese stocks.

Baillie Gifford Japan performed exceptionally well during the initial recovery phase from the pandemic and was 30% up on pre-COVID levels by February, but since then it has drifted lower as investors try to work out where the market is headed. The broker Investec has just reiterated their buy recommendation as they believe the pullback is anattractive opportunity to acquire what they regard as a core strategic holding.

BGFD has an amazing long-term record of beating the market and there is no reason to believe that it will not continue to do so. Its focus on growth works well in the technology-oriented market in Japan, while its small and mid-cap bias helps to differentiate it from the majority of trusts and funds operating in the country.