The challenges facing growth investors have been well documented in countries like the US and the UK, but they are also relevant in less obvious places such as Japan. A case in point is the £800m Baillie Gifford Japan Trust (LON: BGFD), whose shares are down almost 40% from their all-time high in 2020 and are now available at an eight percent discount to NAV.
A recent research report from the broker Investec says that the manager has a clear philosophy, which has been refined over many years, with long-term, quality growth-oriented stock-picking driving portfolio construction. Their high conviction approach means that there will be times when it falls out of favour and when this happens, the underperformance is likely to be material.
Baillie Gifford Japan is currently enduring one of these troughs and since the relative peak of performance in February 2021, it has lagged the TOPIX index by a massive 33.8%. The manager accepts that the last two years have not been vintage, but they describe the current situation as the greatest opportunity for growth investing in Japan since the global financial crisis.
In the annual accounts to the end of August the NAV was down by four percent, whereas the TOPIX achieved a total return of 6.7%. This was the second consecutive year that the bias towards higher growth and smaller companies acted as a drag on performance and it has had a material impact on the medium term record, which the manager acknowledges is now disappointing.
One of the problems was that there was very little exposure to the more cyclical businesses in the iron and steel, banks, marine transportation and construction sectors, which performed strongly. The manager did however take advantage of the de-rating of a number of small-cap growth stocks that were added to the portfolio.
On a more optimistic note, he believes that the leap forward in Artificial Intelligence represents a key development. He says that while there has been much excitement about the impact on chips, the opportunity set will be much broader including data centres, models and applications.
The Board has recently conducted a thorough analysis of the five-year performance record with the manager, looking at both the investment process and the outcome. As a result, they remain strongly supportive of the growth-focussed strategy and believe that companies that are able to demonstrate idiosyncratic growth should command a premium valuation and outperform over time.
In order to enhance the returns the trust has consistently maintained a high level of gearing, which is currently just under 20%. This will inevitably add to the volatility and will have contributed to the eight percent discount, despite the active share buyback programme.
Baillie Gifford Japan has significantly outperformed the TOPIX over the long-term, although there have been a number of relatively extended periods when it has materially underperformed. Investec currently has a buy rating on the trust, but it comes with a health warning, as in previous downturns there has been an intensification of the sell-off in the months before the nadir, followed by a powerful V-shaped recovery.