Fidelity Japan Trust plc (LON:FJV) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: You called your recent report on FIDELITY JAPAN TRUST, FJV: recent performance into perspective. What can you tell us about it?
A1: As we outlined in our initiation, FJV has a long-term track record of outperforming UK markets, UK-listed competition, UK open-ended peers and Japanese benchmarks. The main drivers are structural, including its investment processes, flexible mandate and active management.
However, as we noted in the initiation, FJV can see temporary periods of underperformance when its investment approach is out of favour. During the current manager’s mandate, these episodes, typically, have been around a quarter, and, immediately after, there has been significant outperformance. We put FJV’s recent performance into this historical perspective.
Q2: So, its sounds like you are really breaking down the performance into two bits. The long-term outperformance, which is driven by long-term structural factors and the underperformance, which is more sentiment-driven and, historically, has lasted around a quarter. If we look at the outperformance first, what makes you suggest it is structural?
A2: First, there is the known market attractions of innovation-led growth, government-led structural reforms, better corporate governance, balance sheet strength and an affluent population.
Secondly, there are trust-specific procedures and management including its investment processes; so, compared with local investors, FJV has a competitive advantage in Fidelity’s global presence, while, compared with international investors, it has been on the ground, with a local team, speaking Japanese, since 1969. FJV has a flexible mandate with 3.6% added to the NAV when an unlisted position IPO-ed in March 2021, and it is an active user of derivatives. It is an active manager with average turnover between 2016 and 2020 often over 70%, its closed-ended structure, allowing gearing, and its positive relative ESG credentials with ESG viewed as enhancing performance, as well as social credentials.
There are known risks and, in our initiation, we highlighted the market appetite for FJV investment style, potential volatility of FJV returns, sentiment to Japan’s historical GDP growth and productivity, the impact of the ageing population on future growth, and sentiment to the level of government debt. The bottom line, though, is FJV has a long-term track record of outperforming UK markets, UK-listed competition, UK open-ended peers and Japanese benchmarks.
Q3: So, that sounds good, but what about the periods of recent underperformance, including the most recent one?
A3: While it would obviously be ideal to have no periods of underperformance, we believe it is an inherent feature of the approach that has delivered long-term outperformance, and we do not believe that a period of underperformance should be considered as abnormal or unexpected.
We highlighted in our initiation that, for short periods, the management style has fallen out of favour, and the most recent fall will be the third such period since the manager took over in 2016. Unfortunately, the timing (both start or end) cannot be accurately predicted. So, if we look at what drives them.
First, there has been a conspicuous style rotation, leading to the outperformance of value and sharp declines for growth stocks – most evident in the buying of low price-to-book (PB) names and selling of high PB stocks.
Secondly, there is an extreme narrowness of price movement with intra-sector divergence, so, when we wrote our report, Toyota Motor (a zero position in the fund, against nearly 4% in the index) in one month had outperformed its own group company Toyota Tsusho (an overweight holding in the fund) by nearly 20%. Additionally, FJV suffers from being geared and, in falling markets, investors may be overly cautious in the valuation its private company holdings.
Historically, the underperformance has been quite short, typically just a quarter before FJV showed outperformance in the subsequent period. In stock markets, timings can be everything. In terms of calendar year effects, a sharp fall near the year-end in 2018 saw an underperformance in that calendar year of 7%, but, in 2019, FJV outperformed by 22%. Similarly, a 7% underperformance in 1Q’20 on style rotation reversed so, in 2Q, you would have made a 33% return investing in FJV, compared with just 11% in the market.
Q4: So, your overall summary?
A4: Hopefully, our reports are clear. Fidelity Japan Trust has a long-term track record of outperforming UK markets, outperforming UK-listed competition, outperforming UK open-ended peers and outperforming Japanese benchmarks.
The main drivers are structural, including its investment processes, its flexible mandate and its active management. It operates in markets with clear attractions and known, visible risks. FJV has periods of underperformance when its investment approach is out of favour and it is difficult to predict exactly when these periods will begin or end, noting, in the past, they have typically been around a quarter.
