JPMorgan Japan Smaller Companies Trust plc (LON:JPS) announced that, in order to better reflect the Company’s current investment objective and dividend policy, that it has changed its name to JPMorgan Japan Small Cap Growth & Income plc (LON:JSGI).the change took effect 8.00 a.m. on 17th
December 2020. The Company’s ISIN, SEDOL and LEI remain unchanged.
In the chairmans recent statement Alexa Henderson said:
The first half of the Company’s financial year continued to be dominated by the effects of the global coronavirus pandemic. However, following the negative return reported in the last financial year, I am pleased to report a significant turnaround in the Company’s investment performance for the six months ending 30th September 2020. The total return on the Company’s net assets was +40.2% compared with a total return of +18.6% recorded by the benchmark, the S&P Japan SmallCap Net Return Index (in sterling terms), representing an outperformance of +21.6%.
The return to shareholders was +49.3%, reflecting a narrowing of the Company’s share price discount to its Net Asset Value (NAV) over the half year. The investment performance is explored in depth in the Investment Managers’ Report, where the team explain the challenging market conditions and highlight the stocks and sectors which have most impacted performance. The Company continues to build on its strong long-term performance, as illustrated in the Financial Highlights on page 4 of the 2020 Half Year Report.
The Board commends the investment management team on the remarkable outperformance they have delivered. It comes on the back of the Company’s challenging year ending 31st March 2020 when, notwithstanding some extraordinarily volatile trading days in early 2020, the Company still outperformed both its benchmark and other competitor funds.
Dividend Policy and Discount Management
The Company’s revised dividend policy, which has now been in place for over two years, aims to pay dividends approximating 4% of the average NAV of the Company over each preceding financial year. These dividends are paid quarterly from a combination of revenue, capital and other reserves. For the year ended 31st March 2020, dividends paid totalled 17.7 pence. In this half year, two dividends of 5.0 pence and 5.5 pence respectively were paid. Two further dividends will be declared on the first business day after 31st December 2020 and 31st March 2021.
Over the period, the Company’s discount narrowed from 11.9% to 6.4%. The Company did not repurchase any shares during the six months. However, the Board continues to monitor the discount closely with its advisers and is prepared to repurchase shares when it feels that it is appropriate, taking into account market conditions. At the time of writing, the discount stands at 5.8%.
Company Name and Ticker
Reflecting the now established dividend policy, the Company has changed its name to JPMorgan Japan Small Cap Growth & Income plc. This change is effective from today, 16th December 2020. Following the change of name, the Company will change its London Stock Exchange stock ticker symbol (TIDM) from JPS to JSGI with effect from 8.00 a.m. on 17th December 2020. The Company’s ISIN, SEDOL and LEI remain unchanged and its website URL will shortly be renamed www.jpmjapansmallcapgrowthandincome.co.uk
Following a review of the composition of relevant indices, the Board has decided to change the Company’s benchmark from S&P Japan SmallCap Net Return Index (in sterling terms) to MSCI Japan Small Cap Index (in sterling terms). This change will be effective from 1st April 2021. It reflects the Board’s view that the new benchmark is an index which has similar long term performance but is more widely recognised.
The Company has a revolving credit facility with Scotiabank which is flexible and provides the Investment Managers with the ability to gear tactically. The Company’s investment policy permits gearing within a range of 10% net cash to 25% geared. However, the Board requires the Investment Managers, in normal market conditions, to operate within the range of 5% cash to 15% geared. The level of gearing is reviewed by the Directors at each Board meeting. During the six months, the Company’s gearing level ranged between 6.1% and 10.4%, ending the half year at 8.8%.
Whilst the pandemic continues to dominate the economic and investment outlook globally, and with further challenges inevitable in the short term, the Board and the Investment Managers take the view that the current problems will ease with time. The Board is encouraged by performance over this six-month period and confident that the Investment Managers’ focus on strong businesses with solid balance sheets, robust cash flow and leading market positions will continue to deliver long-term outperformance, as it has done in the past.
The Investment Managers continue to identify many interesting stock opportunities amongst smaller companies that are at the core of the Japanese economy – including so-called ‘disruptor’ businesses that are at the forefront of Japan’s technological advance. Particularly in focus for the team are areas benefitting from the structural changes taking place across Japan, such as automation and information technologies, where the Investment Managers have uncovered many companies with strong future growth potential. The team’s location ‘on the ground’ in Tokyo provides a huge advantage in this respect, since investors benefit from a stock selection process based on extensive experience and local knowledge of an under-researched market.
Given the Company’s positioning, there may be times ahead when relative performance will falter, but we believe that any such periods of underperformance will be short-lived and marginal. Moreover, the Board maintains full confidence in the Company’s stance, strategy and stock selection process: we believe the Company is well placed to deliver positive and superior returns for investors over the longer term.
JPMorgan Japan Small Cap Growth & Income plc Investment Managers’ Report
Investment Managers Eiji Saito, Naohiro Ozawa, Michiko Sakai wrote:
Performance and market review
Over the six months to 30th September 2020, the Company’s benchmark, the Standard & Poor’s Japan SmallCap Net Return Index (in sterling terms), produced a total return of +18.6%. In contrast, the Company’s net assets outperformed the index by 21.6% over the same period, delivering a return of +40.2%.
The Company’s performance is ahead of the benchmark by 22.6% over twelve months, by 9.9% per annum over three years and by 6.4% per annum over five years. This continued strong performance has resulted in annualised net asset value total returns of 12.5%, 17.9% and 14.5% over three, five and ten years respectively.
Over the six months, the broader TOPIX index advanced 15.8% in Japanese yen terms. The market bounced back from the turmoil witnessed towards the end of the Company’s March year-end, amid signs that post-lockdown resumption of economic activity had got off to a good start, but the rally was limited by concerns about a second wave of COVID-19 infections in the US and Europe. During the same period, the Japanese yen strengthened against the US dollar and weakened against sterling.
Spotlight on stocks and sectors
During the six months under review, both stock selection and sector allocation recorded positive contributions. Stocks that contributed most positively over the review period included Bengo4.com, BASE, and Net One Systems:
• Bengo4.com is an internet media business that provides an online legal consulting portal which is at the forefront of Japanese law firms’ office digitalisation. Bengo4.com also operates a cloud-based service for digital contracts called ‘Cloudsign’, which is the pioneer and market leader in Japan, with about 80% market share in its field. Japan maintains many old-fashioned business practices, such as the use of small ink signature stamps to certify documentation. However, COVID-19 has accelerated the move away from many traditional practices, such as this one, which has, in turn, created a growing need for digital signatures. We believe this will be a continuing trend and provides Bengo4.com with a strong competitive advantage.
• BASE is an e-commerce platform for smaller companies and individuals. It allows anyone to open an online store easily and quickly, with no set-up or recurring monthly fees. In Japan, e-commerce market penetration is lower than in many developed countries and also well behind China (which has undergone rapid digital transformation). Whilst e-commerce was already growing in Japan before COVID-19, the pandemic has provided added impetus, with consumers and store operators shifting significantly online.
• Net One Systems provides network integration services to enterprises, telecommunication companies, schools and hospitals. It has also benefitted from Japan’s digitalisation wave which has created stronger demand for cloud and cyber-security infrastructure services.
Negative contributors to relative performance included real estate company Star Mica, leasing services provider Mitsubishi UFJ Lease & Finance Co, and Teikoku Electric Manufacturing, which manufactures pumps and electric parts. We believe that all three companies possess competitive advantages that will support their long-term prospects, so we have kept faith with these holdings in spite of short-term headwinds.
Top sector contributors included Software & Services (where we were overweight), and top detractors included Retail (underweight).
The Company’s gearing level was within the expected range of 8-10%, ending the period at 8.8%. Gearing contributed positively to returns over the period.
The Company maintained its focus on individual stocks that we believe can deliver earnings growth over the long term; these are companies with strong competitive positions supported by robust management teams and healthy cash flow. We avoided stocks that have no clear differentiation and operate in industries plagued by excess supply. Many shares in the Financial Services and Real Estate sectors fall into this category.
Three of our new purchases during the review period were Fuso Chemical, Medley, and HENNGE.
• Fuso Chemical is a specialist chemical manufacturer, mainly engaged in the life science and electronic materials businesses, including specialist chemicals used in semiconductor production.
• Medley is an online healthcare provider providing human resources across the medical healthcare industry and is also at the forefront of telemedicine, remote medication instruction and digital medical records, all of which stand to gain traction thanks to recent regulatory reform.
• HENNGE provides cloud security services, increasingly relevant to the Japanese market as businesses upgrade their aged systems to facilitate more flexible working practices such as working from home. HENNGE offers identity authentication and access control services, a market that is expected to expand strongly off the back of the structural change underway in Japan.
Three of our largest divestments were MonotaRo, Pan Pacific International, and Daikokutenbussan.
• We were obliged to sell our entire holdings in e-commerce business MonotaRo and retail group Pan Pacific International (owner of the Don Quijote discount retailer) as both companies have now become amongst Japan’s largest 100, as measured by market capitalisation, so are no longer permitted investments under the Company’s investment restriction guidelines.
• We sold to take profits on supermarket business Daikokutenbussan, after its strong share price rally.
Over the last twelve months, the annualised portfolio turnover was 18%. The overall shape of the portfolio has changed little, and we maintain its positioning towards quality and growth stocks: good quality businesses with improved governance structures and the opportunity for re-rating.
Our investment philosophy and process
The Company celebrated its 20th anniversary earlier in 2020 and our commitment to providing access to the innovative and fast-growing smaller companies’ universe at the core of the Japanese economy is undimmed. Our portfolio favours quality and growth and we aim to invest in companies (other than Japan’s largest 200) which we believe can compound earnings growth over the long term, supported by sustainable competitive advantages and good management teams. We believe such companies’ strong and durable market positioning will allow them to substantially increase their intrinsic value in the future. This also means that the portfolio tends to enjoy a high active share and differs significantly from the benchmark which provides a further source for additional return and hence the Company’s outperformance.
Our stock selection is based on fundamental analysis, local ‘on-the-ground’ knowledge and extensive contact with company management. The Company is managed by a team of three and further supported by over 20 Tokyo-based investment professionals offering expertise and in-depth knowledge of local markets in what is a very under-researched and under-appreciated market. This local knowledge provides us with a significant strength in identifying investment opportunities, with a focus on businesses that reinvest to provide higher growth potential.
Smaller companies in Japan comprise diverse sectors with strong growth potential, serving both local and global market needs. Moreover, an increasing number of constituent stocks within these sectors have latterly adopted a greater focus on improving return on equity and also enhancing dividend yields.
Trends and themes
While our decisions are based on company-specific factors, there are also structural, long-term trends and themes that underlie much of our stock selection. For example, Japan’s elderly makes up an ever-increasingly large percentage of the total population: this is a significant economic challenge for the Japanese government but one which it is committed to tackling through regulatory reforms and digitalisation. The country’s new Prime Minister, Yoshihide Suga, is spearheading a digital revolution and smaller companies are at the heart of this.
Our investment themes include:
• Changing demographics: Japan’s ageing and declining population is providing opportunities for innovative smaller companies that are working to improve the quality of life for seniors. Also, businesses which focus on labour productivity improvement in the workplace are benefitting from the tight labour market.
• Government policy reforms that improve labour productivity: Japan’s new Prime Minister is supportive of regulatory reforms, and the government will establish a digital agency, which aims to accelerate the digitalisation of national and local government, education, and the healthcare and medical sectors.
• Technological innovation: many companies are embracing the productivity opportunities that technology offers. Despite Japan being an advanced industrial economy, certain areas such as financial services and payments lag other markets in terms of technological sophistication. Japanese manufacturing however is world class, and the country is a leading supplier of factory automation equipment, robots, and electronics parts and materials. These present attractive investment opportunities for companies that specialise in niche product/technology segments.
• Corporate governance: improving governance standards across Japanese companies has resulted in increasing numbers of independent, external directors serving on company boards, as well as better policies overall; these include enhanced shareholder returns, internal controls and disclosure. The market is likely to reward companies that improve their governance standards, and we maintain a constructive dialogue with companies on this broad theme.
• Overseas growth: businesses operating beyond Japan’s shores are in a very strong position to capture the benefits of the dynamic economic growth across Asia which is creating demand for high quality Japanese goods, services and brands from new customers in overseas markets.
On the ground in Japan, we see that COVID-19 and its aftermath have cast a shadow over the country’s economic outlook. The pandemic has already delivered a massive shock to global economies, with Japan and most other global economies stunned into recession. Whilst we acknowledge that investors will need to maintain a patient attitude during this unprecedented period, we believe that the problems will ease with time. We may see industry consolidation and productivity growth through trends such as diversifying production sources, adoption of flexible working practices and better use of information technologies.
As always, we believe it is important to continue focusing on good quality companies that possess the following attributes: leading market positions; strong cash generation; structural growth potential; and robust finances. Our task is aided by the fact that Japanese companies typically have significant cash on hand as well as the strongest balance sheets among its peers in developed countries. We are confident that our strategy puts the Company in a strong position to benefit from long-term trends in Japan as well as weathering any potential short-term changes in sentiment, driven by the pandemic, trade policies or other economic roadblocks, that could lie ahead.
Japan remains set on its long-term goals of achieving sustainable and broadly-based growth, driven by digitalisation, free trade and the government’s major corporate governance and stewardship reforms. Japan’s signing of the RCEP (Regional Comprehensive Economic Partnership), an agreement between 15 Asia-Pacific member states to reduce trade tariffs and lay the foundation for deeper cooperation, represents a positive step towards boosting its trade in the decades to come. In sharp contrast to other developed economies, it is Japan’s smaller and more entrepreneurial companies which are at the forefront of innovation; as such, we are confident that the long-term outlook for smaller companies remains positive and that we will continue to uncover exciting investment opportunities.
Even though the Company has delivered an excellent performance over this half-year review period, it is important to highlight that average valuations of Japanese companies remain reasonable, both lower than historical averages and below those of most other major markets. In tandem with the structural changes taking place in Japan, we remain confident that our investment approach will deliver positive and sustained returns over the long term.