Japan has a number of characteristics that make it a compelling investment opportunity. From a valuation perspective, it is the one major global stock market where we are able to find many companies trading on cheap valuations. In addition, Japanese company managements are coming under increasing pressure to improve corporate governance and boost shareholder returns. To capitalise on both of these factors, we have created a basket of companies that trade on extremely cheap valuations. Our basket makes up 11.7% of the overall portfolio and contains a diverse set of companies that have a substantial proportion of their market cap in net cash. This is a play on the theme of improved corporate governance in Japan. The potential upside to shareholders from improved balance sheet efficiency amongst these companies is substantial.
“Proactive approach to engagement with management in Japan”
In addition to the basket investment, we are also taking a more proactive approach to engagement with management in Japan. Amongst some of the larger holdings, we have been communicating with boards and making suggestions for ways to improve governance and balance sheet management. We are hopeful that this constructive engagement will yield positive results for all shareholders.
The Japanese Special Situations basket consists of 18 stocks that have inefficient balance sheets and diversified domestic sector exposure. Really, these should be thought of as one basket – made up of cash and assets that trade at a discount. Our investment thesis is that with a large portion of their value in net cash, which is being under appreciated by the market, they will outperform, particularly under the pressure of improving corporate governance.
We found the most opportunities in small-capitalisation companies which often are not accessible to other large market participants due to lack of liquidity and size. British Empire Trust’s fixed base of capital allows us to bear this illiquidity risk and to remain agile so that such opportunities can be exploited.
“While the holding period has been short, the performance has been strong”
In addition to the focus on highly capitalised balance sheets, we also sought companies with strong cash generation despite a large portion of capital being used inefficiently. By investing in this basket, we have effectively placed 49% of invested capital in cash yet are still receiving a 6.5% Free Cash Flow (‘FCF’) yield and a dividend yield of 1.3%. If these companies were to return their redundant tangible assets to shareholders, these investments would have a FCF yield of 15%.
There are few markets outside Japan where a portfolio with the above statistics could be created. While the holding period has been short, the performance has been strong, with the basket outperforming the TOPIX index by 11%.
We find the changing corporate governance theme in Japan to be an interesting one and believe that we have built a compelling basket of companies, at attractive valuations, that should be a beneficiary of such change.
* As at 31 October 2018
** Source: Morningstar, performance period 30 June 1985 to 31 October 2018, TR net of fees, GBP
*** As at 30 September 2017, includes: management fee 0.70%, marketing and administration costs
British Empire Securities and General Trust p.l.c is referred to as ‘British Empire’ throughout the website. British Empire’s investment managers, Asset Value Investors are referred to as ‘AVI’