Baillie Gifford Japan investment trust aims to achieve long term capital growth by investing in a concentrated, high-conviction portfolio of Japanese shares.
The Trust is managed by Matthew Brett, with Praveen Kumar assisting as co-manager and providing smaller company ideas as lead manager of sister Trust Baillie Gifford Shin Nippon. The managers believe the Japanese economy is undergoing structural transformation, with companies being run more efficiently and the service sector becoming a larger and more dynamic component. To capitalise, they target companies that enjoy sustainable competitive advantages in their respective industries and are capable of growing earnings and cash flows at a faster rate than the market average. This is based on the belief that share prices ultimately follow earnings and a concentrated portfolio of companies capable of above-average growth will, over time, deliver superior investment returns.
From a universe of around 3,500 listed companies, an initial screening based on liquidity (ease of buying and selling in volume) and business viability eliminates more than two thirds. The next stage in the identification of potential investments is a more rigorous process which focuses mainly on an assessment of a company’s status as a successful, growing business. Investments are split between four ‘buckets’: secular growth (notably internet, automation, retailers), special situations (companies turning their fortunes around), stalwarts (steady growth with hard-to-replicate ‘franchises’) and cyclical growth (autos, resources etc.).
Matthew Brett shares the typical Baillie Gifford approach of tending to run with successful investments if their continuous review process indicates the investment case remains intact. They pay less attention to current valuation and more to long-term value, so there tends to be relatively little turnover of stocks making up the portfolio. The focus on growth potential results in a higher risk collection of holdings, which is exacerbated by gearing (borrowing to invest) of up to 20% and an ability to invest in nascent unlisted companies. All in all, it is a riskier option within the sector.
Current positioning and activity
After years of natural disasters and man-made financial crises, cash-hoarding has generally stood Japanese companies in good stead for the economic downturn we are currently seeing. In addition, the Trust’s portfolio appears to have been relatively well-placed for the pandemic disruption in terms of sector exposure. Online ecommerce, digital disruptors and automated manufacturing have long been themes, and exposure to companies with high financial or operational gearing is limited.
Beyond the immediate impact, the managers have been exploring how recent alterations to life could morph into more significant structural changes to both businesses and consumer habits. For instance, whether behaviours exhibited during the pandemic will persist (in gaming and online trading for example), and if the coronavirus will act as a catalyst to existing trends.
Of particular focus has been the acceleration of a contact-free economy and the localisation of manufacturing. For instance, in terms of current portfolio holdings, the managers are considering how wider adoption of digital services could aid internet infrastructure provider GMO Internet and drive growth for Rakuten’s ecommerce ecosystem. They are also looking into whether Japan’s global leaders in robotics, automation and vision learning will benefit from offering companies with stressed supply chains new labour-saving solutions. They believe more dynamic companies capable of flexibility tend to come to the fore in crises and are assessing current and prospective holdings with this in mind.
Already, there have been some obvious winners from recent societal shifts among companies held. Social distancing has resulted in a surge in activity for gaming, which has benefitted Nintendo, Mixi and Sony. There has also been robust demand for various hygiene and food products that has helped Pan Pacific International. In addition, there was strong recent performance from Sysmex after it achieved approval for an in-vitro diagnostic coronavirus kit. In contrast, the collapse in crude prices caused a sell-off in oil and gas related businesses such as Inpex and other commodity linked companies such as Sumitomo Metal Mining.
Pursuing higher growth companies in Japan has been a winning strategy for a number of years and Baillie Gifford have fully capitalised on the favourable conditions with strong stock selection on top of the stylistic tailwind. The recent market slump has interrupted the Trust’s strong run of returns versus its benchmark, the Topix index. However, the its considerable differentiation, distinct philosophy and consistent process continues to draw our attention. It was previously a constituent of the Direct Investment Service Preferred List between May 2014 and July 2015 and was removed on concerns that the share price was consistently trading at a significant premium to net asset value (NAV), and thereby didn’t offer great value for new investors. Today, shares are at discount to NAV of around 9%, so there is potentially better value on offer compared with an equivalent open-ended fund. We, therefore, feel the time is right to reintroduce the Trust to the list as one of our highest-conviction ideas in the area for new investment.
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Baillie Gifford Japan IT – added to the Preferred List
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