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How Waverton is blending an active and passive approach for its Japan exposure

21 September 2017

Waverton’s Luke Hyde-Smith outlines the investment case behind Japanese equities and explains why the team uses a blended active and passive strategy in the asset class.

By Jonathan Jones,

Reporter, FE Trustnet

Investors should consider using an active and passive blend when looking for exposure to the Japanese market, according to the team behind Waverton Investment Management’s managed portfolio service. 

The team are overweight equities and one of their favourite areas is Japan, which is benefitting from a number of encouraging drivers, portfolio manager Luke Hyde-Smith (pictured) said.

“We like the Japanese market, we think there is a good structural story there and we have recently moved to a more overweight position,” he explained.

The Japanese market, measured here by the Topix index, has returned 103.67 per cent to investors over the last five years, and is up 49.79 per cent since its fall in February last year.

Performance of index over 5yrs

 

Source: FE Analytics

“We are constructive on Japan from a valuation standpoint but also there are some pretty major dynamics going on in the market from a central bank standpoint,” the manager said.

“One of the things that has probably been overlooked is that the Bank of Japan [BoJ] have basically said they are unlimited QE [quantitative easing] there.

“They are going to target the 10-year government bond at zero no matter how much they have to spend to do that.

“That is quite a significant departure from all the other central banks and is alarming in one sense but is extremely supportive for the Japanese equity market.”

As well as this, the BoJ is now buying domestic passive vehicles such as exchange-traded funds (ETFs) and may even look to buy shares in certain companies which are able to deliver better returns on equity.

As such, Hyde-Smith said the team have bought the Source JPX-Nikkei 400 Ucits ETF, which tracks an index composed of 400 companies listed on the Tokyo Stock Exchange meeting global investment standards.



“It isn’t quite the broader market but that is exactly the place where the Bank of Japan has said they’re targeting ETF purchases,” the manager said. “These are companies that are producing better ROE [return on equity], maybe looking at more shareholder-friendly policies, possibly increasing dividend payouts etc.

“So [it is a collection of] structurally improving stories and the BoJ have said would like to buy companies with those characteristics.”

A strong push towards better corporate governance, with more non-executive board members and an increased focus on shareholders leading to higher dividend payments and share buyback programmes have also been supportive of the team’s view on Japan.

Performance of fund vs index over 1yr

 

Source: FE Analytics

Over the past 12 months the index tracker has returned 27.46 per cent, with a tracking error to the Nikkei 400 of 0.2.

The £272m fund, which has a clean ongoing charges figure (OCF) of 0.2 per cent, makes up one-third of the exposure to Japanese equities in the managed portfolio service.

This year the team has seen earnings improving faster than the broader Japanese market, meaning that companies have actually been de-rated, said Hyde-Smith.

“It is one of the rare parts of the world where we have seen that. We think that is a constructive backbone or tailwind for the Japanese equity market,” he added.

To take advantage of this, the team have allocated two-thirds of their Japanese equity exposure to an active fund.


 

“We use one very concentrated, long-term stockpicking fund which is Lindsell Train Japan,” Hyde-Smith said.

The five FE Crown-rated fund has been a top quartile performer of the IA Japan sector over the long term, returning 157.5 per cent over the past decade. It also sits in the top quartile over three and five years and has comfortably beaten the Topix benchmark across all of these periods.

Performance of fund vs sector and benchmark over 10yrs

 

Source: FE Analytics

“Lindsell Train are a very well-known shop – primarily for their UK and global equity funds – but they have a Japanese fund run by Michael Lindsell, though he runs it together with Nick Train,” the Waverton manager said.

“It is investing in long-term, high-quality growth companies and while you wouldn’t want to always characterise it as a defensive fund, the reason we like it is [that] it does have somewhat defensive characteristics i.e. a large exposure to staples.

“It also has a large exposure to healthcare and technology and we believe those are the structural growth drivers in Japanese equity market, at the moment,” he added.

Indeed, the fund has a 44.4 per cent weighting to ‘consumer franchises’ with 25.7 per cent in media including software companies and 21.3 per cent in pharmaceuticals & healthcare.

Healthcare is an important driver due to the shifting demographics of the country, with more people living for longer.

Meanwhile, technology is important because of the “fourth industrial revolution that is going on, at the moment”, Hyde-Smith said, with Japanese technology companies among those at the forefront.

“We think the fund provides a compelling way to play an interesting opportunity in Japan,” he noted.

The £147m Lindsell Train Japan fund has an OCF of 0.85 per cent.

 

Earlier this week, FE Trustnet looked under the bonnet of the Waverton managed portfolio service and has also considered some of the preferred equity areas the team have been adding in recent months, including UK smaller companies and the emerging markets.

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