NAV and Manager’s Report

May 2017

May is meant to mark the high point of the first half of the year in stock markets. In more genteel times, a savvy gentleman investor would sell his stocks and go about enjoying the summer months when equity prices fell back, before returning to the market after the St Leger Stakes in early September. What a life, especially if one finished the summer by picking some winners at the races, and one which probably only existed in the imagination of market scribes and among the lazier inhabitants of the gentlemen’s clubs of St James, London. In Japan, where the summer months are hot, humid and best spent inside with the air-conditioner set on high, there is evidence to support the view that seasonally, the equity market has its weakest period during the summer before recovering in the autumn and early winter. A little over one week into June, it is far too soon to conclude much at all, but after May’s 2.3% rise, June has begun with a continuation of the leisurely increase in the Topix index. Notwithstanding past seasonal trends and the old market adage, we continue to see upside for Japanese equities in the months ahead.

Even though the Topix index was up in May, it felt like a partial return to the days of “risk-off” with defensive sectors performing well and economy sensitives (shipping, oil, textiles, steel, banks and autos) all negative. The real estate sector was one of the better performers but unfortunately for our portfolio, Mitsubishi Estate had a stroke of vertigo after April’s 5% gain and promptly gave up almost 2% in May. It is difficult to identify a specific reason for the contrasting performance of Mitsubishi Estate with the strong gains of rivals Mitsui Fudosan (+7%) and Sumitomo Realty (+13%) but the divergence began around the time Mitsubishi Estate announced their FY16 results and earnings and dividend plans for FY17. Given there was no change to dividend policy and only the mention of possible consideration of share buy-backs, it is likely that some investors were disappointed and sold or switched their holdings into the other developers. It is also possible that it was profit taking by short-term arbitrage seekers, but trying to ascribe cause to market moves is a dubious exercise in most cases.

What is not in question is the continued good health of the real estate market in Japan with welcome strength in metropolitan areas other than Tokyo. Office vacancy rates in Osaka are now lower than they were in the 2007 mini-boom, but interestingly, this tightness in supply-demand is at lower average rent levels than existed back then. The office market seems to have found a sweet spot, but landlords have had to accept lower rents per tsubo to achieve full occupancy. In Tokyo the office vacancy rate remained at 3.4% and while rents are well off their 2013 lows, they remain 15-20% below the levels reached in 2008. Talk of a bubble in Japanese real estate is exaggerated, and there is certainly no excessive exuberance for the listed real estate plays like Mitsubishi Estate which trades at an implied cap rate of 6% while actual prime office buildings in their Tokyo base Otemachi change hands at more like 3% cap rates. Funny, as we always thought there was meant to be a premium for liquidity.

The Panasonic bid to buy out minorities in subsidiary Panahome is due to be completed by June 13th, and while Panahome shares briefly went to a 3% premium over the Y1200 bid price, they have drifted back to Y1202 and it would appear that the bid will succeed. Panahome shareholders might not have got the benefit of a full scale bidding war, but they certainly have a much better deal than the one initially offered by Panasonic.

It can hardly be said that global geopolitics is all “low vol”, what with the political scene in both the US and now the UK providing daily thrills, and North Korea continuing to thumb its nose at the warnings of all and sundry while lobbing missiles into the sea. The global economy however is quietly returning to growth rates commensurate with the average of the past 50 years and problem areas such as Europe have been showing welcome strength. Japan meanwhile, is a haven of political stability and like Europe, has been recording better economic performance than it has in the past year or two and certainly better than the consensus estimates. We are convinced in the long-term positives of governance reform in corporate Japan and with Topix still well below the “Iron Coffin Lid” of 1800, we remain bullish on the outlook for Japanese equities.