OPTIMAL JAPAN ABSOLUTE LONG FUND
Optimal Japan Absolute Long Fund (‘OJAL’) invests in the Japanese equity market with the objective of maximising investor returns. This includes hedging the portfolio. Although the Fund’s NAV is denominated in USD, the underlying investments are in Japanese Yen securities and the Investment Manager does hedge this exposure to the Yen by using forward contracts.
|NAV PER UNIT US$15.931|
|As at 30 November 2018|
|As at 30 November 2018||1 year||3 years||5 Years||10 years||Inception*|
|*Since inception (start date 1 September 2004). Data provided by Apex Fund Services.|
|As at 31 March 2018||OJAL||Topix Index|
|Number of Holdings||26||830|
Value of US$10,000 INVESTED
Source: Apex Fund Services
After the brutality of October, investors enjoyed some respite in November as the Yen was slightly weaker against the US dollar and equities rose, a little. More than half way through December as we write, however, market conditions look more like October’s than last month’s, and a year of grinding disappointment seems set to end on a poor note.
We traveled to Hong Kong and Japan in mid-November with a busy agenda full of company meetings. The good news is that in most meetings the companies held largely positive outlooks for 2019. The caveat to this is that in our experience over the past 30 years, companies have never been any better than economists in predicting changes in demand, and so one must take their optimistic forecasts in that context. Economists can usually give a good account of the recent past but few get the timing, or magnitude, of demand shifts before they are already coincident.
The other thing that struck us in many of our meetings was just how dependent the companies are on government policy and regulations. Whether it be in gaming (or gambling as it used to be known), water and sewage treatment, garment manufacturing or cement production, the fortunes of the businesses were all exposed to risk of changes in regulations and taxes affecting their industry. Political and policy stability used to be a hallmark and advantage that developed economies offered when compared to the developing world. With the increased fracturing of political power in many countries over the past decade, the risks of policy about-turns or uncertainty are faced by companies across the globe. It is no longer isolated to emerging markets and it is likely that the uncertainty will continue for some time, and probably continue to suppress valuations.
We were also interested to see how some businesses are beginning to see growth taper off in markets where ongoing growth has been a received wisdom. An example of this was Want Want China Holdings – a food producer with a market cap of just under US$10bn. Want Want has three segments - rice crackers, dairy & beverage and snack foods - and has maintained strong operating profit margins around 20% and an RoE until recently in the high 30% range. In the half year to 9/18, the company saw overall revenue rise 3.2% yr/yr but in their rice cracker segment, sales actually fell by 1%. Listening to the spokesman talking about the ways the company would lift declining margins (change in product mix etc etc) and facing low or even negative revenue growth and declining asset turnover, one could have been forgiven for thinking that this was a Japanese food maker and not one from high growth China. It struck us a business that has had a wonderful past 20 years, but for whom the years ahead will be a lot more challenging and it would struggle to hold onto the high profit margins it has enjoyed thus far.
Our meetings in Japan were encouraging and the range of companies broad. These meetings ranged from the dependable and solid (Bridgestone) to the dominant and high margin (Tokai Carbon, Tokyo Electron and SMC) to the fast growing (Outsourcing and Zozo) and a bunch of others dealing with the familiar need to slim down and concentrate resources on their strengths (Hitachi, Panasonic and Omron).
We met makers for games played on mobile phones and tablets and came away better informed but still unsure how to value these and a real estate developer that we believe cares about its shareholder returns (Hulic). Whereas 10 years ago it was night and day comparing the IR presentations from Japanese companies ("we are terrible, times are tough") with those from other Asian companies ("we are shiny and the future is ours"), the gap has narrowed significantly with Japanese companies far more certain of what they are doing and their own merits. Perhaps this has come about with recognising the need to compete better but some of it comes also from stable policies and the same prime minister for the past 6 years.
Following our Japan meetings, we began positions in Outsourcing, Zozo and Tokyo Electron. In our last monthly we mentioned the important changes in the labour market that will see more foreign workers coming to Japan for jobs. Outsourcing is heavily involved in this process and sees it as a very big opportunity. We met the founder/Chairman (Mr Doi) who owns 12% (worth US$150mn at the current bargain share price) and who shows every sign of wanting his wealth to grow. We agree with his view and believe that the shares look good value now post a capital raising and 50% down from their July high.
Zozo is Japan’s largest dedicated E-commerce retail specialist and commands fantastic profit margins and growth. It is not cheap on a PER basis, but with a return on assets of 40% and an RoE of 66%, it is never likely to trade at a low PER. The Chairman and founder is 44 years old, has energy and a big reputation in the fashion world and holds 36% of the stock (US$2.4bn at today’s price). The recent dip in the shares - also down 50% since July – is partly due to the general market environment, partly due to gravity, and also due to their investment in the "Zozo Suit" concept. For those interested, we encourage you to go to the Zozo website and read about the Zozo suit. Suffice to say, we do not expect it to be a global success and think the company will quietly shelve their ambitions in this area and cease to invest any more in the concept. The Zozo suit has understandably attracted a lot of attention, but leaving it to one side, the main business is strong, highly profitable and should be able to grow as online shopping continues to take share.
We look forward to 2019’s market, believing that 2018 has been a year of fearfulness and discounting of bad times ahead. In Japan and much of the region, we think good investment opportunities are everywhere, but global politics may weigh heavily on valuations for some time yet.
Best wishes for the year ahead.
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|Strategy||Long Only Equity|
|Net Asset Value (NAV)||US$15.931|
|Trustee||Optimal Fund Management Pty Limited|
|Launch Date||September 2004|
|Performance Fee||20%*||*the fee is levied on the investment’s positive excess returns above the return on the Topix index (in USD terms) with a high watermark.|