OPTIMAL JAPAN AND ASIA TRUST

Objective

Optimal Japan and Asia Trust (‘OJAT’) invests in the Japanese and Asian equity markets with the objective of maximising investor returns. To this goal, the portfolio might sell index futures, short sell stocks or ETFs and raise cash. The portfolio is concentrated in our best ideas across the region and places emphasis on ensuring an alignment of interest with minority shareholders, long-term business prospects and always ensuring an attractive price at entry. Since its inception, the strategy has concentrated on Japan only and it will continue to keep a strong focus on Japan. It is Australian dollar denominated.

NAV PER UNIT A$7.016
As at 31 October 2018

Annualised Performance (Net of Fees)

As at 31 October 2018 1 year 3 years 5 Years 10 years Inception*
OJAT -11.7% -1.1% 0.5% 2.8% 5.6%
Benchmark -1.7% 3.3% 9.2% 4.1% -1.1%
Relative -10.0% -4.4% -8.7% -1.3% +6.7%
*Since inception (start date 20 December 1999). Data provided by Apex Fund Services.
As at 31 March 2018 OJAL Topix Index
Number of Holdings 26 830
Beta 1.0 1.0
Absolute Risk 12.3% 11.1%
Active Risk 7.0%
Active Share 92%

VALUE OF A$10,000 INVESTED

OJAT Performance ST Oct18.png

Source: Apex Fund Services.
Note: The benchmark from 20 December 1999 through 10 August 2018 was the Topix Index, thereafter it will be the MSCI AC Asia Index.

MANAGER's REPORT

Investing with a focus on medium to long term returns can have a downside, and October 2018 was definitely one of those months. Macroeconomic and political uncertainties led to a big pullback in most equity markets and the closer one was to China, the worst was the damage. The return for the Fund was as bad as any month since we launched in 1999 – and that covers some epic downturns such as in early 2001 and the nightmare of 2008. With every fall of significance, you are faced with the question of whether the horse has already bolted or is still in the yards. Shutting the gate – in this case by selling, raising cash or going short – means you miss the upside should markets regain their composure, but if you don’t, you take the risk of more painful losses. With the US mid-term elections now over and Messrs Xi and Trump making more (slightly) constructive comments about the chance for a trade deal, the horses seem to have calmed for now. We are betting that October was more akin to February 2016 than to June 2007, and that the lost ground can be regained soon. Market nerves are decidedly frazzled.

The sell-off in some stocks has left one looking on with envy at index declines of “only” high single digits. Within the Topix index, the economic sensitive/global cyclical sectors fell by as much as 18% with the least bad sector returns off only 2% or so. Notable among the less awful sectors is banking, which fell 5% and has continued its recent run of outperformance against the market starting in late June. We have had many periods where banks have had a burst of better performance but over the past decade these have been mere blips in a long, inexorable decline of the sector versus the broad market. Given the clear link between the slope of the yield curve and banking profits and returns, the move in US bond yields to 3.2% - and the general, though muted, rise in most other sovereign bond yields seen this year - is supportive to financials. This even extends to Japanese banks, though when JGB yields rise to any extent will be determined by a change in current Bank of Japan buying policy. There is little to get excited about when looking at the near term trajectory of earnings growth in the Japanese banks, but when there is, it is likely that this will be evident, in the main, with hindsight.

Within our portfolio the only gains were from our shorts, and we did not have enough of these. The region’s worst returns were in stocks and sectors that were most aggressively valued for potential earnings growth. These include Healthcare (biotech), Communication and IT. Next on the list of offenders come economy sensitives such as Materials, Energy, Industrials and Consumer Discretionary. Utilities, Real Estate and Financials were the least bad. Our timing in beginning to add Asian companies from August could have been a lot better, as what were high quality and reasonable value stocks became great value during September and October, while remaining high quality. The stock price falls were really gut-wrenching and although there have been solid rallies in the past week or so, they are a long way off their recent peaks. Most of these hit peak prices in late 2017 or early 2018, but in the case of XiabuXiabu (0520 HK), the shares hit HK$18.14 in late July and had plunged almost 50% to $9.53 in early September. Our cost price is $12.98 and the shares have recovered to $11.50. We will meet XiabuXiabu management in Hong Kong next week.

The indices for Hong Kong and China are down 13-25% YTD but most of the stocks we own have had peak to trough price falls of between 35-70%. Only venerable CK Hutchison Holdings and TSMC have held up better, but their own shares have fallen 25% or more and underline how not even the region’s bluechips have offered a safe harbor.

Rising US bond yields against a moderate inflation backdrop means real interest rates have now moved decidedly positive and creates a more challenging environment for equity valuations. Markets, both in the US and elsewhere, will cast a more critical eye over company cash flow and strong free cash flow yields will become that much more prized. It is likely that the market’s penchant of the past few years for companies which hold out a promise – however fantastic – of outsized future earnings will morph into a desire to identify value and near term earnings. Growth has smashed value in most markets in the period of negative real interest rates, so if we are leaving that era behind, it is very likely that value will become more fashionable – and profitable.

Putting stock market ructions aside, we believe that there is a very big change afoot in Japan that is in its early days and that will have real significance for the assessment of economic opportunities and asset values. We are talking about labour market reform and especially, relaxed rules towards foreign labour, both temporary and perhaps, even permanent. Anyone trying to find the right price for Japanese assets such as equities or real estate has had to take into account the ageing and declining population and the associated decline in consumer demand. It is clearly a factor at play in the undervaluation of Japanese growth assets relative to the low/no growth assets of cash or JGBs.

No politician in Japan is going to be brave enough to trumpet immigration or looser rules for foreign workers given the disproportionate influence of older, socially conservative voters, but there is clear evidence that there has been a low-key but meaningful relaxation of rules allowing foreigners into Japan to help fill shortages in the labour market. Expect to see more articles and commentary about temporary workers from Asia and increasing immigration in the remaining years of Mr Abe’s final term as PM. With Tokyo hosting the 2020 Olympics, the picture they will want to the world to see if going to be different to that long held view of Japan as a closed, xenophic and ageing country. It should boost the surging tourist boom further, and will lead to rising valuations. Mr Abe will claim responsibility for both victories – with plenty of justification.

Important change to Optimal Japan Trust

In light of the increasing importance of Asia to Japan, we have broadened the Fund’s investment mandate from Japan-only to one which covers all of Asia. This will allow us to capitalise on the extensive research we have undertaken to identify Asia’s best managed and most attractively valued businesses and in selectively adding these to the fund, we expect to improve the fund’s overall return and quality. Japan will remain the Fund’s core and major focus.

As a result, the Fund’s name has changed to Optimal Japan and Asia Trust. We have a new Trust Deed and Information Memorandum which formalise these changes, and will send them out to anyone wishing to invest.

We have lowered the Fund’s performance fee from 20% to 15% with all other major terms remaining the same.

Please contact us for more information and join the Optimal team investing in this improved version of the Fund.

FUND DOCUMENTS

HISTORICAL LETTERS

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Key Facts
Strategy Long / Short Equity
Benchmark MSCI AC Asia Index
Net Asset Value (NAV) A$7.016
Fund Size A$9m
Domicile Australia
Trustee Optimal Fund Management Pty Limited
Currency Australian Dollars
Launch Date December 1999
Income Distribution Annual
Fees* 1% pa
Performance Fee 15%*
*the fee is levied on the investment’s positive excess returns with a high watermark.