Focus on Asia – Japan, Land of the Rising Equities?

In our continuing series of features on Japanese equities, we focus today on Swiss & Global Asset Management, which combines fundamental and systematic styles in its strategy.

Swiss & Global Asset Management combines independently managed fundamental and systematic strategies when it comes to Japanese equities.

As a result of this, says fundamental portfolio manager Ernst Walter Glanzmann, the overall SICAV regulated fund exhibits lower volatility than if just one portion were used, and has the highest information ratio among its peer group over four years. These facets are important for institutional investors wanting to invest in Japanese businesses without it consuming too much of their risk budget.

The two portfolios are combined in such a way that they contributed equally to risk.

“It is quite a unique approach, we believe, to combine fundamental and systematic strategies into one fund, and it is based on more than 20 years of portfolio management and empirical analysis.”

Glanzmann (pictured) and Carlo Capaul, portfolio manager for the systematic portfolio, have worked together since 2004.

Although the Julius Baer Japan Stock fund traces back to 1993, the two managers introduced the current investment approach on 30 June 2008.

Since then, the fund gained 20% in euro terms, on volatility of 14.3%, compared to MSCI Japan’s 0.1% returns on 15% volatility.

The fundamental portfolio, called Diamond, is very concentrated with 20 to 30 positions, focussing on growth investing. The systematic strategy invests half-yearly in 100 deep value names based on a proprietary model built on empirical evidence of the Japanese market.

Glanzmann says having just 23 stocks in the Diamond portfolio means it can focus on a few firms with lasting competitive advantage. But for the model-based Systematic portfolio, the team does not base its selections purely off value metrics either. There is a qualitative health check as well, to ensure ‘value traps’ or highly problematic firms are not included.

As a result, in December it stopped investing in Elpida Memory Inc., the country’s third largest PC manufacturer which faced pressure from rivals in South Korea. It was cheap, but became even more so, before filing for bankruptcy in February.

Tokyo Electric Power Company was another it has avoided “but we did not buy it because it depended too much on regulators and government, and conditions for it are very uncertain. It was very cheap, but the risk was too great for us.”

Stefan Fröhlich, deputy portfolio manager, says a holding period of at least six months – as Swiss & Global Asset Management applies to its systematic pool – makes sense for value investing, “because value stocks need time to recover, and if you balanced the portfolio every month they would not have that time”.

At present, with each portfolio contributing equally to risk, some 35% of the fund’s net assets are held in the Diamond portfolio, the rest is invested with the systematic approach.

Sometimes stocks will be held in each – Honda is a current example – and Glanzmann said his team is comfortable with this as the allocation is nothing but a natural outcome of the team’s stock picks.

The Diamond portfolio focuses on excellent firms, explains Glanzmann, and pursues a buy and hold strategy of at least five years. “We want to participate in the development of sound business models over time, and that takes at least five years.”

“We have to spend a lot of time analysing business models and build up a great deal of know-how before we invest. Our research into a company prior to making an investment decision can take up to three years.”

A sound business model must be underpinned by products appreciated by consumers. Glanzmann explains such products generally allow for pricing power, or have few rivals in a niche where it is difficult to steal market share, or require low operational or competitive costs helping the producer to innovate.

A robotics software company like Fanuc might qualify for inclusion due to low labour costs and high competitive barriers.

As with the systematic portfolio, so too the Diamond portfolio is selective: “If we think the market is overestimating a particular company’s business model, we would sell the stock.”

A key problem for Japanese companies overall has been their profitability. Their ROE has consistently lagged major rivals, and has trended downwards since early 2011, to below 5% now. This is less than half of the ROE of competitors in North America, Europe and Asia ex-Japan.

But Glanzmann says the fall, after a sharp recovery in 2010, was a result of the natural disasters in Japan and Thailand.

“Companies have lost production facilities and had to write them off, and the impact of these events can last for up to a year before firms can operate a normal type of environment again.

“However, most of these negative effects will have been reversed this summer. On that basis we can expect earnings in Japan to rebound strongly. We are now almost back to the expectations prevailing before the catastrophe happened.”

Glanzmann said a common hesitation to invest in Japan is its economy and the assumption that Japan’s corporations cannot grow if its population is not.

But recent data from the Ifo World Economic Survey and International Chamber of Commerce showed Japan has the second best economic expectations of 10 major economies over the coming six months, only lagging the UK and roughly on level with America. This, combined with its current economic situation, put it in the ‘upswing/recovery’ quandrant of the economic cycle.

“The national accounts or GDP of Japan do not have much in common with its corporate sector. Corporations can untangle themselves from the demographic pattern, and the most successful companies are well established in overseas markets, as well. While half of Japan’s exports go to Asia, many companies have also established production facilities overseas to sell in these local markets, so their footprint is truly global, not just based on ‘exports’ in a the classical sense.”

If profit expectations for MSCI Japan stocks for 2013 and 2014 are accurate – Yen 25trn and nearly Yen 30trn respectively – then this will continue the uninterrupted quarterly profits growth path that began in the first quarter of 2011.

He rejects another investor argument, that one should play Japan via ETFs.

“The success of our strategy has been to be selective, so ETFs do not make sense at all. Beta bets were quite popular earlier this year and people had hopes the economy would recover, but then China and the US and Europe started turning sour again, so high beta stocks fell apart again. Japan is particularly interesting for active investors, and an opportunity for those who are patient.”


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