Schroder Japan Trust plc (SJGL.XC) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Schroder Japan Trust plc Annual Results Webinar coming to you today from the heart of the city of London in the Schroder's headquarters. My name is Roland Jones. I'm responsible for the Investment Trust sales here at Schroder. And it's my pleasure to be your host for the results webinar. I'm joined today by your Fund Manager, Masaki Taketsume, who's based in our Tokyo office. And Masaki has been running the fund since July 2019 with some very strong results. So, over the next 40 minutes or so, we are going to cover the performance over the last 12 months. I'm going to ask Masaki to talk about the positioning, the style orientation of the Trust. And then, we're going to cover the macro outlook for Japan and Japanese equities, covering some of the exciting developments in corporate governance. We will be spending a little bit of time on the developing political situation. As many of you will know, there's a strong possibility that Japan appoints its first female Prime Minister. However, some of the euphoria around that announcement has dissipated somewhat over the last few days or so. So, I'm going to ask Masaki to cover that in as much detail as he can. We're also going to have plenty of time for questions. So, please do submit your questions on the app. I will get that on my iPad, and I will relay those questions to Masaki. There is also a feedback box. We'd be very grateful for your feedback. This allows us to tailor the conference in the future to ensure that it meets everyone's requirements. So, let's head over to Tokyo. Masaki, good afternoon. How are you? How is Tokyo?

I'm fine. Thank you. Tokyo is warm. Warmer than London, any time. Anyways, that's good to have you.

That's good. Okay. Let's talk about the Trust. Over to you.

Okay. So, let me start with the key feature of Schroder Japan Trust. Our investment approach is a bottom-up driven by in-house fundamental research. Basically, we are aiming to generate the ARPU from the bottom-up stock selection. We have a long-term investment horizon, around 60 to 70 holdings with a relatively low turnover. And as a result of the bottom-up stock selection, portfolio typically has a style bias towards value and the contrarian, and that we also are potent to overweight in the mid to small cap stock, which we see more alpha generation opportunity leveraging our in-house research. And other Investment Trust, we are using the gearing range is typically around 10% to 17.5%. So, if we think of the performance driver of the Schroder Japan Trust, now all of the importance, alpha generation from the stock selection biased towards the value and the small cap and the gearing. So, those are the major drivers of the performance of the Schroder Japan Trust. Next slide, please. So, when we talk about the alpha generation from the stock selection, we typically look for the three or four kind of the investment opportunity. We call it as the opportunity sets. But among the three to four opportunity sets, fast to opportunity sets showing this slide are the most important driver of the alpha generation as well as the performance of the Schroder Japan Trust. Fast opportunity set, we call it as a Market Misperception. So, simply put, we are looking for the company with internal changes. Internal changes, such as the management changes, strategy changes, which could structurally improve the growth or ROE prospect of the company and leading to the devaluation of the share price. Second opportunity set, we call it as a Market Oversight. It tends to be in the mid- to small cap areas. So simply put, we are looking for the mid- to small cap company, which has a strong global franchise in a niche market. So, in other words, we are looking for the niche top company, which is underappreciated by the market. But once market realize the value of that niche top franchise, share price is going to be devaluated. So, Market Misperception, Market Oversight. Those are the important driver of the alpha generation from the bottom-up stock selection. So, this is a key feature of the fund. Let me talk about the performance of the Trust for the last 1 year. Next slide, please. Yes. So for the last 1 year from ended July 31, we outperformed the overall market by 200 basis points. And also, we maintained the long-term strong track record on both 3 and 5 years. And all of the performance drivers, alpha generation from the stock selection, style bias towards the value and the small cap and the gearing, all of the three drivers contributes outperformance of the fund over the last 12 months. Next slide, please. And also, we maintained a strong performance on a discrete year basis for the last 4 years. Next slide, please. So, this slide shows solid performance over the long term. Next slide, please. Next. So, this slide shows that the top 5 and the bottom 5 contributor to the performance for the individual stock basis. I'd like to touch upon two things. First, if you look at the upper table, I mean, top 5 contributor. Top contributor is Fujikura. This is a mid-cap optical component, optical cable company. Second, Sanki Engineering. This is a small-cap construction company. And the third one is Hitachi, it's a large conglomerate. So, as you can see, the name from the top contributor, it came from all aspects from the market cap, large cap, mid-cap, small cap, as well as a very diversified industry, optical component, construction, conglomerate. That suggests that we generate a good alpha from the individual bottom-up, individual stock selection. So, that's the first point. On the bottom part, I mean, lower table, top 5 detractors. Biggest detractor was the Mitsubishi Heavy, followed by the Sony and Nintendo, all of which we don't own in the portfolio. And this stock shows a strong performance, because it has been seen as a sort of proxy of the bit of the thematic telecom market. But despite such a headwind, we managed to generate a sufficient alpha to generate a good outperformance of the Trust. So, that's the overall message from this slide. Next slide, please. So, this is the top 10 and the bottom 10 sector position. Overall, we don't take meaningful sector biases, in order to maximize alpha generation from the stock selection. So that's the sector overweight and sector underweight is relatively small. Next slide, please. This is top 10 and the bottom 10 holdings. So, for example, in the top 10 holdings, there are many mid- to small cap name, which you may be familiar with like our Fujikura, in the second T&D, on the third, Sanki Engineering or Niterra or Aica Kogyo. So, that illustrates that our style bias towards the mid- to small cap, again, to generate more alpha from the bottom-up stock selection. Next slide, please. This is a top 10 holdings by absolute weight. Next slide, please. So, let me talk about the one contributor -- one strong contributor for the Trust, Sanki Engineering. Because we have a positive view on the Japanese equity market from the long-term viewpoint, because there are two structural tailwinds in Japan. One is inflation, another one is the corporate governance improvement. And this stock is a good example that the inflation and the corporate governance improvement work as a strong tailwind for the corporate earnings as well as the share price performance. Sanki Engineering is a small cap constructor -- sub-constructor, focusing on air conditioning or electric wiring in office building or a factory. And that area of the segment has a very tight supply-demand balance of the capacity. So that, Sanki Engineering has a pricing power. So, in other words, Sanki Engineering is a beneficiary of the inflation in Japan. So, as a result of the pricing power on the bottom left table, on the dark blue line -- dark blue line shows that the gross profit margin of Sanki Engineering along with deflation in the Japanese economy, which provides a huge pricing power for the Sanki Engineering. Gross profit margin of Sanki has been significantly improved from 15% to above 20%. That led to the significant improvement in the underlying earnings. And because of another trend of the corporate governance structure trend, I mean, corporate governance improvement in Japan, Sanki Engineering significantly improved the shareholder remuneration along with the improvement in corporate earnings. So, this bar chart, I mean, green and the blue bar chart show that the shareholder remuneration is a dividend or share buyback by the Sanki Engineering. As you can see, we saw a huge jump in the shareholder return for the Sanki Engineering on the back of the strong earnings growth. And as a result, as you can see on the top right-hand side chart, share price performance for Sanki Engineering, because of the inflation and because of the corporate governance improvement, Sanki Engineering share price has been significantly outperformed the market. So, that's one of the good example of the underlying driver of the market. I mean, inflation and the corporate governance to significantly benefit the company like Sanki Engineering. Now that's the kind of the stock we are looking for through the bottom-up stock selection. So, that's a key feature of the Japan Trust and the overall performance for the last 1 year. Thank you.

So Masaki, that -- the performance generated by some of those mid-caps, it looks really quite interesting. Perhaps you could develop that theme a little bit more and talk about some of the strengths that we at Schroders can use to exploit these opportunities.

Yes. So one of the key advantage of Schroders, we have a local-based analyst team and through other carrier analysts, who have been covering their company for the quite a long period of time, even in the mid- to small cap space. So, having the local resources, local deferred research resources, especially in the mid- to small cap space is one of the key advantage we have as the Japanese equity fund manager. Yes. So, in terms of the current positioning of the portfolio, overall portfolio positioning remains largely unchanged. So, we continue to have a style bias towards mid- to small-cap and the value. So, this chart shows that last year performance by size and the value. So, as you can see, light blue line, small-cap value was the best performing style for the last 1 year, which is clearly work as a tailwind for our fund. Next slide, please. Despite the good outperformance of the small-cap and value stock, we maintained the style bias towards the small-cap and value, because this chart is a relative variation of the small cap against a large cap measured by the price to earnings ratio. So, as you can see, despite the strong outperformance of the small-cap, small-cap remain relatively inexpensive or cheap against a large cap from the -- compared to the historical average. So, even after the strong performance of the small cap, small cap remains attractive relative to the large cap. So that, we maintain the style bias towards the small-cap. Next slide, please. So, when we talk about the individual stock contribution, I mentioned about the thematic driven market. So, especially in the early part of this year 2025, so, what I mean by that, that in a very uncertain macro environment under the Trump's tariff, markets tends to move to the desirable or visible themes like gaming and IP growth or defense or AI. And the people buy up and -- people market and -- people buy up and bought up some of the frothy of that thematic -- that theme. And that led to the two phenomenon. First one, shown on the left-hand side, increase in the market concentration. So, this dark blue line shows the level of the market concentration. So, as you can see, for the last 1 year, market concentration was quite high. So, some of the market performance was led by the selected number of the large cap store, which met with some of the key theme. And that led to the huge variation of the proxy of that thematic stock. On the right-hand side, dark blue line is the variation of the Mitsubishi Heavy, kind of the proxy of the defense stock. Green line is the Nintendo proxy of the Game, and the light blue line is the Advantest proxy of the AI. So, for the last 6 months or so, because of the thematic-driven market, some of the large cap proxy type of -- some of the large cap variation have been expand significantly. So, that is a -- was a bit of a challenging environment for us. But we tend not to follow that type of trend. Instead, we are looking for a much more interesting or cheaper opportunity to have exposure to such type of theme. Like in the case of the defense, we don't own the Mitsubishi Heavy, but we do own the Mitsubishi Electric. Mitsubishi Electric is a key component supplier for the Mitsubishi Heavy defense business. So that, Mitsubishi Electric can benefit as much as the Mitsubishi Heavy in the increase -- from the increase in defense spending, but the valuation is much cheaper. And the Mitsubishi Electric itself is having the internal changes, which is under the new management. So, in that sense, we think that Mitsubishi Electric is much more interesting investment idea. So that, we maintain such type of approach. And as a result, as we talked in the performance section, despite such a tailwind -- sorry, headwind in the thematic-driven market, we successfully managed to generate a sufficient alpha from the bottom-up stock selection to lead to the outperformance of the fund. Next slide, please. So that's also shown in this chart. On the active share, left-hand side, we maintained the high level of active share, 76%. Right-hand side, light blue bar is the overall market topics and the dark blue bar is the portfolio by market cap breakdown. So, as you can see, we maintain the overweight stance for the mid- to small-cap space. So, we maintain the high level of active share to generate sufficient alpha from the bottom-up stock selection, especially in the mid- to small-cap space. Next slide, please. So, in terms of overall valuation of the portfolio on the right-hand side, compared to the overall market topics, we -- our portfolio have a higher dividend yield, lower price to book, lower price to earnings. So basically, our portfolio maintains a value style bias. So, that's our overall portfolio positioning of the Trust. Thank you.

Thank you, Masaki. So, our shareholders can expect the mid-cap domestic bias to continue on the portfolio that's generated some very strong performance, but also we've got the people on the ground in Tokyo who are able to exploit some of those opportunities. That's really good to hear. Now, ladies and gentlemen, there's still time to ask questions. We have quite a few already. But if you have any questions, please submit them on the app. I'm going to ask Masaki now to turn to the macro background and the relative attractiveness of the Japanese equity market and the economy for investors. So, Masaki, let's talk a little bit more about the macro environment, please.

Yes. Okay. So, in terms of the macro environment, we'd like to initially touch up on short-term outlook and long-term outlook after that. So, in terms of the short-term outlook, -- so along with the other equity market, Japanese equity market showed a very strong rebound after the initial tariff shock. So then, a natural question arises. So, how much upside there remain? So, our answer is that considering the next year earnings outlook, there are still some upside in the overall market. So, if you can please go to the next slide. So overall, some stabilization of macro concern, tariff concern about the tariff, overall earnings expectation hit the bottom in early this year. That leads to the rebound in the overall market. On the left-hand side, green line and the dark blue line is the earnings expectation, year-over-year earnings growth for this year and the next year. As you can see, around May to June, earnings estimate hit the bottom and now show some demand and reflecting that improvement in earnings expectation, light blue line TOPIX overall market performance shows a strong rebound. But on the right-hand side, from the valuation viewpoint, based on the next year earnings estimate, currently, overall market is being raised up around 15x to 16x price to earnings ratio, which is a high end of the historical range. So, probably we may not see the further expansion on the earnings multiple. In other words, from here, market performance is more dependent on the underlying earnings growth, especially for the next year. So question here is that, how much earnings growth we can expect for the next year. Next slide, please. So on the left-hand side, next year, 2026, currently, market consensus is assuming roughly 10% earnings growth, which is solid. And if we breakdown that contribution to the 10% earnings growth for the next year, it comes from the very diversified sector. So, left-hand side shows us some breakdown. So, out of the 10% earnings growth, half -- I mean, 5 points coming from the quota, shown on the dark blue bar. And the next 2 percentage points come from the material sector, global commodity shown in the light blue; and another slightly below 2 percentage points coming from the financial year over; and the last 1 percentage point coming from the domestic cyclical. So, next year earnings coming from the very diversified sector. So, then do they have a solid driver to realize such a strong earnings growth? To which, our answer is yes, we think so. Next slide, please. So, starting with the exporter and material, I mean, global commodity. So, export going to contribute half of the earnings growth next year and the material represent roughly 20%. So, in terms of exporter or global material, underlying business environment remains relatively resilient. On side of the chart, this chart shows that the global trading volume measured by the world export. So, as you can see on the green line, year-over-year growth, despite a lot of the tariff or something like that, global trade shows that the positive growth shown the resilience, that's going to support the earnings growth for the exporter into the next year. And if we move into the next year, we have a much better -- much lower hurdle for the tariff. So for example, on the right-hand side, so this year, I mean, 2025, we're just measuring the tariff impact on major automotive company, just nine automotive company tariff impact has a minus negative 30% year-over-year earnings growth for them in this year or 4% negative impact on the overall Japanese corporate earnings. That kind of a negative impact going to dissipate for the next year. So, that creates a much easier hurdle for the exporter and the global commodity company to show the solid earnings growth in the next year, especially under the relatively resilient global trade environment. So, that supports the earnings growth for the exporter and the global commodity company into the next year. Next slide, please. So, in terms of moving to the domestic side, domestic cyclical company like retailer. So, on the left-hand side chart, the dark blue line is the real wage growth, so inflation adjusted wage growth. Finally, we started seeing that the positive real wage growth into the next year. That provides a strong support for the consumer spending and that could provide a strong support for the earnings growth for the domestic cyclical company like a retailer into the next year. In the case of the financial, we continue to see the normalization of the monetary policy. I mean, I continue to expect the rate hike by the Bank of Japan. So, currently on the right-hand side, this bar chart shows that the number of the BOJ rate hike in the market discounting in the market. So, up until the end of the next year, we may see another 2x of the rate hike by the Bank of Japan, that's going to support the earnings growth for the financial. So, all in all, next year, we are expecting roughly 10% earnings growth for the Japanese company. Coming from the broad range of the sector, exporter, global commodity, domestic cyclical and the financial. And all of those sectors have some solid base to realize such a solid earnings growth into the next year. So, given -- so in that sense, we maintain that we think that there still remain upside in the Japanese equity market, led by the solid corporate earnings into the next year. Next slide, please. Next slide, please. Underlying inflation trends remain quite positive in Japan. So, we have -- we continue to have about 2% inflation, which is important because corporate earnings is nominal. I mean, nominal means that the combination of the volume growth and the inflation. So, that's why on the left-hand side, equity market performance on the dark blue line is highly correlated with the nominal GDP shown green line. So nominal GDP take account of the inflation. So, on the right-hand side, dark blue line is the real GDP, I mean, the volume growth. And the green line is the nominal GDP volume growth plus inflation. So as you can see, clearly, over the last couple of years, we saw the outperformance of the nominal GDP against the real GDP because of the inflation. That is a clear support for the performance of the overall Japanese equity market as well as the corporate earnings. So, that's the overall macro picture.

Well, so that's great news there, Masaki. So we've got decent corporate earnings outlook. We've got rising wage growth. We've got inflation, which is benign. This represents quite a good backdrop for Japanese equities from what I can see. Let's talk a little bit more about the corporate governance, because I know this is something you've got really quite excited about over the last couple of years. I know, we've been talking about it for perhaps a little bit longer, but it's -- I sense it's starting to have real teeth now and having a positive impact on the equity market. Can you tell us more about that, please?

Yes. So, in terms of the corporate governance, it has been evolving a pretty good way. Next slide, please. Obviously, because of the corporate governance improvement, each individual company has been improving the shareholder remuneration is measured by the dividend as shown on the left-hand side. We are continuing to have a record high level of dividends payment as well as the share buyback. On the right-hand side, we continue to have a historical high level of the share buyback plan each year for the last 3 consecutive years. But the story doesn't end here. Next slide, please. Because of the corporate governance improvement, we are starting to see that improvement in the capital allocation in the Japanese equity market or Japanese economy as a whole, which going to support the further improvement in return on equity for the overall Japanese equity market. So, for example, on the left-hand side, this dark blue bar shows the number of the listed company in Japan. So, up until 2023, we always have a more number of the company listed in Japan. But finally, in the last year, first time in the history, we had this number of listed company in Japan, and we are on track to have this number of listed company in Japan in 2025. Why is that? On the right-hand side, reasons for delisting. Important thing that the dark -- sorry, green bar M&A, merger and acquisition. So, parent company fully acquired the listed company or private equity company. Those are LBO or MBO to take out of some of the underperforming company or industry consolidation. So, M&A activity has been picking up company for the last 7 or 8 years. So, that led to the less number of listed company in Japan and a much better capital allocation for the Japanese economy or Japanese equity market as a whole. So, that should lead to the further improvement in return on equity. Next slide, please. So historically, despite the steady improvement in EPS, because of somewhat lag in capital allocation improvement, ROE has some ceiling around 9%. But given what we saw in economy-wide improvement in the capital allocation through, for example, merger and acquisition, we expect that the Japanese ROE will break out that fee of 9% and that could go higher, that, that may lead to the further devaluation for the Japanese equity market over the long term. So, that's one of another structural tailwind for the Japanese equity market. Yes.

That's really quite interesting. In fact, we just had one of the questions in was saying, so why now? Why are Japanese boards more willing to embrace M&A activity or M&A and then dispose of their cross shareholdings in the way they are doing. What's been the -- why is the change of attitude, which wasn't there maybe sort of 5, 6, 7 years ago?

So, corporate governance improvement started with the introduction of the corporate governance formed in 2014. Yes. Since then, all of the interested party, I mean, corporate, regulatory body like Tokyo Stock Exchange and investor are steadily improved -- steadily working closely each other to improve the corporate governance and improve the overall return on equity of the Japanese equity market. And the mindset is clearly converging among those interested parties. So, that all the corporate management, Tokyo Stock Exchange or investor think that we need to improve the capital efficiency for the Japanese equity market or individual company. That type of the mindset is driving the management to make an effort to further improve the return on equity or growth prospect by their own effort and the market appreciate such company and the corporate see the positive reaction by market and further accelerate that effort. So, that's a very good type of effort among the interest party, in terms of corporate governance improvement. Yes.

Okay. That's great. Well, look, ladies and gentlemen, we are moving into the question-and-answer session now. We've had a couple of questions come through on the app. But one question I've got for Masaki, which I'm sure a few of you may have out there is the political situation. Now you may know that Mrs. Takaichi was appointed Head of the LDP on Thursday, Friday last week, and the stock market raced ahead really quite strongly. However, there seems to be some problems with the coalition that, that LDP are party to0. And since then, the -- some of that euphoria has dissipated. So Masaki, what will this mean for Japanese equities going forward, because it seems to me that the market was quite excited about the appointment of Mr. Takaichi. Can you comment, please?

Yes. So honestly, so Japanese political situation is now quite uncertain. So as they pointed out, Ms. Takaichi became the leader of the LDP, one of the ruling party -- one of the ruling coalition party. But Komeito, junior coalition -- junior member of the coalition party decided to leave the coalition. So, that is quite uncertain if Ms. Takaichi can become the Prime Minister in the upcoming emergency dive-in. So, but even though that the political situation is quite uncertain, I should point out two things. One, ruling party as well as the opposition party, almost all the parties in Japan has more -- has a bias towards physical stimulus. So, we don't know that how the coalition effort is going to end up. But whatever the combination is, it is quite likely that any ruling party -- ruling coalition party going to be up a more political bias towards the fiscal stimulus. So in that sense, political background, fiscal policy or monetary policy remain quite supportive for the Japanese economy whoever the Prime Minister or whoever the new coalition -- new ruling party is. And another thing I have to point out that, I have been saying that the inflation and the corporate governance improvement are the two structural positive tailwind for the Japanese equity market. And both drivers are somewhat independent from what's happening in the political environment. So, as we talk about the corporate governance improvement, initially, it was started by the government. But now, it is a whole wide effort by corporate regulatory body and investor. So, whoever the government is or whoever the Prime Minister is, plan towards the corporate governance improvement. We never stop. And probably so as the inflation, given consistently tightening the supply-demand gap in the Japanese economy. So, political environment is quite uncertain, but whatever the outcome is, political background, I mean, fiscal policy, monetary policy, remain supportive for the Japanese equity market and the Japanese economy. And the inflation, corporate governance improvement continue to evolve positively, whatever the political outcome is. So, that's our message, yes.

Okay. Well, that's reassuring to know. So, that despite the political uncertainty, which, to be fair, there's been quite a bit in Japan over the years, the stock market still represents an attractive proposition with the inflation and corporate governance improvements that we're seeing almost independently of the political situation. Well look, we've got, ladies and gentlemen, time for just one or two more questions. We've had a question in from one of the viewers saying, can Masaki comment on the threat of Chinese competition to manufacturing firms in the fund? Obviously, that's quite a big element of the portfolio. So Masaki, Chinese competition impacting some of your wonderful Japanese companies. Do you have any comment there? What do you think the threats really are?

Yes. Some of the end product like electric vehicle or some of the machinery, yes, we do see a competitive threat from the Chinese company, especially in the local market in China. So in that sense, Chinese local manufacturer either automotive or machinery company, clearly catching up with some of the Japanese companies. So, that's a threat. But at the same time, still some of those competitive Chinese companies rely on some of the key components from the Japanese manufacturer. So, in that sense, some of the Japanese component manufacturer, I mean, enabler for the Chinese company could benefit from the improving competitiveness by the Chinese local market. So it's good and bad. So, if you cannot differentiate your product against the Chinese local company, yes, it's going to be quite difficult for the Japanese company to survive. But even under that situation, there are some key components that the Japanese company maintains a strong competitiveness. For example, FANUC is one of the largest robotics company. So, we could do feel some competitive threat in some of their machines, especially in China. But at the same time, they are providing some of the key component and machines to those companies. So, on the one hand, they are competing with. On the other hand, they are benefiting from that. So, that's sort of the situation that the Japanese company competing with the Chinese local company. Yes.

Okay. So possibly, there's a few more, Fujikura is out there that, that you can benefit from.

Yes, we did. Yes.

That's good. Okay. Wonderful. Ladies and gentlemen, we're coming to the end of our time now, but we've got time for one more question. We've had a question about the yield on the portfolio, which is a 4% paid half yearly. So Masaki, does the yield have any impact on the way you run the portfolio? And how do you generate that yield?

Short answer is, no. 4% payout policy, we recently introduced, doesn't have any impact, not by investment approach or investment philosophy. As we talked, our portfolio currently generates a 2.6% dividend yield, but we also have some top-up by share buyback as we talked. And that type of the dividend payment or share buyback, we continue to see the improvement on the back of the corporate governance. And that provide us a sufficient buffer to support the 4% yield for the Trust, yes.

Okay. Wonderful. So, great performance on a 4% yield. Wonderful. Thank you, [ Keith. ] That's good to see. Well, ladies and gentlemen, let's draw this morning's proceedings to a close. Thank you all for your questions. Thank you for taking the time to dial-in to listening to Masaki's update on the Schroder Japan Trust Fund. Please do give us some feedback. If you find this useful, let us know. If there's more aspects, other things you'd like us to talk about for the future, we're always looking for ways to improve, please let us know as well. Masaki, thank you so much for joining us this morning. It's your evening. Have a good evening. Thank you very much. We'll see you soon. Ladies and gentlemen, let's bring things to a close. Thank you. We'll see you all and good afternoon -- sorry, good morning.