e-fundresearch: "Which facts are relevant in the current market environment to value Japan Small/MidCap stocks?"
Tadahiro Fujimura, Fondsmanager, "Swisscanto (LU) Eq Fd Small & Mid Caps Jap B" (24.11.2011): "Currently small-cap stocks, relative to the large-caps, are underperforming due to profit-taking following an increase in their share prices in September. In our opinion, the underperformance against larger cap may continue at least till the end of the year when many funds close their fiscal year. Also, in our opinion, investors may favor larger caps against smaller caps due to attractive valuation like small and mid caps, better liquidity and lower credit risk within the environment that many investors are still concerned about the lingering problems in Europe."
Weijun Yin, Produktspezialist, "Allianz RCM Japan Smaller Companies - A - EUR" (25.11.2011): "Price to Book value is a useful tool in these circumstances. PER, which relies on earnings, may be misleading given unclear earnings visibility. Therefore, PBR that uses book value is more appropriate.
Of course it depends on each stock; i.e. for a cyclical company, PER may not work, but in the case of a non-cyclical company that has high earnings visibility, PER can be used. Dividend yield can be good as well.”
Max Godwin, Fondsmanager, "M&G Japan Smaller Companies A Inc" (21.11.2011): "Valuations for Japanese equities are now attractive compared to its history as well as versus the rest of the world for the first time in a generation. Importantly, history shows that low company valuations tend to rise back to their longer term average, and we believe this will drive future equity market performance in Japan. At the same time as historically cheap valuations, companies have now reduced leverage and strengthened balance sheet health. For example, corporate Japan is now consistently generating strong free cash flow. This is typically used to invest in new businesses, repay debt, and return value to shareholders in the form of dividends and buy-backs. There are three main considerations for investing in smaller companies over the broader market which are:
1) Japan smaller companies are arguably a bigger bargain than large cap stocks as we can identify companies that are priced at a greater discount to their medium term sustainable earnings potential.
2) Japan smaller companies are significantly under-researched by the asset management industry as they are ‘out of fashion’. This leads to price inefficiencies in the market and this is precisely what our investment approach aims to exploit. We believe this is a great investment opportunity.
3) There is very a wide universe of ‘smaller companies’ to screen for investment opportunities, which in turn offers diversification.
The smaller company universe in Japan offers broad exposure to domestic and foreign consumer demand, domestic and global capital goods demand, services, and defensives, which is similar to broader market indices. The small cap market universe is not only deep – we currently screen more than 2000 companies – but it is also diverse."
Ayumi Kobayashi, Fondsmanager, "Schroder ISF Japanese Smaller Companies A Acc" (22.11.2011): "Our measures to assess valuation are straightforward. We see PBR as underlying valuation support, which indicates downside risk. As a primary valuation indicator, we use PER based on current and "normalized" (cyclically adjusted) EPS level."
Kevin Chen, Fondsmanager, "AXA Rosenberg Japan Small Cap Alpha B JPY" (22.11.2011): "Mid Small cap equities are an untapped source of excess return. Typically, they tend to have a stronger growth profile given their higher cyclical exposure. In general, we have observed that they are also far less researched while still offering sufficient liquidity. Japan mid/small cap equities as a group are currently among the highest yielding assets in the world, which is important during periods of low interest rate environment
Current valuation suggests a long-term buying opportunity, in a very uncertain short-term market. Japan mid/small cap delivered the strongest earnings growth within the regional mid/small cap asset class, as well as, higher realized earnings yield growth compared with its larger counterparts over long term (figure 1). Japan mid/small cap is less correlated with the global economy than its larger counterparts which are more sensitive to the global economic movement. Hence Japan mid/small cap serves as an asset class that can be used to hedge against global economic uncertainty (figure 2).
Figure 1: Realised earnings yield growth
The chart was built by plotting the realised earnings yield growth of small cap (defined as the bottom 20% by capitalisation of the Japan Universe) less the realised earnings yield growth for large cap (defined as the top 20% of the Japan Universe of stock) from Sept 2000 to Oct 2011. At 31/10/2011 the universe included 3023 stocks.
Source AXA Rosenberg
Figure 2: Trailing 12 month returns Japan Small Cap/Japan Large Cap compared to world index
The chart represents the 12 months trailing return of Japan small cap relative to Japan large cap (red line), as previously defined, as well as the trailing 12 months return of global equities developed markets universe composed currently of 14330 stocks."
Source: AXA Rosenberg
e-fundresearch: "What is your expectation concerning the relative performance of Japan Small/MidCaps over the coming 6-12 months?"
Tadahiro Fujimura, Fondsmanager, "Swisscanto (LU) Eq Fd Small & Mid Caps Jap B" (24.11.2011): "Although we are less optimistic due to the overseas risks, we remain bullish on Japanese small and mid caps due to expectations for a recovery from the disaster and the market’s inexpensive valuation. For the next 6-12 months, some domestic sectors are expected to benefit from reconstruction demand in the damaged area under new Prime Minister Noda who is more willing to compromise when dealing with opposition party. In addition, small and mid caps’ less exposure to European markets compared with the larger caps may help limit their downside risk."
Weijun Yin, Produktspezialist, "Allianz RCM Japan Smaller Companies - A - EUR" (25.11.2011): "We are bullish on Japan Mid&Small because this is less affected by the global economy or markets.
The mid and small sized companies that focus on niche business areas can grow regardless of global economy condition. The current PBR of Topix Small index is the second lowest over the past 20years, following the time of Lehman shock.”
Max Godwin, Fund Manager, "M&G Japan Smaller Companies A Inc" (21.11.2011): "We continue to see considerable valuation support for Japan equities, which will drive future performance. General market expectations remain low and company projections continue to be conservative. As a result, any positive news is likely to surprise the market to the upside. In general, small to medium sized companies have continued to outperform their larger peers in 2011. However there exists significant opportunities for disciplined valuation driven investors, such as ourselves, as there remains a long tail of companies whose shares trade at very attractive levels relative to their own history and to the broader market. Japan is not immune to the high levels of volatility evident across markets globally and we believe it is inherently problematic to accurately forecast future market performance, especially in the short term. In the medium term, we believe that there is a compelling investment opportunity, especially for investors like ourselves. Whilst we do not claim to have an edge in market timing or forecasting company returns, we will continue to play to our strengths, namely the disciplined and patient application of our investment process by focusing on company valuations and fundamentals."
Ayumi Kobayashi, Fondsmanager, "Schroder ISF Japanese Smaller Companies A Acc" (22.11.2011): "Relative performance of Japanese small caps versus Japanese large caps largely depends on macro condition as large caps have more exposure to exporters. It is possible for small-caps to temporarily underperform large-caps in the first few months of market recovery, though we expect small-caps to eventually catch up. Regarding relative performance in the world stock market, we think Japanese equity has a good chance of outperforming others for next 6-12 months on the back of the attractive valuations and better shape of economic recovery in 2012 versus other developed countries."
Kevin Chen, Fondsmanager, "AXA Rosenberg Japan Small Cap Alpha B JPY" (22.11.2011): "Since the middle of 2010 through June 2011, Japan mid/small cap in general has been demonstrated superior earnings revision with more upward than downward revision as compared to other regional mid/small cap asset classes. The only exception is in June 2011, we think mainly due to the March 11 earthquake and tsunami that resulted in disruption to local supply chains. However, in the third quarter ending September 2011, the outlook for equities deteriorated significantly due apparently to the perceived sovereign risk of countries that were previously believed to be relatively safe, the outlook of significant tightening in the US fiscal policy and the slashed global GDP growth forecast. Subsequently, all mid/small cap asset classes had a negative net revision with the exception of Japan small cap. At present, we feel the asset class should be more leveraged to take advantage of an upturn due to their more cyclical mix at a time when capacity utilization remains well below historical averages with high opportunity for earnings expansion. Many commentators believe that Japan is expected to have the highest GDP growth amongst developed nations in 2012 following March’s devastating earthquake. We think Japan’s mid/small companies stand to be prime beneficiaries of the country’s reconstruction drive because of their more domestic/local nature (figure 3) This bodes well for their near- term profitability."
Figure 3: Japan Mid/Small companies classification – Global/Local
Question 3
e-fundresearch: "Which are the most important elements in your investment process?"
Tadahiro Fujimura, Fondsmanager, "Swisscanto (LU) Eq Fd Small & Mid Caps Jap B" (24.11.2011): "We believe our direct-research approach is extremely effective and is the most important element in finding attractive value gap situations in mid and small caps. Meeting with top management is one of the most effective approaches to understanding a company´s business model in an effort to determine intrinsic value. The influence of top management on a small company´s business and future direction is much more important than that of large cap companies. The information gap between publicly available information and information obtained from direct research is huge. Our 21 years of direct research experience enables us to identify not only new growth opportunities, which most small cap managers tend to identify, but also re-growth opportunities which are companies that suffer a temporary slump in earnings and trade at cheap valuations as illustrated below. With this approach, the portfolio has a blended style of growth and value which we expect will provide consistent outperformance during phases of a market cycle."
Weijun Yin, Produktspezialist, "Allianz RCM Japan Smaller Companies - A - EUR" (25.11.2011): "We think there are three alpha generation factors; Earnings surprise, Trend Line and Perception gap.
- Earnings surprise refers to a quarter earnings´ positive number against street consensus. This will be a positive surprise and boost the share prices.
- Trend Line is the underlying potential growth rate from a long term perspective. If we can confirm the solid trend line, the share price will go up as well, in accordance with the EPS growth from a view point of long term investment.
- Perception gap is a difference of market participants´ perception and our analysis on a company. If we are more bullish on a company´s fundamentals strength and earnings forecasts than the other investors (and if we are right), it is a good chance for investment. In particular, the small caps tend to be ignored (due mainly to little coverage by sell-side analysts and low liquidity), which could lead to false- perception of a company.”
Max Godwin, Fund Manager, "M&G Japan Smaller Companies A Inc" (21.11.2011): "We are disciplined and price-sensitive investors who make decisions on material price changes relative to longer term earnings based valuations. Our small team has deep experience and our valuation framework drives our approach to identifying high conviction opportunities. We focus our research efforts solely on high conviction ideas screened from a wide universe of over 2000 companies. We don’t perform maintenance research across the investment universe which differentiates us from many of our competitors. We aim to buy shares trading at significant discounts in companies where we have a high level of conviction around the sustainability and level of the company’s longer term earnings. Today’s volatile markets can be useful in providing such opportunities. Whilst we are price sensitive we are distinguished by our longer-term investment horizon. Our valuation driven approach often identifies high conviction stocks which may be deemed contrarian to shorter term market consensus views. However we are willing to be patient and if need be we will hold our highest conviction investment ideas for the longer term in order to capitalize on mis-priced opportunities. Whilst short term market movements are likely to be unpredictable, history has shown value investing to significantly outperform other investment styles over the longer term. We believe this distinguishes our approach from many of our competitors, and the finance industry in general, who tend to focus on the very near-term. The most important point is that we are continually focused on uncovering the most undervalued companies based on their likely level of sustainable longer term earnings and we are therefore well positioned to capitalize on changes in market conditions."
Ayumi Kobayashi, Fondsmanager, "Schroder ISF Japanese Smaller Companies A Acc" (22.11.2011): "We use bottom up fundamental research. We focus on finding gaps between current market price and intrinsic value, which is identified by our research activities."
Kevin Chen, Fondsmanager, "AXA Rosenberg Japan Small Cap Alpha B JPY" (22.11.2011): "We believe in the power of comprehensive and unbiased information for investment decisions. Our expert system overcomes many of the limitations of human decision making by enabling us to evaluate information on a global universe of up to 21,000 stocks (data permitting) with greater efficiency than could a traditional fundamental manager who does not employ similar systematic methods. It is our conviction that this is a particularly strong advantage in the small cap space where analyst coverage of companies is often limited and information is harder to obtain. The investment process, which is based on over 25 years of experience, is applied globally and implemented locally by experienced investment teams based in the US, Europe and Asia. The process currently generates views on approximately 21,000 companies from which broadly diversified portfolios are generated. The AXA Rosenberg investment philosophy has remained constant since the formation of the company in 1985, namely that: Company fundamentals and earnings ultimately drive price performance and therefore by identifying and investing in companies that display superior fundamentals at an attractive price, it is possible to add value. For this philosophical premise to be valid, markets must be efficient but not perfectly efficient at pricing stocks. So, whilst on average the price of a stock will reflect the market’s consensus view of the stocks’ ability to generate future earnings, there will be times when stocks are either under or overvalued relative to this fair value, and it is these mispricings that AXA Rosenberg seeks to identify and exploit. AXA Rosenberg believes that it is difficult to time markets or sectors consistently and as a result seeks to add value purely from stock selection rather than top-down asset allocation. The stock selection approach, which can be characterized as a systematic implementation of the traditional analyst’s methods, seeks to estimate the fair value per share for every company. This is done by estimating the market’s valuation of each component of company value to identify companies that are trading at a premium/or a discount to the value of the sum of their parts. In the context of Japan’s smaller companies, we have found that our disciplined valuation approach has been a significant source of outperformance over the long term. Our studies show that reward to valuation characteristics has been a particularly important driver of stock performance over the long term in Japan."
Question 4
e-fundresearch: "Which over- and underweight positions in stocks do you have currently implemented in your fund?"
Tadahiro Fujimura, Fondsmanager, "Swisscanto (LU) Eq Fd Small & Mid Caps Jap B" (24.11.2011): "Portfolio construction is based on our bottom-up fundamental research. We see the portfolio as a result of our one by one stock picking. Please find top 5 active holdings as well as sectors (based on TSE 33). We intend to invest in the financially stable manufacturers such as Electric appliances names that have attractive valuation due to the oversold situation after a temporary decline in their earnings. In addition we like those names due to their growth opportunity on the back of the clean technology. We also invest in real estate related names that has attractive yields. Also, in our opinion, the rent in urban area has bottomed."
As of Oct 2011
Weijun Yin, Produktspezialist, "Allianz RCM Japan Smaller Companies - A - EUR" (25.11.2011): "We own low PBR and high dividend stocks that have long term high earnings visibility.
Our fund has tended to have a growth factor tilt, however, given the above strategy, the growth tilt decreased.”
Max Godwin, Fund Manager, "M&G Japan Smaller Companies A Inc" (21.11.2011): "We build fund positions on a bottom-up, stock by stock basis. Any sector biases are as a result of the bottom-up stock selection process. Traditional domestic defensive names such as utilities, food and railways are underrepresented in the fund compared based on their relatively expensive valuations. The fund has a bias towards selected retail, (Pal Co Ltd, Onward Holdings, and Komeri); real estate (Tosei, and Hajime Construction); I.T services (Meitec, and CAC Corp); and domestic services names (Fuji Media Holdings). The fund also has exposure to credit card companies (Credit Saison, and Pocket Card) rather than banks. The fund holds high conviction positions in companies that are sensitive to the global cycle including selected auto-related names (Ahresty, and NOK Corp) and electronic component names (MEC, and Iriso Electronics). Global basics names (e.g. resources, trading companies) are relatively expensive and underrepresented in the fund.
Ayumi Kobayashi, Fondsmanager, "Schroder ISF Japanese Smaller Companies A Acc" (22.11.2011): "We put weight on defensive growth stocks, such as health care and competitive exporters that can benefit from continuous growth of developing countries."
Kevin Chen, Fondsmanager, "AXA Rosenberg Japan Small Cap Alpha B JPY" (22.11.2011): "Given our investment process, AXA Rosenberg Japan Equity Alpha Fund has a strategic bias toward “value” stocks as defined by its overweight exposure to companies with an attractive Book to Price ratio. Aside from this consideration, the portfolio is currently well balanced across sectors and risk dimensions. We feel that attractively valued stocks can primarily be found among companies geared towards domestic demand. Such companies have been the prime beneficiaries of Japan’s reconstruction efforts following the devastating earthquake in March. Rising concern over global economic growth and the strong yen have led to a noticeable number of downward earnings revisions in recent months. The steepest downward revisions have taken place among export driven sectors. This trend has triggered a reduction in our exposure to market segments such as autos and auto parts, metal products, machinery companies and chemicals to underweight exposures. One of our recent sells in these areas is Nippon Soda, the producer of basic organic chemicals on to concern over its earnings outlook. To account for the deterioration of the global economy and the prevalent atmosphere of risk aversion, the strategy is overweight defensive areas of the market such as food, beverage, and retail. Food processing, distribution and convenience store owner Kato Sangyo is one of our favourite companies in this area given its attractive valuation (B/P of 0.70 and PE of 8.1X). Earnings guidance from the company and analyst forecast appear to be on the conservative side. The reduction of our underweighting in the financial sector towards a more benchmark like exposure is less conventional. Today, we believe companies in this sector carry a much lower risk as bad debt disposals and the unwinding of cross shareholding have been significant. While there are still some clouds over the horizon for the sector, the sectors look undervalued in terms of assets and earnings valuations. Our models are particularly keen on real estate development companies like Tokyu Land Corp in which our portfolios are overweight, a clear beneficiary of the reconstruction efforts on attractive valuations."
Question 5
e-fundresearch: "Please comment on the performance and risk parameters of your fund in the current year as well as over the past 3 and 5 years."
Tadahiro Fujimura, Fondsmanager, "Swisscanto (LU) Eq Fd Small & Mid Caps Jap B" (24.11.2011): "36 Months ended Oct 2011
Annualized Return: SWC +4.33% BMK +0.22% Excess +4.11
Tracking Error: 5.03%
60 Months ended Oct 2011
Annualized Return: SWC -9.31% BMK -11.24% Excess +1.93%
Tracking Error: 4.73%."
Weijun Yin, Produktspezialist, "Allianz RCM Japan Smaller Companies - A - EUR" (25.11.2011): "In 2011, the fund is outperforming. We had a tough time in August and September. After the earthquake, we positioned to pro-cyclical because we expected that the manufacturers can recover once they restore the supply chain. This story was right until August. The fund suffered from the "flash crash" of the market.
In September, the value factor beat the growth factor, which was a headwind of the fund as it tends to have growth tilt. We shifted to neutral in terms of sector allocation and growth/value factors, then the performance started recovering.
The fund has been outperforming over the past 3 and 5 years. The stock selection was the biggest contributor.
We want to maximize the stock specific risk and minimize unintended factor risks, therefore, we try to control the factor bias if they have too much impact.
Since middle of last year, we started decreasing the number of holdings (used to be around 50-60 names, and now it is around 40), because we want to bet more on the high conviction stocks so that our research strength can be reflected on the performance more clearly.”
Max Godwin, Fund Manager, "M&G Japan Smaller Companies A Inc" (21.11.2011): "Significant investment opportunities can arise in volatile markets, as stock prices are often driven to extremes. The period since 2007 has been one of significant volatility, not just in share prices but in market trends such as sector, style, and breadth. Throughout this period the fund has consistently delivered top quartile performance, which we believe is ultimately our proof statement around the success of the Team´s disciplined longer-term investment approach. In 2007 the market paid huge premiums for perceived certainty of near term earnings. Then in 2008-2010 it swung back and forth between a focus on companies linked to global growth and those of a more defensive nature. Each time we maintained our discipline and took profit as prices moved and we continued to add to shares in existing and new positions with the most attractive valuations. All this paid off throughout this period. Furthermore, the period after the Lehman’s crisis in 2008 and into 2009 posed a significant investment opportunity to us as contrarian investors. For many, the world as we know it seemed to be over. As a result of the losses in equity markets and uncertainty for the future, many investors were happy to pay a very high price for shares in companies that appeared to be “safer bets”. For example many investors paid significant premiums for defensive companies, such as utilities, in the hope of more certainty. During this time, we bought by contrast shares in a number of healthy cash-rich companies with strong balance sheets trading at extremely cheap valuations. Whilst we do not make sector bets, we found that a lot of our bottom up stock picks came from industries that were especially sensitive to the global cycle. Amongst these were auto-related companies that were so cheap they were priced for bankruptcy and technology-related companies that were trading on extremely attractive valuations. During 2010, as sentiment grew for the global outlook, many investors had begun to significantly favour companies that were sensitive to the global cycle global growth and these stocks had become expensive in our view. Early in 2011 we identified cheap valuation outliers which were out of favour and happened to be more domestic in nature. We were able take profit in the outperforming stocks to build high conviction positions in attractively valued domestic names. As concern for global cycle increased during 2011, domestic names in the fund tended to outperform. The domestic stocks in Japan were surprisingly resilient post the earthquake. During the third quarter of 2011 we were able to allocate capital away from outperforming domestic names and deployed the proceeds into high conviction positions that had underperformed including selected financials as well as in some underperforming technology-related names."
Ayumi Kobayashi, Fondsmanager, "Schroder ISF Japanese Smaller Companies A Acc" (22.11.2011): "As for past 3 and 5 years, our fund outperformed the benchmark (Russell Nomura Small Cap index) and the most of peers. Stock selection contributed largely to the positive performance. Regarding current year, our cyclical bias has been contributing negatively to a certain extent, and the fund has underperformed the benchmark so far. We stick to our bottom-up approach but are mindful about macro environment to avoid to taking undue risk."
Kevin Chen, Fondsmanager, "AXA Rosenberg Japan Small Cap Alpha B JPY" (22.11.2011): "The key foundation of AXA Rosenberg´s investment philosophy is our belief that over the long-term, company fundamentals drive investment performance. Specifically, we believe that, historically, in Japan equity markets (both large and small cap) stocks which exhibit attractive valuations and superior earnings have outperformed the market on average over the long term. Our stock selection models are designed to identify such stocks from which we seek to build portfolios with a superior earnings yield when compared to the benchmark.
Our proprietary Risk Model is intended to be fully integrated into our portfolio construction system. Our portfolios are constructed to represent the optimal return to risk tradeoff as identified by our Stock Selection and Risk Models within investment and other applicable constraints. After we have predicted returns for all stocks, data on the relative rankings are fed into an optimization program that builds the portfolio. The portfolio optimization system seeks to balance the trade-off between risk and reward relative to the client´s benchmark. The optimizer recommends positions in companies that in aggregate constitute the optimizer’s view of the most efficient portfolio.
As a result of this focus on earnings, in general we would expect our strategies to outperform when companies delivering superior earnings are being rewarded with higher share prices by market participants; that is when there is a positive relationship between superior earnings (relative to price) and stock prices.
Although we believe this link between earnings and stock returns has historically held over time, there are periods in the market cycle, when investors appear to switch their focus away from earnings and towards macro issues or market themes, for instance, without regard to price.
We often find these periods when investors seem to be turning away from a focus on earnings challenging for our active performance. Fortunately, these periods historically have proven to be unsustainable as, ultimately, investors tend to reconcile the earnings companies are delivering with the prices paid for their stocks over the long run.
The last three years in particular have delivered periods during which the relationship between earnings and price has been disrupted and this has affected our ability to generate positive active returns.
In 2011, aside from the period shortly after the earthquake when market participants appeared to take stock of the damages caused to infrastructure and production capacity which ultimately affected the earnings power of companies, investors have generally focused on fundamentals. The strategy’s “value” bias, as defined by its overweight exposure to companies with an attractive Book to Price ratio, has so far proved a positive driver of our relative performance year to date.
2010 was challenging for stock pickers like AXA Rosenberg – particularly the first part as investors appear to focused on the macro risk of recession and yen strength. These concerns subsided following a stronger than anticipated first-half earnings publication and a retreat of the yen; and in general, investors started to differentiate once again on valuation and earnings providing a much improved environment.
In 2009, concerns about the global economy and extreme volatility weighed heavily on markets and investor sentiment appeared more driven by emotions than by the fundamentals of valuations and earnings prospects. Underperformance was particularly acute during the 4th quarter when investors sacrificed valuation for high beta, leverage and more liquid/actively traded companies.
2008 proved a positive year for our Japan mid/small cap strategies, particularly in the first part of the year. Results from our stock selection provided strong returns as investors predominantly favoured attractively valued companies. The later part of the year proved more challenging as investors seemed to lose sight of the earnings power of companies as the global economic picture deteriorated."
All performance data per 14.11.2011
