Despite all the concerns about the world economy and the perception that Japan is very dependent upon global growth, Japanese economic statistics in 2019 were generally positive. GDP growth for the January-March period significantly exceeded expectations at 2.2 per cent annualised and held up reasonably well in the following quarter, boosted by high levels of consumer spending during the 10-day public holiday in May. The labour market hit a 30-year high and the tourism sector continued to thrive, despite the yen rallying over the course of the year, benefiting from its status as a traditional haven for risk-averse investors. Elsewhere in the domestic economy, the real estate market continued to go from strength to strength. Data released in September showed that the Tokyo market had enjoyed its 68^th consecutive month of rental growth. As the period ended, a bidding war broke out for a small real estate company called Unizo. Real estate stocks in Japan have looked attractive to us for a number of years. If the big US funds are getting involved in the sector, we might be getting closer to seeing some of that value realised.

Nonetheless, despite this benign backdrop, foreign investors continue to shun Japanese equities. This was confirmed by the Tokyo Stock Exchange annual share ownership study, which showed that foreign ownership of the market had dropped below 30 per cent (as at 30 June 2019). Whilst investors remain focused on the global macro environment, it would be naïve to expect them to suddenly focus on the profound undervaluation of individual Japanese stocks. However, the disconnect between the quality of individual companies and the valuation ascribed to them by the market is increasingly striking.

With global bond yields falling in reaction to global growth concerns and investors focused on finding predictable earnings streams in a low-growth world, the market extended its multi-year clamour for defensive growth stocks, so called ‘expensive defensives’ or bond proxies. This continued to present a major style headwind for our ‘value’-biased Japan and Japan Dividend Growth equity strategies, and both approaches underperformed markedly over the year. It is worth noting, however, that ‘value’ stocks did enjoy a long overdue rally in September as global bond yields rose. Although one month clearly does not make a trend, the strength of this market rotation demonstrated the performance potential in ‘value’ names after years out of favour.

Looking in more detail at our strategies, our Japan fund focuses in particular on small and mid-cap sections of the market and is a concentrated portfolio of typically 40-60 undervalued names with strong balance sheets. Over the year, the Fund’s sector tilts added value in aggregate, with our significant overweight in the strong performing real estate sector contributing well to relative returns. The positive effect from sector allocation was not enough to offset negative stock selection, however. Weakness came from the portfolio’s construction, manufacturing and transport, and communications names, areas of the market where we see palpable value, particularly in companies primarily exposed to the domestic economy rather than export-focused firms.

Our large-cap Japan Dividend Growth Fund (JDG) incorporates a blend of dividend growth and dividend yield that taps into increased demand from Japanese institutional and retail investors for higher-yielding equities. It was a similar story for the JDG strategy. The divergence between company fundamentals and share prices widened as investors continued to pile into over-owned growth names, seemingly irrespective of their lofty valuations.

Over the summer, we have continued to build positions in undervalued domestic companies that we believe are largely immune to the current global economic uncertainty. The global macro funds are not interested in Japan at present, but looking at the market from the bottom up, as we do, there are many reasons to get excited about Japanese stocks. Whilst the general view is that growth can only be found in a very few Japanese sectors such as cosmetics, pharmaceuticals and IT, there are many companies in other sectors offering equally attractive growth rates trading on much lower valuations.