PRESENTER: To discuss the Japan Equity Fundamental Active strategy from Daiwa SB Investments, I’m joined now by senior product specialist at the group Eiji Fukumuro. How would you define your investment style or approach?
EIJI FUKUMURO: This product is style agnostics giving us the freedom to generate alpha in different market conditions, which has worked in a very mature value-orientated Japanese equity market. Our investment approach is to effectively combine quality value and earnings momentum-focussed growth stocks to generate extra alpha.
PRESENTER: What’s the performance objective of the strategy?
EIJI FUKUMURO: The objective is to outperform the benchmark by more than 3% per annum on a calendar year basis and the benchmark is TOPIX on a total return basis.
PRESENTER: What are the key drivers of the idea generation process?
EIJI FUKUMURO: The main key driver is the profit growth, such as increasing recurring profits and EPS, and for example for value stocks we look for profit growth and attractive valuation, and for growth stocks we look for earnings momentum with effective growth indicators for different sectors and stock groups. Also macro and micro themes are key drivers in the idea generation process.
PRESENTER: And what’s the investment process?
EIJI FUKUMURO: We start with the whole universe of 3,600 stocks and we apply quants to it to remove illiquid and weak balance sheet stocks to be left with an investment universe of around 1,200 stocks. Then our sector analysts will conduct research on those stocks, focussing on major stocks in each sector, heavily invested stocks by our portfolio managers, as well as undervalued stocks as indicated by our proprietary valuation ranking model. Then the next step is our portfolio managers also conduct research jointly or separately with analysts, and they also cover stocks not covered by sector analysts. And Fundamental Active groups, their fund managers have a daily meeting to discuss research findings to decide on stocks to be included in our buy list, and separately there’s a monthly Japanese equity committee meeting, during which a sector allocation decision is made, which is overlaid to produce a model portfolio of maximum 150 stocks, and almost all the portfolios within the strategy we manage in the same way, subject to client specific guidelines. So that’s the outline of the investment process.
PRESENTER: And when you look at the attribution analysis on the strategy where’s the bulk of excess returns come from?
EIJI FUKUMURO: We generally say the source of excess return is 70% from stock selection and 30% from sector allocation, but the message we are trying to get across is that we try to get more alpha generation from stock selection rather than sector allocation. We take more risk with stock picks, which is where our strength lies, and the actual data suggests that more than 80% actually comes from a stock selection, and when you feel bullish about the market we tend to find more investment opportunities in mid and small caps to generate extra alpha.
PRESENTER: How do you alter the market cap exposure to benefit the portfolio?
EIJI FUKUMURO: Yes, when we feel more bullish about the markets, that’s when the opportunities for mid and small caps tend to increase. So we tend to increase the holdings in mid and small caps. So that typically happens in a sort of fundamentally driven and strong market environment. And in a bearish market we tend to take a risk-off situation, so we tend to stay in a large cap focussed portfolio without turning over the portfolio.
PRESENTER: What’s the investment team behind the strategy and what other resource can you draw on?
EIJI FUKUMURO: Okay, the team has five portfolio managers with an average investment experience of 15 years, and this team is led by a very experienced portfolio manager, Masashi Kamohara, who has over 26 years investment experience, and they’re supported by three research teams. One is the economist who provides top-down views and second are sector analysts, of which there are 13, and thirdly quants analysts, of which there are four who maintain our quants scores.
PRESENTER: What’s the sell discipline and what examples have you got of it?
EIJI FUKUMURO: Principally, there are four conditions when we decide to sell a stock. Our first one is if there’s a deterioration in company fundamentals, one good example would be the Tokyo Electric Power after the nuclear power plant disaster, and the second one is the change in the sector allocation strategy, which is a fairly standard one. A third one is when there’s a corporate governance issue, one good example may be the Olympus when there was accounting issue, and the final one is when a sector analyst gives sell ratings when we have to consider whether to hold the stocks that we have in the portfolio.
PRESENTER: How does the fundamental active approach link to what’s going on in the Japanese economy?
EIJI FUKUMURO: Well it’s very strongly I would say. As I mentioned earlier macro and micro themes are key drivers in the idea generation process.
PRESENTER: What are the current investment themes as of autumn 2014?
EIJI FUKUMURO: I would say there are three main themes. Our first one would be the increase in construction activities, especially with public works on the back of, maybe leading up to the 2020 Tokyo Olympics, and the second one is the recovery in capital expenditure, helped by improved corporate earnings as well as government subsidies, and third point would be the yen weakness beneficiaries, which is a more recent theme on the back of the expectation of an early interest rate hike by the US Fed. And many companies are still using ¥100 to the dollar for corporate earnings forecasts for the current fiscal year ending March 2015, and the current exchange rate is around ¥107 at the moment, so there’s quite a significant upside potential for export-related companies.
PRESENTER: You mention the yen, is that a source of risk or return to the portfolio?
EIJI FUKUMURO: Well, if you’re investing directly in yen share class, that’s not the issue; you’ll get a full benefit. Obviously investing in non-yen currencies you lose out from the yen depreciation effect, but we do offer hedged share classes. So you don’t have to worry about that.
PRESENTER: What qualifies your team to run a fund like this?
EIJI FUKUMURO: Well, we’d say we are very well qualified, the team is part of a very well-established domestic Japanese equity specialist investment house in Japan, and the product has won a number of awards from local consultants, and the firm also has been ranked number one for a number of years in a survey conducted by a leading pension consulting firm in Japan in the management of Japanese equities.
PRESENTER: Is there an advantage to running Japan money from Japan?
EIJI FUKUMURO: Oh definitely, I think we have a definite advantage over overseas-based Japan equity managers in that we have much easier access to company management and investor relations, and we can have sort of face-to-face meetings to ask questions directly, and we have also access to Japanese reports that not all get translated into English.
PRESENTER: What’s your outlook for the Japanese economy and how are you planning to take advantage of that?
EIJI FUKUMURO: At the moment, we need to see a clear sign of recovery post-consumption tax increase which took effect from April this year, and one of the main things that we need to focus will be the GDP number for the July to September period, which will have a major implication on Mr Abe’s decision whether or not to increase consumption tax from October next year. As well as it has implications for monetary easing by the Bank of Japan. Having said all that, Japan is in a very unique situation in that, or should I say special situation country with reflationary policies.
So we will focus on increasing construction activities, recovering capex and also yen weak beneficiary as the main themes for now, and we’ll be watching closely the macro data in the coming months, especially CPI and the labour market data, and we’ll be also monitoring closely if Prime Minister Abe can sustain his high approval rating that he has managed to recapture following his cabinet reshuffle earlier this month.
PRESENTER: What sort of investor is this fund aimed at?
EIJI FUKUMURO: I would say it would suit investors who want broad exposure to Japan equity and want to utilise our expertise in outperforming the TOPIX stably, as well as those investors that want to take advantage of the Abenomics story which may last until 2020 Tokyo Olympics.
PRESENTER: Eiji Fukumuro, thank you.
EIJI FUKUMURO: Thank you.
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