Man GLG Japan CoreAlpha Fund - Q1 2019

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  • 18 mins 21 secs
Stephen Harker, Head of the Man GLG Japan CoreAlpha team, provides an update for the first quarter of 2019.

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Man GLG

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RICHARD PHILLIPS: Good morning everyone. My name is Richard Phillips and I’d like to welcome you to today’s Japan CoreAlpha Conference call with my colleague Steve Harker.

STEPHEN HARKER: Good morning everybody. For the past three years or so Japan has been through quite high intra-market volatility, which has been rather testing at times; however, we’re extremely pleased with how we’ve managed to navigate through this choppy period. We attacked in 2016, we were more defensive in ’17 and ’18, but now we’ve returned to the attack with a much more expansive portfolio. Active fund managers have had a rather tough 12 months in Japan, but I think we’ve done really well from a peer group perspective, helped by the poor performance of small cap indices where we’ve got very little exposure.

If we could turn to page 3, you will have seen this before if you’d listened to one of my quarterlies. It’s just a reiteration of the fact that we are large cap value managers. The only change that we’ve seen and that took place last year was a shift out of mid cap value into top cap value. So we’ve now got probably the biggest exposure we’ve ever had to top 70 stocks in the Japanese stock market. And that’s because that part of the market in our opinion is a pocket of extraordinary cheapness.

Turning to page 4, the first quarter of this year has been a little bit choppy, as have most other quarters. In January, we got off to a great start with value winning, the market was very strong, and then growth took over from about the 29-30th of January and ran through to the end of the period. Over the quarter as a whole that, you can see on the right-hand side, total growth was up nearly 10% and total value up 6%. We basically in portfolio terms tracked the large cap value index in many ways it was a very unremarkable period for us.

Turning now to page 5 and just looking at value versus growth from a longer-term perspective, each line here shows performance of value divided by growth in each calendar year from I think 1985 onwards. The yellow line shows what happened last year. And it’s a repeat of what’s been happening over quite a few recent years where in the ‘70s I think and the ‘80s, ‘90s and early 2000s, value tended to have a first quarter and first half bias and then lost it from there onwards; whereas, latterly, we seem to be suffering from weak value in the first half and then stronger value in the second. I have no idea why this has happened but it’s certainly a feature that we’ve had to get used to. There was no January effect and there is no first quarter, first half value effect. As of today we’re roughly where we were this time last year, and it’s relatively low volatility against historic norm.

Moving on to page 6, these are the stocks that have won and lost for us relative to large cap value in the first quarter. We’ve had a big position in real estate for a few months now, Mitsubishi Estate was our best performer. AGC - which is the old Asahi Glass, a combination of glass and chemicals and more diversified business now - did well having suffered a little bit in the second half of last year, and Mitsubishi heavy industries continue to perform well. On the negative side two securities companies performed weakly, as did Nikon which had a good second half last year, so to a large extent the first quarter was a reversal of what we saw in the second half of 2018.

Page 7 shows the completed transactions in the first quarter. This is the busiest quarter in terms of completed transactions that we’ve had for I think probably two years. We have been shifting the portfolio around over that period but the number of new holdings and the number of stocks sold has been quite low. In Q1, and this follows on from our purchase of Takeda towards the end of last year, so we’ve bought four new stocks in the last three and a half months. We bought two life insurers - T&D Holdings, Dai-ichi Life - one auto components, electronics, Denso, it’s an affiliative, Toyota, really top class company that’s underperformed. All of these stocks have been underperforming really badly in the second half and into 2019. And we thought they’d got down to levels that justified them being in the portfolio. The only liquidation is Tokyo Gas, electric power and gas sector, the regulated low profit and certainly economic defensive sector. And I want to talk about that in a minute, but the only electric power and gas we sold was Tokyo Gas.

Moving on to page 8, I won’t dwell on this because there’s not much to say, December ’18 versus March ’19, the top 10 holdings in the two data points: 52½% of the CoreAlpha model in these top 10 at the end of last year fallen slightly to 51.9%. The same top 10 as we had then. There’ve been a couple of small drops. Mitsubishi Estate is down. On strength Japan Post Holdings, we’ve been selling for some time on strength. I think it was probably our best or second best performer last year, and Cannon has gone up, but other than that essentially unchanged.

Now, page 9, I said in the introduction that we’ve now got a much more expansive portfolio, and what I mean by that is we’ve taken out a lot of defensive stocks and put in a lot more oomph in terms of manufacturing stocks and in terms of financials. And then even within the financials, we’ve raised the volatility in the market sensitivity of our financials weighting as well. You can see the blue line which was our historic weighting back to ‘15 in electric power and gas sector. This was a very defensive low beta sector and we boast our fantastic performance in late ’16. We put quite a big exposure into the electric power and gas sector as we were derisking. Our performance was very strong and we just started to buy stocks that were depressed and which were cheap. We maintained that position until the second quarter of last year and then we’ve been losing height ever since and cutting the weighting in the electric power and gas from about 7½% down to the current 2½%. So that sector performed really well last year and it was a complete non-consensus call and we were really pleased with the end result there.

The yellow line shows our exposure to life insurance stocks, it was a very high position of over 4% in the middle of ’16 before the interest rate surged in value in our portfolio. We then sold on strength, because these were our best performing stocks in ’16 and ’17, and eventually got out. They’ve underperformed somewhat. They are interest rate sensitive. And in February and March we started to invest again. And we bought back T&D and Dai-ichi Life, as I mentioned.

On page 10, another way of looking at our move from defensive to attack is to look at our weighting in the financial sector. We’ve gone up to 29½%. But we’ve also increased the interest rate sensitivity and the market sensitivity. We’ve been selling SMTH, which performed really well for us, and invested [unclear 0:08:53] life insurers but also in Mitsubishi UFJ and just generally raising the oomph of the financial holdings as they get cheaper.

On to page 11, there are two charts here, on the left-hand side, and these are really significant I think and I’m just going to spend a little bit of time on these. I’ve mentioned it before, but this is large cap value divided by the whole market on the left-hand side. We’re just going through the 10th anniversary of the peak in large value. Large value performed fantastically well in Japan with a couple of exceptions right up to April of ’09 and for the last 10 years, or certainly the last eight, the eight years from ’09 to middle of ’16, large cap value was having a terrible time. I said in December of ’16 that I was looking at the market and thinking that looks like a radical change in market leadership, the collapse of value in the first half of ’16 and then the subsequent recovery. And everything I’ve seen since confirms that in my mind and my opinion that we are now not in a growth market in Japan. And I may be proved wrong, but it feels to me like that was the big event.

What’s really pleasing is over the 10 years since April of ’09, we’ve outperformed TOPIX despite the fact that large cap value was underperformed by nearly 15% which is extremely pleasing - and that’s net of the costs and the professional share class. On the right-hand side, I mentioned that small caps had performed poorly which was obviously good news for us because we haven’t got more than a sliver of them. Large cap, relative to total small cap, turned about a year ago I guess. And large caps have been winning since then which is what we want to see. Since ’08, large caps have been really performing badly and they’ve performed even worse since 2000. And it’s one of our contentions that large cap value, well large cap stocks in general are extraordinarily undervalued and underowned and under-loved, and it’s about time they had a run.

Page 12, another reiteration, this is the value of value, the price to book of large cap value divided by the price to book of the total market: 10% discount typical until ’98; 15% typical until 2009; and then this massive derating of large cap value that took place up to ’16. As of today, the large cap value index is trailing at a 30% price to book discount to the total market. And I think we’re at an all-time low, 45% discount to TOPIX in terms of our PBR versus TOPIX PBR which is quite extraordinary. I think this is a time to be more optimistic about value. I think the odds are improving as each day goes by.

Page 13, just to finish off, this shows the unit price in sterling of the professional UK share class. We obviously did really well until April, well actually until August of 2009 even though we didn’t make any money. And since then we’ve been making a lot of money and just keeping ticking over. But I’m really pleased with how we’ve managed to negotiate the period since the peak of large cap value. We’ve had a number of surges in ‘09/10, in ‘12/13. In ‘14/15, in ’16, and then over the last three years the unit price has gone basically nowhere, which is a very long time for it to go nowhere. Given the cheapness of the market, the fact that foreigners have sold a bucket full of stock, given that value is really cheap, given that large caps are a giveaway in my opinion, I hope and I hope that the next move upwards is not far away. But I think this is a time to be, as I said, expansive and positive and not one to be shy, because foreigners have been throwing the towel in, I think. Hopefully it’s a mistake but we shall see.

So page 14 shows the last five-year discrete period. And I’ll now hand over to Richard, thank you.

RICHARD PHILLIPS: Thank you very much Steve. Is your increase in interest rate sensitivity a call on rates or just a call on value? And do you think there will be a change in approach from the BOJ?

STEPHEN HARKER: We never make forecasts about economics or policy changes; we’ve very rarely been able to understand what’s going on. And we’ve always been price takers in terms of that sort of thing. Our style and approach is always the same. If stocks go down and become uniquely cheap, then we want to be involved with them. And this change in our interest rate sensitivity, our change in market sensitivity, our change in view, is contingent always on the contrarian approach that we’re trying to identify stocks that are going into a hole and trying to get near as the bottom as we can. I have no idea what happens, but negative interest rates seem to me to be an offence against reason. And I think at some point we will not have negative interest rates.

RICHARD PHILLIPS: OK. This still on the banks, do you have any outlook for banks in the current yield environment?

STEPHEN HARKER: Yes. I haven’t got the data for the most recent three years to the end of March, but I’ve got the three years to the end of December ’18 which was a more difficult period than the one we’ve just finished. We lost some ground from a performance perspective by being overweight in banks but we had very good stock selection in banks. And in particular two things: one, we had a very big holding in SMTH, Sumitomo Mitsui Trust, which performed much better than the average. And we also managed the switch in and out of the three big ones: Sumitomo, Mitsubishi and Mizuho really well and added some value there. And we had a very low exposure to the regionals. And the regionals have been the big problem.

As far as the big ones are concerned, interest rates in Japan are an issue and they’re an issue everywhere. And that’s constraining the net interest margin, there’s no question. They are better financed, better managed and under greater and better control than they’ve ever been. And it’s really back to the interest rate question that, interest rates below zero are an offence against reason. We believe that at some point, they will be higher. Mitsubishi UFJ’s book value per share has been systematically rising for 10 years. The dividend yield is, like all of the big banks is way above the market average. We can’t see where things can get worse because the loan to deposit ratio is very low as well. So I mean we’re just sitting waiting for something to turn up and it will, we think.

RICHARD PHILLIPS: Do you have any expectations for the upcoming earning season?

STEPHEN HARKER: No, in a word. We expect some surprises but we always get surprises and we don’t know what they will be. This is not an easy environment for corporate profits. Corporate profits are at an all-time high. And they're at all-time high mainly because, well, the government, Abe’s government has trashed the currency since 2012 and there’s a long lead time on the impact of currency trashing on profitability. And Japan’s corporate sector which is heavily laden with manufacturers, benefits enormously from a weak currency. And the profit margins are very high and, you know, it’s really hard to see how corporate Japan can keep growing profits at anything other than nominal GDP. Domestic stocks are facing another 15 to 20 years of terrible demographics, and the overseas stocks are potentially going to get squeezed by global competition and maybe a stronger yen. But I think all of this stuff is priced in. But we have no foresight in terms of what the surprises would be. But I think by and large they’re more or less baked in. But we’ll just see.

RICHARD PHILLIPS: Thank you for that Steve. Thank everybody for dialling in and we look forward to speaking with you again, thank you very much.