Man GLG Japan CoreAlpha Fund - Q4 2018

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  • 17 mins 34 secs
Stephen Harker, Head of the Man GLG Japan CoreAlpha team, provides an update for the last quarter of 2018.

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RICHARD PHILLIPS: Good morning everyone my name is Richard Phillips and I’d like to welcome you to today’s Man GLG, Japan CoreAlpha update. So with that I will hand straight over to Steve.

STEPHEN HARKER: Thanks Richard. Q4 2018 turned out to be a good one for us in index and competitive terms; however, TOPIX was down by more than 15% and slightly more than 10% even in sterling terms with a strong yen, so it was by no means an easy time for investors. The first quarter January has started very nicely. The market is up strongly. The UK fund has recovered all of its December losses in sterling terms and we’ve outperformed TOPIX by 2% of our own Large Cap Value by about 1%, so a very nice start to the year and we hope that it continues. Today, I’d like to really concentrate on reviewing the whole of 2018 rather than Q4 2018 but I will make reference to the last quarter.

If we could turn first of all to page 3, we normally just show where we are in terms of style boxes, at the last quarter end December 2018, but I’ve added December 2017 for reference this time, because we’ve made a very significant increase in our exposure to the very Top Cap stocks within the Value spectrum. Top Cap Value is basically top 70 stocks, some of the top 70 stocks, the other top 70 stocks are in Top Cap Growth, so these are real big names, and we’ve been gradually raising the Top Cap Value weighting, particularly towards the end of the year, because the valuation opportunities and the price movements have forced us in that direction. And this is the biggest overweight we’ve had in Top Cap Value at any point in the 13 years of the life of the strategy.

Turning to page 4, the style box’s performance in 2018, it was a fairly broad brush drop of 15% in Top and Mid Cap. The only really standout feature was that Small Caps performed rather worse than the rest of the market – which is obviously a good thing, helpful for us being a Large Cap fund.

On page 5, we look at Value divided by Growth in each year since 1985. We’ve highlighted 16, 17 and 18; 18 highlighted in yellow. Very much a game of two halves again. It was a mini repeat of 2016. And for the last three years, 2016, 17, 18, values had a difficult first half. And 16 was a difficult period up to the 21st of June and then recovery so that by the end of the year there was very little difference between Value and Growth. And that was reflected in our performance and our competitive ranking and as the year went on both improved and we ended up with a good competitive return against our main competitors, a very pleasing year. Just on the left-hand side you can see in red 2019 has kicked off with Value winning which is nice to see. And we’re just hoping that we can get back to a normal environment which we’ve had for most of the last 30-odd years.

On page 6, I won’t dwell on this for very long but this is our quarterly excess returns for the strategy going back to 2006 when we launched. And against Large Cap Value we had high tracking error in the early phases because the opportunities were big both into Lehman and out. Since then the tracking error has been dropping and we’re basically running a much more subdued position against Large Cap Value and you can see we’ve had two positive quarters.

Turning to page 7, this can’t be said for our performance, our tracking error against TOPIX, we still have a very significant tilt because of the bifurcation of the market between Value and Growth, and between Small Cap and Large Cap. Small caps have been outperforming since 1999. Value stocks have had a difficult time from 09 to 16 and we still have a portfolio which is very skewed against TOPIX, even though it’s not particularly skewed against Large Cap Value. So the tracking error against TOPIX will be higher than against Large Cap Value.

On page 8, I’m just looking at the top six contributors’ performance against our portfolio weight in 2018 as a whole. The biggest positive contributor was Japan Post Holdings. Japan Post is a low volatility stock, although its so-called bank is the dominant part of the business, it’s by no means performing like a bank, and we didn’t expect it to. It’s been a very low volatility, low beta performer and it’s probably still the cheapest stock anywhere on the planet. Amongst Large Caps, it’s really compelling. We’ve been cutting it latterly because it’s performed so well but we’ve still got a big position. The other feature was real estate. Mitsui Fudosan and Mitsubishi Estate both performed very well after a slow start, and that’s really pleasing because when we started CoreAlpha, 13 years ago, and for a very long time we had nothing in real estate and we’ve been gradually upping it over the last couple of years and it turned from mid-year onwards and it’s been a good performer. And then also Toyota’s worth a mention because the autos are extremely cheap. And for the first time in probably in 20-odd years, as Value managers, we’ve been able to have an overweight position in the auto sector which is really interesting. If you look at the industrial business just take out the financing business, these things are on very compelling EV to EBITDAs. And Toyota performed very nicely towards the end of the year.

On page 9, the losers, and this group of losers includes one bank but another mixed bag of stocks: both winners and losers are a mixed bag from sectors. And these really reflect the super Value opportunities within the portfolio and they represent now very significant weighting in the portfolio. Five of them I think are a top 10. Nippon Steel and JFE, the two steel companies, were negative. JFE had been our best performing, best contributing stock in 17, but we sold a lot of it towards the end of 17, early 18. But even so it’s still been a negative. Nippon Steel has just been getting cheaper and cheaper and is really unbelievably cheap and wrongly cheap in our opinion. And then Honda, in contrast to Toyota, Honda has had a difficult year particularly in the first half and then recovered somewhat but again Honda is unbelievably cheap. And these are really the sort of core holdings within the portfolio now: glass, steel, banks and autos.

Moving on to page 10, compare and contrast December 17 with December 18, top 10 holdings represented 52½% of the CoreAlpha portfolio at the end of 18, which is very close to the highest concentration that we’ve had in the 13 years. There are a small number of very big companies that are compellingly cheap, and we’re in them. And at some point we hope that they’re all going to deliver, or most of them are going to deliver. And it’s, we’re just doing what we’ve always done, just building risk, building risk into downturns, you know, reducing risk into upturns, but at the moment we’ve been spending the last six to eight months building risk again.

On page 11, it shows two lines, blue and yellow. The blue line shows our month end weighting in the electric power and gas sector which is regulated and low risk and low beta, and the yellow line shows the index weighting in life insurers, which is very punchy relative to interest rates and interest rate sensitivity and market sensitivity. And you can see in 16, around the time of the Brexit vote, we had a very big position in the punchy interest rate sensitives and we had an underweight position in, as it happens, electric power and gas. And as we won in the latter part of 16, we reduced risk significantly by raising our holdings in electric power and gas, and cutting our interest rate sensitivity life insurers. Life insurance sector is now zero, and you can see the blue line has been declining since the middle of last year. That represents a response to one that being the best sector in 2018. It performed really well and was really positive contributor for us. And the fact that they’re no longer cheap and we’re now bringing them back to base again. So the portfolio’s been gradually re-risking from about April onwards. And that continues into 2019, selling defensives, economic defensives.

On to page 12, these are the completed transactions in 2018. We’ve missed off [Kanta? 0:10:34] Electric Power which was a tiny buy. It moved up very quickly after we bought it. And we sold it after about three months. But it needs to be mentioned. This has been the quietest year since 2006 in terms of new holdings and complete disposals. We’ve essentially we bought four and sold four. And really there’s not much, they’re not very big, they weren’t very big holdings, and so far there’s probably been the net effect is positive.

I would just like to mention Takeda, which had a terrible year last year and bottomed around mid-December and we actually bought it on the day that it bottomed. We placed the order on the day that it bottomed. And we’ve got a position in the pharmaceutical sector for the first time in a long time, probably about five, six years. And that was an outlier within pharma because of its purchase of Shire. And as soon as the Shire uncertainties have been settled and the new stock has come on the market that Takeda stock price has performed really well. So that’s a really nice move. But it’s not a very big holding but worthy of note I think.

Moving on again to page 13: where are we in the cycle? I mean this is the price to book of Large Cap Value against the price to book of the total market. And we still have the Large Cap Value segment of the market trading as a 30% discount to TOPIX. Our portfolio is trading at a 45% discount. And when this line goes up we win. And when it goes down we lose. And our betting is that over the next 10 years this line will go up and we’ll be reversing back to some sort of neutral rating that we saw in up to 2011. We’d be expecting something like a 15% discount for it rather than a 30%. And if we go from 30% to 15% discount we will win big.

And then finally page 14, the last five years, our Growth performance was in line with TOPIX last year and a real non-event. We did underperform Large Cap Value by a little bit, which was really a reflection of about three stocks that we didn’t have. Which we looked back at and we still wouldn’t have had and they weren’t really Value stocks. So we’re very pleased with our competitive return last year. And we’re not very happy with the fact that we lost money for clients because the market was down. The yen was a little bit stronger so that helped a little bit but we’re in down in single figures which is some relief. Anyway at that point I’ll pass over to Richard for Q&A.

RICHARD PHILLIPS: Thank you very much Steve. We’ve had the first question which relates to the end of last year and the beginning of this year, really asking has Value turned and have Large Caps turned?

STEPHEN HARKER: Yes. I think we could look at the chart of Large Cap Value in total market. Our view was that the big turning point, was July 7th 2016. At the time it was such an aggressive move, back in favour of Large Cap Value, assisted by Trump’s election victory that bond yields suddenly shot up in the US. The Value stocks performed really well up to the 9th of December. And the vigour of that bounce from early July was so powerful that we felt that that was probably telling us something. And then the market fell back as one might have expected from a big move of that sort but it felt that rather more than we’d hoped. But it did stabilise around a higher level than the July 7th 16 low. And we were thinking that that was just a digesting phase and that the next move would be in favour of Value. And it has been.

Since June 21st last year Value and Large Caps have both been winning as you can see from this chart. And we think that Value’s been winning for two-and-a-half years, and it’s obviously an opinion. It’s not a forecast. And we certainly not in a position to forecast how this will evolve but as I said earlier the discrepancy in Value between Value and Growth is so powerful and so big that it seems a reasonable proposition that unless something really crazy has happened here, Value has to win on a five to ten year view. And, you know, there’s going to ebbs and flows but that’s our core opinion that the turning point was two-and-a-half years ago.

RICHARD PHILLIPS: Thank you Steve. Right the next question here, given the rise of asset light businesses, has the nature and risks of low PBR investing changed in the past 15 years?

STEPHEN HARKER: I think the jury’s out on that. People have always said to me that you can’t value Growth stocks, and that would include asset light stocks as one example: people businesses. You can’t value Growth stocks using PB, and this was said to me in the 1980s and 1990s, and it’s a repeating mantra and I don’t think that it stands up really. I think that you can value anything on a PB basis and the real question is the gap between the two. And the gap between the two, we think, is overstating the long-term prospects for Growth stocks, and you should be in Value. And we don’t see any sign of a change in the nature of market dynamics which are led by human behaviour and the usual green fear that we’ve been in a very interesting situation where interest rates have collapsed below their long-term required rate. And that interest rate weakness and fall has led to a period where long duration assets win. And I just think it’s an unusual period and we’ll find at some point in the next 10 years that we just normalise. But again that’s just an opinion.

RICHARD PHILLIPS: Thank you very much Steve. That looks like all the questions we’ve had for today. So thank you all very much for dialling in again, and Steve and I look forward to speaking with you in the next quarter. But for now thank you very much.