Man GLG Japan CoreAlpha Fund update - Q1 2018

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  • 19 mins 36 secs
Stephen Harker, Head of the GLG Japan CoreAlpha team, provides an update of the fund for the first quarter of 2018.


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WARREN SHIELDS: Hello and a warm welcome to the Man GLG Japan Core Alpha conference call with Steve Harker, Portfolio Manager, and myself, Warren Shields, Director within UK Retail Sales. We’ll follow our usual format for these quarterly calls. In a moment, I’ll ask Steve to provide an update on the strategy, with the slides you can access and follow online. On the call, Steve will provide an update on the performance of the fund versus Large Cap Value, discuss the changes in the portfolio and cover the current positioning and top 10 stocks, which we hope you find useful. I’d now like to hand over to Steve.

STEVE HARKER: Thanks Warren. If we can start on page 3 and look at the, I show this all the time as the first slide. Large cap Value represents about 40% of the Total market in Japan. And as you can see from the large block on the left-hand side that’s where we’re committed. Well over 90% of the assets are in Large Cap Value, with very little change between the end of December and the end of March, so pretty consistent. Another very uneventful quarter in terms of relative performance where we lagged the Large Cap Value by a microscopic amount; the bigger story of course is the relative performance of Large Cap Value against the market, which I can talk about on page 4.

There was a clear Q1 2018 bias in favour of Growth stocks. The worst performing segment was Mid Cap Value and there was no real side effect. There was a very small outperformance by Small Caps. But that was largely a result of relative performance within the Growth segment where we’re not present. And as you can see on the right-hand side the really big gap is between the performance of Total Value and Total Growth, about a 3½% gap.

If you move on now to page 5, this is a slide that we’ve shown before. It’s essentially the last 34 years starting in January, finishing in December of Value, Total Value divided by Total Growth in Japan. The red line is 2018 and that picks up the 3½% underperformance of Value versus Growth. It’s almost exactly in line with where we were at this time last year, better than where we were in 2016. And I think what’s really striking is that these three years appear to be, the details, let’s assume that they are the three worst, but the 2016, 2017 and 2018 I think have been the three worst years for kicking off the year for Value segment in the last 34 years, which is quite some record. Obviously in 2016 Value was turned from early July onwards and ended up winning. Last year there was no further deterioration between this point and the end of the year. And I hope that we can get something more like 2016 this year. But the future is unknowable as we know. And so essentially we’ve had a pretty dull start for Value stocks.

Turning now to page 6, this is the Strategy Composite, since inception of the UK fund and the strategy in January 2006. So we’ve been at it for over 12 years now. And the last four quarters, the last three quarters are shown up to the end of the year and the fourth quarter is missing because we haven’t got the numbers yet but it’s very close to zero, maybe a slight positive, and I think this is the first time we’ve ever had four quarters as dull as this against the Large Cap Value index.

We’ve done some good trades. The underlying, I’m really pleased with the way that the portfolio has been managed over, well certainly the last year we’ve been doing some very good things and in particular the sale of JFE in steel towards the back end of last year. We got rid of about 65% of our holding there. We reduced dramatically Glass and Asahi and Nippon Electric, and we also reduced by about 90% our holding in Kyocera. And all of those four sales were not complete but they were very significant positive contributors relative to had we done nothing.

Turning now to page 7, this shows the top 10 portfolio list at the end of 2016, 15 months ago, and the top 10 at the end of March. We’ve lost three stocks out of the top 10 from 2016: Canon, which was our biggest bet against Large Cap Value. That’s been reduced dramatically, but is still in the portfolio.

JFE was our second biggest active weight against Large Cap Value and that, as I said we’ve taken a lot out of that and we’re now about 2½% weighted in JFE. And that was our biggest positive contributor to the portfolio last year. And the third one is Impex, which has drifted out of the top 10 as well. So those are the three that have gone out. And they’ve been replaced by Japan Post Holdings, which is now our biggest active weight against Large Cap Value. Mitsubishi has stayed, which is also a relatively chunky position in terms of active weight, Mitsubishi Heavy Industries. The portfolio really has shifted. We’ve been selling cyclicals really since the middle of last year and that continued into the early part of this year. And we’ve been buying defensive stocks and I’ll talk about that in a moment.

If you can now turn to page 8, this is really quite extraordinary. We’ve had, this chart you’ve probably seen before shows the TOPIX index, the blue line and the weekly net purchase and sale of equities by, Japanese equities by foreigners. Blue is obviously buying; yellow is selling. And historically really since I started doing this job, whenever foreigners buy the market goes up and whenever foreigners sell it goes down quite a bit. And that’s certainly been true throughout the whole of the ‘80s, ‘90s and currently. What is really remarkable is the extent of the selling, not just in cash equities but also in futures. We reckon, well our suppliers and information gatherers reckon that about $75bn has been taken out of the Japanese equity market by foreigners, which is not just unprecedented, it’s off the scale.

In the first quarter, with a maximum peak liquidation in the third quarter of March, third week of March running up to the 23rd of March, where $20bn was taken out of cash equities in one week. Normally this would have led to a collapse of the Japanese equity market and it’s only down about 5%, which is really quite remarkable and offset by the strength of the yen. I can only assume that there is a buyer and it’s the Bank of Japan buying ETFs, which has been acting as buyer of last resort, and we’ve certainly seen the numbers which suggest that the Bank of Japan has been the main buyer of equities. I mean this is one of the problems for the Japanese market. They’ve taken the volatility out of the bond market and they’re now attempting to take the volatility out of the equity market as well. The Bank of Japan I think now owns 4% of all equities in issue; foreigners own about 30%.

Now, turning to page 9, we have been very quiet in 2017 and 2018. Not only in terms of completed sales and new purchases, but also generally the turnover in the portfolio. What we show here is the number of new holdings, which numbers five in the last 15 months. If you look at the four or five years prior to this, we were running at about one new buy a month. So we should have done about 15 net buys, new buys if we’d been running at previous rates. And we’ve only bought five: Nissan, Daewoo and Asahi Glass last year and in the first quarter East Japan Railway and Kansai Electric Power. We’ve sold eight, again that’s running way below the previous run rate and only sold one stock, Chiba Bank, which was a smallish holding in the first quarter. And those holdings were not the biggest within the portfolio. They were just really ½, 1, 1½% holdings.

As I mentioned in addition to that we sold Kyocera. We sold about 90% of our holding in Kyocera before it fell, 80% maybe before it fell in the results in January. Nippon Electric Glass is another bad performer which we’d sold a lot of prior to the results and Asahi Glass peaked in May and we’d already been selling quite a lot of Glass. So these are examples of cyclicals, and JFE another one, of cyclical stocks that we’ve been reducing quite significantly over the last six to nine months.

Turning now to page 10, I won’t dwell on this but the price to book of Large Cap Value relative to the market remains at what I would describe as giveaway cheap levels: a 30% discount to the market. And even cheaper than at the peak, very peak of the TMT bubble. It’s an old record, I’m afraid, but I still think that this is a really profoundly important slide to take notice of.

On page 11, we show the unit price of the professional share class since inception in January 2006, the UK fund. And in the first few years until the early part of 2009 we were losing money, but outperforming everybody else. And then since then the unit price has tripled. And we’ve had a number of surges: one in 2009, which was technology driven; one in 2013, which was the start of Abenomics and that was a really powerful run in exchange rate, yen sensitives and manufacturing which we were very heavily overweight in; and then there was another little run in 2015; and then a really big one, and this is on a log scale, a really big one in the second half of 2016 when I think the fund was up something like 50% in five months.

And after all of these runs you tend to get a period of backing and filling and you can see that since 9th of December 2016, which was the peak, we’ve actually managed to get the unit price up, which is largely a function of the market appreciation, even though the yen has been relatively weak. We’re really pleased with the long-term track record that we’ve built here. It’s been a very difficult period since 2009 April when Value peaked. And Value’s been on a long trending slow decline and we’ve been able to outperform that very well and outperform TOPIX by a smidgen. So it’s been a really tough time and we appreciate your patience. I think the portfolio typically builds risk into turning points and we may well be in a process of building risk in a different direction from the one we had in 2015.

And then finally on page 12, this is - MiFID insists that we show this - it’s the performance up to the end of February for the last five years. Over the five-year period we’ve beaten the Large Cap Value index and TOPIX. And certainly not over the last year, we’ve been lagging TOPIX and we’re a little bit behind Large Cap Value. But in the context of history it’s nothing really very significant. And I just want to reiterate I think we’re really pleased with the way that the portfolio has been handled in a very tricky circumstance over the last few months. And then I think that’s it really. I’ll pass over now to Warren to field any questions that you may have.

WARREN SHIELDS: Thanks for the update Steve. Steve, we have our first question, which is how sensitive is the fund to the yen and how does this compare to a year ago?

STEVE HARKER: That’s a good question. Since 2012, in 2011/12 we were building exchange rate risk, so we had, when Abe got in in late 2012 we had a portfolio which was really yen sensitive, i.e. a yen weakness was positive, and that’s one of the significant benefits that we’ve derived from Mr Abe. The other is we had a portfolio beta which was very high too and that helped. What’s happened over the period, 2016 we had a very aggressive portfolio, which was more interest rate sensitive than exchange rate sensitive, but still even though less than three or four years back we’re still very yen sensitive. And what we’ve found over the last six to nine months is that yen sensitivity of the portfolio has been dropping and dropping and dropping. And if you look at Barra and you look at other indices, it suggests that we went neutral about Christmas.

So we came into this year with no bet on the yen. So we’ve got an equal balance between domestic and external profits and assets relative to the TOPIX index. So we haven’t really got a tilt. What we do still have is a tilt towards a market rising, which obviously hasn’t been helpful, and we still have a very significant tilt to interest rates. But we’ve neutralised our overweighting in the yen weakness.

WARREN SHIELDS: Thanks Steve. We’ve got another three questions I’ll try and wrap up into one. You’ve now built a big holding in Japan Post Holdings and recently added to JR-EAST. What was the rationale behind these decisions and are there any other areas of interest at the moment?

STEVE HARKER: Yes, Japan Post Holdings as I mentioned has become the biggest active weight against Large Cap Value. We’ve got 6% holding in JPH and we’ve got about 1.7% in Japan Post Bank, which is a listed subsidiary of Japan Post Holdings. So we’re nearly 8% in Japan Post Group. And our view is quite straightforward. This is a stock which is, I can’t remember a Large Cap stock as cheap as this. It’s trading at a 70% discount to market book. It’s yielding 3.9%. Its market cap is equivalent to number 10 in TOPIX. So it’s a top 10 stock if it was fully listed, which of course it isn’t because the Japanese government continues to hold it.

It’s three businesses: it’s the Royal Mail; it’s National Savings; and it’s also an insurance business. The company had a profit upgrade in March, helped by an improving outlook for the postal business, particularly door-to-door parcel delivery where volumes have been rising about 25% because the competitors are just fully laden. I mean they can’t cope with any more volume. And so JPH is benefiting from Yamato Transport raising its price and walking away from a lot of business. So volumes have been picking up there. So I think the postal business, which is regarded as being valueless, has actually been showing signs of significant life. It’s been behaving like a defensive and it’s actually our best contributor in Q1 2018. It delivered quite a nice excess return for us, having had a difficult period since the secondary offering in September.

Just as a note the other things that have done well for us in terms of contribution are two utility companies. There’s [Tubu? 0:17:00], Tokyo Gas, and also Ricoh. As far as JR-EAST is concerned, we’ve been in JR-EAST before, and it became really cheap relative to its history on a price to book basis in the first quarter, early first quarter, and we decided, our land transport exposure was zero, and it just seemed like a very sensible thing to do to inject a bit of a defensiveness into the portfolio with a stock that was trading at a very low price to book relative to its recent past. And that proved to be a slight positive for us. But both JPH and JR-EAST are examples of the defensiveness of our purchases. We’ve been selling glass, steel, technology to some extent and we’ve been buying into things which hopefully will have some good downside protection. And certainly those trades have performed relatively well. Those decisions have worked for us in Q1 2018.

In terms of, there are a lot of stocks that are underperforming across the piece that we don’t own, and we’re monitoring those stocks, your top 150 stocks where we’re seeing prices correcting. We haven’t seen anything that catches our eye sufficiently in terms of price drop and relative value to make us want to buy. But there are some very big intra market swings going on and we’re watching very closely and hopefully trying to pick them up as low as possible.

WARREN SHIELDS: That’s great Steve. That concludes the Q&A session for the update. If we haven’t answered your question we will get back to you individually on those. In the interim if you would like more information on the strategy which is not available on the website that Steve mentioned, please contact your sales representative at Man GLG. Finally on behalf of myself, Steve and the Man GLG Pan Core Alpha team we would like to thank you for your continued support and for listening to this quarter update today. Thank you.