Man GLG Japan CoreAlpha Fund update Performance update – Q2 2017
RICHARD PHILLIPS: Good morning everyone. My name is Richard Phillips, and I’d like to welcome you to the Japan CoreAlpha Q2 update conference call with my colleague Steve Harker. Steve is going to speak for around 15 minutes before we throw open the lines to question and answers. So with that I shall hand straight over to Steve.
STEVE HARKER: Thank you, Richard, and good morning everybody. I’d like to start on page 3, really to just reaffirm what we are, which is Large Cap Value. As you can see, at the end of June nearly 95% of the portfolio was invested in this segment of the market. It represents about 40% of TOPIX. And I just want to reaffirm what our objectives are. We’re trying, over the short, medium-term and long-term to beat Large Cap Value Index, and in the longer term to beat the Large Cap Value Index, TOPIX and hopefully our competitors too. We’ve done that one year, five years, 10 years, and since the inception of the Man GLG Japan CoreAlpha Fund, and I just hope that we can keep doing it in the future. Inevitably with Value and Growth being so spread and disconnected at the moment, the performance against TOPIX can be a little volatile, but I’m afraid we have to live with that.
Turning to page 4, on the left-hand side (we’re reviewing Q2). Q2 was a difficult one for Value. Top Cap Value was only up 3.3%, and Small Cap Growth was up 10.7%. So these are the quarters when JCA will do badly relative to TOPIX and against the competition. Nothing untoward happened, and certainly this year we’re extremely pleased with the way that we’ve managed and executed, particularly after the extraordinary run we had in H2 2016. On the righthand side of this chart you can see that Top Taps were significant laggards, Small Caps won, and on the far right Total Value was only up 4.8% against Total Growth at 8.9%.
Turning now to page 5. We look at Value divided by Growth, going back 33 years to 1985. The red line shows the performance of Value against Growth in 2016. This time last year, we’d just had Brexit - Value had sunk into a hole in Japan. It actually turned after 7th July, and the rest of the year was plain sailing. Even into August, 2016 proved to be the worst start to the year Value has had in the whole 33-year period (which corresponds to my career) and it was an interesting time. Then in the following five months we had a complete reversal with a dramatic run-up in Value stocks. So far, in 2017 (if you look at the orange line) you can see that 2017, up to the third week in June, looked like more or less a repetition of 2016: Value losing and then around 22nd June, Value had a bit of a spike, and is now only the third worst year for Value year-to-date. If we ask ourselves why there has been this little uptick, it’s the usual thing….
If you turn to page 6, you can see the grey line shows Value divided by Growth in Japan. We compare it against the US Treasury because the Japanese have nationalised the yield curve; the 10-year JGB has now been fixed at government and BOJ dictats, and it’s not giving any market signals. The US Treasury Yield continues to act as a very good guide for short-term movements in Value versus Growth in Japan, which is quite interesting. You can see at the very far right of the chart on page 6, a sudden uptick in the US Treasury Yield - we’ve seen the same thing happening in Germany, UK, etc - and that immediately led to an improvement in the performance of Value stocks within Japan.
We have no idea what is going to happen to interest rates. All we can say is that in all likelihood, if interest rates go up, Value hopefully should win in Japan.
Turning now to page 7. We show you here the Japan CoreAlpha strategy excess returns against the Russell/Nomura Large Cap Value Index, which is our internal benchmark. This is the process control engine of the whole Japan CoreAlpha team and it goes back to the inception of this Fund in 2006. The blue lines are quarters when we had an excess positive return, and the red lines negative excess return, ie., a loss. The trick here is to make sure that the blue lines are bigger than the negative red lines, and that there are more blue lines than red lines. We’ve managed both of those. It’s really just a way of checking that the process is working, and that nothing untoward is happening. The far right bar shows (we show gross and net returns where the paler lines are the net numbers) only two months April and May. We haven’t got the official June numbers yet, but they’re slightly less bad than these numbers. So we’ve had a small underperformance against Large Value, which I think can’t really be a big surprise given that we had two spectacularly good performances in Q3 and Q4, and a surprising positive in Q1. So everything seems to be on track.
Turning to page 8, this is against TOPIX. As I said earlier, we are only invested in 40% of the TOPIX Index at most. Even if we were indexed in the Large Cap Value space it would be only 40%. Inevitably, we are going to be volatile against that, because we’ve got very little exposure to Small Caps and Growth stocks. I think the point of note is that Q4 was tied with Q1 of 2009 as our best ever quarter for excess return. That followed a really terrific Q3, and we’ve given back something in the first half of this year and that’s more than explained by the performance of Value versus Growth. I think we’ve done a really good job in terms of process control and doing things properly, and making good timed judgements over the last year.
If we can now look at page 9, I’ll just talk you through one or two changes that we’ve made this year. The top 10 holdings on the right are at the end of December and the top 10 holdings at the end of June, are on the left-hand side. There has been no change to this list. The 10 names are exactly the same as they were at the end of last year. There have been obviously percentage changes - the two biggest changes in Canon. We’ve cut about 2% of our holding in Canon, mostly in June. This was around the time we met the President of Canon in London for the first time - not as a consequence of meeting him - it was a consequence of the fact that Canon had performed very well in the first half. It was a big position and we felt that there were better opportunities elsewhere. Sumitomo Mitsui Trust on the other hand is one of our biggest active bets against Large Cap Value, and we have increased our holding in that stock in the first half of the year.
In the first quarter, we were de-risking. We were de-risking in the latter part of 2016, and that continued probably through to April of this year. In particular, we were selling the life insurers in favour of Electric Power & Gas/Utilities, ie., the power companies, and electricity and gas suppliers to commerce and households. So we were reducing portfolio risk against TOPIX and against Large Cap Value. Since April we’ve been gently and gradually raising risk. We’ve been buying banks, SMTH for example. We’ve been buying steel. Having sold/taken the top off the steel stocks in Q1, we’ve started to buy them back as the second quarter developed. We’ve been doing one or two other things as well, but those are the main messages. In terms of first half of the year, the glass companies, (Asahi Glass and Nippon Electric Glass) have been probably our best overweight performers. We’ve also done well out of electronics (Canon and Hitachi as two examples - Kyocera’s done OK too). The negatives relative to Large Value have been financials and Real Estate, but nothing very dramatic.
So looking now at page 10, just to reiterate Value stocks are still extraordinarily cheap relative to Growth in an historical context, which goes back 37 years. Value stocks have been de-rated - they’ve been outperforming most of this time period, but they’ve been de-rating, ie., the gap between price to book on Value and price to book on Growth has been increasing - ever since 1988; so the whole period of the bear market. There’s been a particularly strong de-rating starting in 2009, a quite extraordinary one. If you look at page 10 on the right-hand side, you can see that the price to book of Value is now at a 30% discount to that of the total market, which seems barmy to me. Price to book of Value is higher relative to what it was at the July 2007 low, but it’s still lower than it was at the very peak of the TMT bubble in 1999. I think we just keep that view in our mind. This is an extraordinary event, and we expect it to be reversed.
One of the problems with this bifurcation - it’s not a problem - it’s an opportunity in many senses, is that the names that we’ve got in the portfolio don’t really change a lot, because the sectors and the stocks that are cheaper, so cheap that they will remain in the portfolio. We’ve had a position in glass, we’ve had a position in financials, and we’ve had a position in steel for a few years now.
So finally page 11. We’ve had quite a rollercoaster 12 months. We had a great five months up to 9th December, and we then lost from 9th December through to June but that rollercoaster didn’t create many significant trading opportunities because of what I’ve just said. In the first half of 2017 we’ve actually only traded out and in three stocks. We bought one new name, Daiwa Securities, which was in the portfolio a few years ago and we sold Dai-Ichi Life, which performed spectacularly well and more than doubled from July last year - we just felt it was a bit rich and Kansai Electric Power, which is a utility company we sold. We have generally been buying electric power and gas, but that one performed extraordinarily well over the year to June, and we decided to ditch it in favour of other members of the sector.
So turnover has been low. We’re still in the same position in terms of the top 10. We’re still in the same position in terms of our overall framework. We should do well if interest rates go up, and we should do well if the yen were to depreciate. Nothing much has changed now for, well, a very large number of quarters. So with that I will hand you over to Richard to field any questions that you may have.
RICHARD PHILLIPS: Thank you Steve. Could you expand a bit further on why US treasuries act as a good
indicator of Value in Japan?
STEVE HARKER: Well normally we would look at Japanese interest rates, and this is not just US treasury, it’s all bond yields globally. They seem to be acting as one. The trends are in the same direction typically. Kuroda changed monetary policy last September and effectively hooked the 10- year JGB at zero/just above zero. If you use the 30year JGB you get a much better result, but the correlation of the US Treasury Bond Yield (and I emphasise correlation rather than causation) has been particularly good. We’ve been in this long period since 2011 of declining global interest rates, economic output not performing in line with the central banks’ best hopes and bond proxies winning in the stock market. As that bifurcation in the market of Growth stocks winning and Value stocks losing has continued, the key driver of relative performance of Value and Growth has become interest rates. US Treasuries are essentially the best proxy that we have for short-term movements in Value versus Growth.
RICHARD PHILLIPS: Thank you for that, Steve. We’ve seen Prime Minister Abe’s approval ratings fall sharply
of late, is this of any concern or will it have any impact on the market?
STEVE HARKER: It’s certainly a concern for Mr Abe. What’s really interesting is that prior to his recent incumbency, politicians have come and gone and they start with an approval rating of 60, go down to 25 and then they’re kicked out. Mr Abe has kept the ball in the air for a very long time and has lasted almost five years since late 2012. He’s become one of the longest serving prime ministers we’ve had in the last 40 year. I think he’s probably in the top three. I think his main objective is changing the constitution to turn Japan from not being pacifists, but his economic policies have essentially been very easy money, easy fiscal policy, and trashing the currency as a consequence. I don’t think that that makes any sense for a country which is a net creditor and trying to build itself, I would have thought, as a financial centre for Asia. What Japan I think needs is a strong currency and I think that policy is full-square against that.
I don’t want to get into too much detail but I think all politicians eventually die in terms of political power, and I think he’s in the process of dying. I’m surprised he’s lasted so long, and I suspect he probably won’t last that much longer before he’s replaced, but whether it makes any difference I really don’t know.
RICHARD PHILLIPS: OK Steve, well that looks like all the questions for today. So thank you everybody for
dialling in. We’ll send round an invitation in the next month or so for the Q3 conference call which will no doubt be in early October, but for now thank you very much.
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