RICHARD PHILLIPS: Good morning everybody. My name is Richard Phillips and I’d like to welcome you to the Man GLG Japan Core Alpha Fund quarterly update. The call this morning will follow the usual format. My colleague, Steve Harker, will speak for around 15 minutes, and then we’ll throw open the lines to questions. For questions as usual if you could click on the tab on the page and then submit your question, I will go through all of those at the end. And again as ever we will email the slides and the transcript of this call to you in the next few days. The replay will also be available on the website in the next few days. So, that’s enough from me, I shall hand straight over to Steve.
STEVE HARKER: Thank you Richard and good morning everybody. As Richard said, I’ll speak for about 15 minutes and take you through about 10 slides. And I’d like to start with page 2 just to have another check on process purity and as you can see 94% of the invested assets were in the Large Cap Value space. And I think it’s worth reiterating that we’re investing only in 40% of the Russell Nomura index, which correlates with TOPIX. So we’re only exposed to about 40% of the market, if we were indexed, which we’re not, in the Large Cap Value space.
Turning now to page 3, and normally at this point I do an analysis of the quarter and this time as it’s the end of the year I thought it would be better if I looked at the year as a whole. Just briefly on Q4 2017. Q4 2017 was a good quarter for the market. It was a good quarter for Large Value, and it was a good quarter for us. We more or less tracked Large Value and outperformed TOPIX. But slide 3 shows the year as a whole, and it was a very good year for Japan. The index was up over 20%. Obviously a lot less in sterling terms because the yen was rather weak during the year. Sterling was consistently strong from October 2016 and continues to be strong into the New Year, so a strong pound is offsetting some of the gains from the local market. It was very much a Small Cap and Growth market: Small Caps were up 30%, Growth was up 25%; both well ahead of the market. And in particular Small Cap Growth, the yellow box, was up 34½%. So it wasn’t a year for us. Inevitably, we underperformed TOPIX, but we performed pretty well in line with Large Cap Value. And it was really quite a non-event year in terms of portfolio. There were no massive gains and there were no particular shocks, so rather dull.
Turning now to page 4, just to put 2017 into context with all the years since 1985, this is Value versus Growth through the year from January through to the end of December each year. The red line shows 2017. And with the exception of the two outlier years of the TMT bubble, 1997 and 1999, which were really crazy Growth market environment years, 2017 is the worst year for Value, with the exception of those two. There was a little bit of an uptick starting in late November which we benefited from, but still Value underperformed the year in all segments. Both top, mid and small, all underperformed versus their Growth equivalent. And the range of performance, which I think is interesting is that Value in typical years has outperformed by 15% or underperformed by 5%, which suggests over that period of time, 33 years, Value has had a good result and a good track record, but 2017 was certainly not a banner year for Value.
Turning to page 5, this is a chart which you will have seen if you’ve been following our presentations. The blue line shows the US Treasury Bond Yield, the 10-year, and the yellow line shows the performance of Value divided by Growth at the same time. And this covers the period since March 2009. Value had performed incredibly well until April 2009, and has had a really quite tough time for the most of the period since. And what has happened over that seven or eight-year period since 2009 has been an increasing correlation between the interest rate and the performance of Value. And I’ve mentioned this over and over again but it’s still the case that Value is extremely interest rate sensitive. As of course being the opposite of the market is Growth, it’s just correlated in the opposite sense. And we saw that with an extraordinary correlation in the latter part of 2016, when US Treasuries went up, particularly after the Trump victory. And to some extent there’s been a bit of a discrepancy this year. But certainly towards the end of the year when US rates went up and have hit 2.6% Value has clicked into gear in Japan again. And I think this is the important thing to be watching to determine whether Value wins against Growth in the months and quarters ahead.
Turning now to page 6, we look at the top 10 in the core alpha portfolio at the end of 2016, versus the top 10 at the end of 2017 on the left-hand side. There have been three deletions from the top 10: Canon, JFE and Nomura. They’re all deletions which have just dropped out of the top 10, but they’re still significant holdings. Nomura we reduced at the start of the year, last year, and JFE we reduced at the end of the year, Canon in the middle of the year – all as a consequent of strong performance. And I think this is reflecting a change, subtle change in tone in the performance, in the structure of the portfolio. The new additions are Japan Post Holdings, Mitsui & Co and Mitsubishi Estate. And I think there’s been a shift away from risk towards defensiveness perhaps, which is reflected in a few different ways. But suffice to say that the main driver of this is price performance and relative valuation. And Canon, JFE, both performed really well at different times last year, and as a consequence we reduced them significantly. And the things that have performed really badly are the three things that we’ve added, plus a few others in places like electric power and gas. So we’re continuing to do what we always do, which is buy low and sell higher, and nothing has changed.
Turning now to page 7, we showed this last quarter, and it’s worth repeating. The chemical sector and the real estate sector over the period of 35 years since 1983 have performed very much in line. It looks like spaghetti; they are connected. But when you divide one by the other, chemicals by real estate on the right-hand side, you see that there is a big cycle, and there are some big events taking place. And the nickel sector started to win in 2013, and has had four-and-a-half really good years. And the real estate sector started to lose in 2013, and has had four-and-a-half really terrible years. And dividing one by the other you see a really dramatic shift in the relative price and relative valuation implicitly of the two sectors. At the bottom of that cycle we had a lot of chemical stocks and no real estate. As of today, we have nothing in chemicals and an overweight position of about 6½%, we’re about 6½% in real estate. So we’re doing what we always do, which is buy into underperformance and sell out of winners.
Turning to page 8, it’s been a quiet year in terms of transactions. Turnover has been very low. These are the completed transactions, i.e. the ones that we’ve added to the portfolio in the year from zero, and the seven stocks that we’ve disposed of. So we’ve had three new buys, seven sells, which is very significantly below our experience over the last five years when we’ve been doing roughly one buy and one sell a month. The most recent acquisitions are Nissan Motor, which has been a terrible performer and has been derated. But underlying the situation at Nissan, Nissan is in a much completely different position from where it was running into the Lehman shock. It has we think about $10bn of surplus cash once you spin out the finance subsidiary. And they’d learned the lesson of the Lehman shock when they got into financial trouble and needed some short-term bank support, and they are much better insulated against the big downturn. And Osaka Gas is a defensive utility which has been terrible. The defensives as a group have been absolutely awful. Whether it’s the bond proxies like the retailers, the pharmaceuticals, the land transports, the telecoms, they’ve been shocking performers for the last 18 months. We haven’t got any and that’s been one of the things that has helped us over the last 18-month period when we’ve performed very well, and the stocks that we’ve sold have had a good performance in 2017.
Turning now to page 9, another repetition, but a repetition which is still worth making: the Value of Value, the price to book of Large Cap Value divided by the price to book of the whole market. In the period from 1980 to 2011 that ranged, the discount of Value, Large Value stocks on P/B was something like 5 to 15%. It was very tightly constrained within those bands, with the one exception of the extraordinary Growth market, which I mentioned earlier, the TMT bubble of 1997 and particular 1999 where valuations shot out of the box and valuation of Value stocks became really cheap at about 27-28% discount. We went back into the 5 to 15% range, and then when the QE experiment started after the global financial crisis we’ve gone into a deep funk where Value has been derated to what we think is the ultimate turning point, and we may be proved wrong, but the ultimate turning point of early July 2016 where the average Value stock was trading at a 35% valuation discount to the total market. We then see a rapid reversal, the elastic stretched back until December of 2016, and then we’ve had another slight derating, but we’re still with a 30% discount, which is way below where we think normal is. We think this is abnormal, and we think that the next few years will see a period of normalisation taking us back somewhere where we were. And if that happens then Value managers are going to be fashionable again and we should be in great shape, I hope.
Turning finally to page 10, this is the unit price of the UK Core Alpha Fund, which we launched in January 2006. On the 31st January 2006 it was 71½p. As of the 18th January it was 193p. And I only realised last week when I was doing some checking that on the 13th November 2012 the unit price hit 71.6p. So in the first seven years of the life of this strategy we made absolutely no money. Our performance was really excellent relative to TOPIX. Relative to Large Value and particularly relative to the peer group, we had a fantastic run, but we made no money. Since the 13th November 2012 the world has turned around. It was just before the Abe election victory, and we’ve gone up not 200% but not that far short of that. We’re sort of in the 170-180% range in terms of return in sterling terms, which has been really for us three upward waves: one the initial Abe election rally up to spring of 2013, the winter of 2014/15 and also the latter part of 2016 post-Brexit and post-Trump election. We’ve had three upward legs. And then more recently we’ve had a particularly strong time because of the market environment in the latter part of 2017. Over the period since mid-November of 2012 we’ve outperformed TOPIX, we’ve outperformed Large Value and we’ve outperformed the average manager by some way I think. So it’s all quite pleasing on a medium to longish term view, but certainly 2017 we haven’t done anything exceptional, and certainly Value has not been the flavour of the month. And then finally we have to show this because of MiFID II, the five-year track record. We’ve had five positive years. We’ve had four of them in double digits, two of them in excess of 30% after fees, and a compound rate of return. I think since mid-November of 2012 when Abe’s election started to be discounted as somewhere around 21% compound in sterling terms, which is all very pleasing. And I don’t know where we’re going, I don’t know what the future holds, but if I had to bet I would bet on a normalisation of the Value/Growth factor, and we have a lot to look forward to I think. And at that point I’ll pass back to Richard and see if there are any questions.
RICHARD PHILLIPS: Thank you Steve. As I said before if you do wish to submit a question please click on the tab on the screen and email that across. We’ve had a couple in already. So, Steve, the first one refers to the yen, and the fact that it’s been strong recently against the dollar. How would your portfolio perform if the yen went much stronger or performed much more strongly from here?
STEVE HARKER: Well the yen, I mean I think if you go back to the Abe victory in 2012, I think one of the main things that he has done is trashed the currency, and the yen/dollar rate was 80, and in a couple of steps it went from 80 to 100 and then 100 to 125. And that has obviously been really a transfer of resources from the consumer to Toyota and the other manufacturers and overseas companies. And the stock market has obviously enjoyed this. Whether it’s to the benefit of Japanese consumers or not, I’m not sure, but certainly we’ve had a tailwind for any company that operates overseas and any company that is exporting, and that’s certainly been reflected in the portfolio.
The portfolio has been exposed heavily to overseas exporters and overseas earnings for a long time. And it’s only in the last six months that we have actually reduced our exposure back to neutral. So against Large Cap Value and against TOPIX we haven’t really got a bet on a weakening yen, and this is the first time for a very long time that we can say that, probably since about 2010. So the portfolio is not insured against anything, it’s obviously got risks in it, but we’ve got no overt bet in favour of a weakening yet now. And I just would like to say that when we start core alpha in 2006, we weren’t very optimistic on the market and we were very optimistic on the yen and that proved to be correct. And it looks to us that the yen is systematically and profoundly overvalued, and it may well be that in the next five years or so one of the big gains to investors in the UK will come from the strengthening of the yen against sterling. But that may not be for a wee while yet. It could be quarters or years ahead. But on PPI, PPP versions of analysis it looks to me like the yen is now very cheap.
RICHARD PHILLIPS: OK, Steve, next question. Japan has become increasingly popular with investors; do you think they will simply chase the Growth momentum stocks?
STEVE HARKER: Year to date the market’s up about 4%, and in the first two weeks Value was winning, and that was a continuation of where we’d come from since about the 28th November. Obviously I don’t know the answer to this question. I mean there are parallels with what’s happening now with the TMT bubble when what seemed crazy became ever more crazy and the intra-market moves are probably less exaggerated in Japan than in many other places. I mean for instance China some of the stock movements that we’ve seen are quite extraordinary. I have no idea what happens to the market and which segments of the market are going to keep running. If foreigners buy then it’s quite possible that the Growth stocks, smaller Growth will win. But it’s not, certainly if you look historically there’s no given relationship there. And it’s quite possible that they could start following other groups which start to perform. So I really don’t want to commit there because I have no idea.
RICHARD PHILLIPS: Well thank you for that, Steve, and that looks like all the questions we’ve had for today. So unless one pops in the next minute I will just say thank you all very much for calling in again and we look forward to speaking to you at the end of Q1 2018. Thank you very much.
STEVE HARKER: Thank you.