Legg Mason Japan Equity fund

In an investment world dominated by shortterm numbers, fund managers prepared to stick to a process whatever the market backdrop are increasingly rare.

“It is natural there should be divided opinion when policy changes as radically as it has since December. It is not easy to turn around the economy from two decades of stagnation and deflation, but the government will draw up a fresh set of more drastic growth strategies this autumn.”

Hideo Shiozumi

Hideo Shiozumi certainly falls into that camp and while that conviction has cost him at certain times down the years, his longterm track record is up there with the absolute best in the industry. A 40-year market veteran, he started off working for Robert Fleming in the 1970s before a spell with George Soros on the Quantum fund. Shiozumi set up his own company in 1983 and Shiozumi Asset Management has run the Legg Mason Japan Equity fund since launch in 1996. In short, his approach focuses on small-cap growth in the country and while this has produced spectacular numbers during bull phases, the fund has often taken harder hits than peers in falling market. A look at current data shows just what the fund can do: first in its peer group over one, three and five years, it has registered a near-200% gain for the longest time period, more than twice the next-best performer. Critics might highlight the fund’s volatility amid tougher conditions – of which Japan has had more than its share over recent decades – but Shiozumi believes ongoing structural shifts are bringing the country more in line with his long-term thinking.‘New Japan’ and ‘Abenomics’Looking at recent numbers – the fund is up almost 80% over 12 months, again more than double the sector average – he says this reflects both the overall market rally and his focus on ‘New Japan’. Taking the market first, the rally has largely been on the back of policy measures from Prime Minister Shinzo Abe’s administration and the Bank of Japan. “This ‘Abenomics’ reflects the government’s determination to break out of Japan’s long stagnation and the three so-called ‘arrows’, namely fiscal stimulus, monetary expansion and economic reforms, have breathed new life into markets this year,” says Shiozumi. Having climbed to a six-year high by May however, the Nikkei Average saw its largest single-day dive since 2000 – and the 11th biggest loss in history – on the 23rd of the month, triggered by concerns about the US scaling back its own QE and weaker-than-expected Chinese economic data. “We saw this correction as a reaction to the excessively rapid move in the index, which soared between November and May,” adds the manager. “In our view, this was healthy and an excellent opportunity to increase exposure to Japanese equities – with shares already bouncing back amid receding concerns over Fed policy.” According to Shiozumi, market strength over the past six months has largely come from the success of the first two Abenomics arrows, which have shifted the economy into a positive cycle. “This is evident in increased personal spending and gradual expansion of corporate production, as well improvements in unemployment and business sentiment among large manufacturers,” he adds. “Investors are now waiting for the key third reform arrow to ensure this recovery continues. Some investors, who had been bullish and optimistic on Abenomics until recently, have turned sceptical as the market corrected. However, it is natural there should be divided opinion when policy changes as radically as it has since December. It is not easy to turn around the economy from two decades of stagnation and deflation but the government will draw up a fresh set of more drastic growth strategies this autumn.” With Abe’s determination and continuing high approval rating, Shiozumi sees a good chance of Abenomics successfully reviving growth, particularly as the administration won a majority of seats in the Upper House election in July. This provides political stability and with no further major national elections likely until summer 2016, Abe will have the opportunity to implement his strategies over the next three years. As for the fund, Shiozumi believes ongoing political change is finally moving the country towards the ‘New Japan’ concept that has dictated his thinking over several decades. “The era of Japan’s high economic growth ended at the end of 1989 with the collapse of the asset-bubble economy,” he says. “Since then, Japan has suffered from deflation for more than 20 years and is currently in the midst of long-term change to its economic and social structure. I believe the days of growth driven by exports and big companies are over – the economy will only be revitalised through the creation of new industries and by deregulation.”Small but mightyShiozumi notes many investors are currently chasing the big companies and exporters, particularly as political change has weakened the yen in recent months, but feels his investment stance is very different. “Legg Mason Japan Equity is grounded in an ideology we call New Japan, based around the idea that, for the country to move forward, its economy has to transform from manufacturing-based to service orientated,” he adds. “The country also has to move from a regulated economy, tied down by red tape and bureaucracy, to one that is far more entrepreneurial.” With the New Japan idea gaining traction in the face of structural change, Shiozumi stresses this is not something his team has been considering for a few months – they have been talking about it for 20 years; it is part of the Legg Mason fund’s DNA. “With politicians and central bankers targeting mild inflation and a weaker currency after years of deflation – and moves toward structural changes to labour laws and more open trade – we believe the era of New Japan is now much closer to reality,” he adds. Shiozumi continues to focus on smaller companies tied into this transition, looking for stocks with potential to grow at least 20% per annum over a four-year period.Aging, the internet and healthcareHe is currently focusing on three main themes: the aging society, which creates opportunities for companies with products and services geared toward the elderly, the internet as a sales channel, and the medical and healthcare fields, regarded as one of Japan’s last remaining growth industries. Almost 90% of the portfolio is invested in companies following these three themes, with considerable exposure to the services sector, retail companies, and information and communications-related stocks. On the medical and healthcare sector for example, Shiozumi says the government is looking to turn this area into one of the country’s top industries by selling Japanese medicine and devices, as well as medical systems and services, to other countries. “Furthermore, while most people know that Japan is aging, they fail to grasp the opportunities created for companies with unique products and services geared towards the senior end of society,” he adds. “This is leading to a change in consumers’ lifestyle – how the Japanese spend money, how they buy different products over time and the channels they use to buy them.”He also sees the broadening of an internetorientated economy as offering enormous potential. “People no longer just go into ‘bricks and mortar’ shops and companies and factories no longer just buy from other bricks and mortar vendors,” says the manager. “This opens up the concept of businessto- business, business-to-consumer and consumer- to-consumer, providing a range of opportunities linked to the internet. These are not operations offering simple goods and services – we are talking about medical companies marketing products online for example or retailers using the internet to talk about fashion and connect with boutiques and buyers.” For Shiozumi, the internet provides an incredibly powerful channel to enable companies to increase and grow their businesses. He notes top holding MonotaRO as an example, which provides a range of factory-use supplies and intermediate materials such as drills, electric wires, pipe joints, and cleaning materials to small and mid-sized factories through its website. “It has its own logistic network, with a few hundred domestic and global supply partners, meaning it can supply items with next day delivery,” he adds. “These attributes are helping the company expand its client base to larger companies, as well as developing its business overseas. We expect this new client base to lead to greater sales and higher earnings growth in the latter half of this year, as well as higher sales and profit growth next fiscal year onwards.” Elsewhere, the manager highlights Don Quijote as a company benefiting from changing consumer habits. “Don Quijote is a leading discount retailer and with 24-hour opening and original display methods featuring compression displays and distinctive exteriors that become local landmarks, their stores focus on shopping as entertainment.”Charging into a bull phaseLooking forward, Shiozumi believes Japan has entered a bull phase, which could last over the coming few years. “While the market has rallied considerably, it is still down 60% from its 1989 peak and the upside could be substantial,” he says. “If Abe can lift Japan out of deflation, and household and public pension funds shift their financial assets from government bonds into equities, this bull market is likely to last for at least another 18 months.”