Baillie Gifford Japanese: November 2024 fund update

• Matthew Brett has a long history of investing in Japanese companies and has the support of a highly experienced team

• The manager focuses on companies he believes have high-growth potential

• Over the long term the fund has performed well against the broader Japanese stock market

• This fund was recently added to our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The Baillie Gifford Japanese fund invests in companies based in Japan. It focuses on larger companies, but invests more in medium-sized companies than some other funds in the Japan sector. Investments in smaller businesses adds risk. The fund is managed in line with Baillie Gifford's growth-focused investment philosophy, with a focus on companies with high or sustainable growth potential.

This fund could be used to diversify a global investment portfolio and add long-term growth potential. It could also be used to sit alongside other funds using a value investment style and a focus on companies that have recovery potential.

Manager

Matthew Brett is lead manager of this fund. He has 21 years’ experience in the investment industry, all of which have been spent at Baillie Gifford. This means he’s well-embedded in the Baillie Gifford culture and style of investing.

Brett joined Baillie Gifford and the Japan team in 2003. He became co-manager of the Japanese fund in 2008, alongside Sarah Whitley, another experienced investor in Japan, and later became the fund’s lead manager. He continued to work closely with Whitley until she retired and left Baillie Gifford in 2018 and learned a lot from her knowledge and experience during their time working together. He continues to have support and works with a 10-person team focused on Japan. We like the collaborative approach, with ideas coming from across the team and a focus on developing talent.

Brett also manages the Baillie Gifford Japan Trust, which has significant overlap with this fund. He also co-manages the Baille Gifford Income Growth fund with Karen See. This fund has similarities with the Japanese fund, though it focuses more on achieving an income. His primary focus is on the Japanese fund and Japan investment trust as he is lead on these funds. We believe his fund management responsibilities are manageable given the overlap in investments and process.

Process

The fund’s philosophy is aligned with other Baillie Gifford funds. This means Brett focuses on the fundamentals of individual companies and their long-term potential for growth. He invests in what he believes to be some of the best companies in Japan with at least a five-year view.

The fund invests in companies at different stages of growth, and is segmented into four buckets:

• Secular Growth - companies with high growth potential

• Growth Stalwart - steady compounders that may deliver steadier rates of growth

• Special Situations - larger conglomerates or businesses trading on a low share price that the manager doesn’t believe reflects their true worth

• Cyclical Growth - companies that could be more sensitive to changes in the health of the economy.

Overall, this means Brett can be categorised as a ‘growth’ investor. That said, he’s flexible and invests in a range of companies with different drivers of growth, and some that are lowlier valued and may not be typical of a growth investor.

Importantly, each business must demonstrate resilience and have an adaptable or durable enough competitive advantage that could help them deliver growth over the next 5-10 years.

This has led the fund to have a bias towards service industries (a broad area including internet businesses), telecoms, automation-related companies, skincare businesses, and computer gaming. On the other hand, he currently avoids industries he believes are in long-term decline, such as autos, ‘old-fashioned’ financial companies and banks, and iron and steel.

Tokyo Metro is a recent addition to the fund. Brett invested in the subway operator when it recently listed on the stock market (known as an IPO). It’s so far contributed positively to performance, though this is over a short timeframe.

Culture

Baillie Gifford is an independent private partnership founded in 1908. It's owned by partners who work full time at the firm. This ownership structure means senior managers have a vested interest in the company, and its funds, performing well. Brett is a partner in the firm, which means he’s well-incentivised for this fund to perform well, as well as to ensure he makes a valuable contribution to the wider business and its success.

We think this has helped cultivate a culture with a long-term focus, where investors' interests are at the centre of decision making. We also like that fund managers are incentivised in a way that aligns their interests with those of long-term investors and should retain talented managers.

ESG Integration

All of Baillie Gifford’s funds are run with a long-term investment horizon in mind. The firm’s fund managers see themselves as long-term owners of a business, not short-term renters. So, assessing whether society will support, or at the very least, tolerate, the business model over the long term, and whether management will act as good stewards of shareholders’ capital is an important part of the investment process.

Investment teams, including the Japan team, have access to dedicated ESG (Environmental, Social and Governance) specialists, and the firm also has a Climate team and ESG services team which is responsible for voting operations and ESG data. Individual investment teams are responsible for voting and engagement for the companies they invest in. Investment in controversial weapons and companies involved in recreational drugs are prohibited across the firm.

Within this fund, sustainability and ESG issues form a key part of the manager’s research and analytical framework. We feel ESG is always considered when the team researches all companies, though this is not a specialist responsible or sustainably invested fund.

Cost

This fund is available at an annual ongoing fund charge of 0.64%. This makes it one of the lowest cost active funds in the Japan sector. The HL platform fee of up to 0.45% per year also applies, except in the HL Junior ISA, where no platform fee applies.

Performance

Since Brett has been involved in the fund’s management in 2008, it’s grown 234.40%* compared with 174.05% for the average fund in the IA Japan sector. This is an impressive return, though as always past performance isn’t a guide to future returns.

Given the fund’s growth-focused investment style, it tends to perform better when growthier companies are in favour, but not as well when value-focused companies or those undergoing a recovery are performing well. Over the longer term, our analysis shows the manager has added value through stock picking – this means the ability to invest in companies that go on to perform well, regardless of what sector they’re in, and without making ‘bigger picture’ economic calls.

All funds have tougher periods as well though, and this fund didn’t perform as well as the broader market or average fund in the sector from 2021-23. This was partly due to the manager’s growth investment style being out of favour. Over this time, value-focused funds performed much better in Japan. The manager also had some stock selection issues.

While it’s always disappointing to see a fund go through a bad spell, this reminds us that different investment styles come in and out of favour. As a result, it’s important to maintain a diversified investment portfolio, spread across different geographies and investment styles.

Over the past year, the fund has seen some improvement in performance. Exposure to companies involved in services, transportation, telecoms, utilities and insurance have been some of the key contributors to performance. Some of the strongest contributors to performance include internet services company SoftBank, MS&AD Insurance, and Rakuten, a technology company that’s involved in areas including e-commerce, banking, and communications.

That said, not investing in some of the market’s largest value companies, including Toyota and Mitsubishi UFJ, Japan’s largest bank, detracted from performance. We expect stronger performance from these types of companies to detract from the performance of this fund, though the reverse is also true.

Over the longer term we expect the manager to deliver performance from good stock picking, though there are no guarantees.