FSSA Japan Focus fund: July 2023 update

• Sophia Li has been the lead manager since 2015 and is supported by experienced co-manager Martin Lau
• The fund has performed well since launch, but has struggled more recently, largely driven by the rotation from growth to value
• The team’s been taking advantage of the market drops by adding to some high-quality businesses at lower share prices
• The fund features on the Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits into a portfolio

FSSA Japan Focus Fund aims to grow investors’ money over the long term by investing in high-quality Japanese companies that are dominant in their industry. The team believes the strength and quality of the companies they own is what drives returns over the long run.

We think this could be a good option for exposure to Japan within a global investment portfolio. Its focus on quality growth companies means it could also work well alongside a more value focused fund which invests in Japanese companies at a lower price than their true worth.

Manager

Sophia Li started her career at First Sentier in 2009, where she initially worked as a China company analyst. She’s covered Japanese equities since 2011 and has been the fund’s lead manager since it launched in 2015.

She runs another similarly managed Japan equity fund alongside this one, as well as being a named co-manager on the FSSA Asia Pacific All Cap Fund. We think this is a reasonable workload given the funds share a similar investment process. We like the fact Li can also draw upon the support of First Sentier’s well-resourced and experienced teams to help with things like idea generation and challenge.

Li benefits from the knowledge and experience of her co-manager Martin Lau. Lau is a highly regarded manager in the Asia and China sectors, with over two decades of experience investing across the region. Lau is a modest fund manager who is candid about what’s worked well and what hasn't in his funds. This is a quality we like.

Li has worked closely with Lau for a number of years, and we think the pair dovetail nicely, providing strong challenge and debate on each other’s investment decisions.

Process

Li and her team focus on high quality companies that are capable of sustainable, above-average earnings growth, otherwise known as growth investing. The companies they invest in typically share three main characteristics: a strong franchise, a high-quality management team and an ability to provide sustainable growth over time.

This means they target companies that are dominant in their industry, with competitive advantages that others struggle to replicate. They want these companies to be run by reputable management teams that don't take unnecessary risks in the pursuit of short-term gains.

The team tends to invest in relatively few companies, meaning each one can contribute significantly to returns. Though this is a higher-risk approach. Portfolio turnover tends to be kept low too, but over the last 12 months, the team have decided to make use of market volatility and invest in a handful of companies at more attractive prices.

The team added to their investment in one of Japan’s largest consulting service firms, BayCurrent Consulting. Alongside a more attractive share price, the team are impressed with its reach. It provides consulting services across an array of sectors and the team believe its positioned well to benefit from the major digitalisation push in Japan.

Existing investments in online shopping operator Zozo and Nihon M&A Center, a company that provides services for mergers and acquisitions, were also increased. While the team feels that these companies are sitting at more attractive share prices, they’ve also built a stronger conviction in both firm’s management and long-term growth prospects.

Several investments were reduced over this period following strong performance. Recent examples include Japan Elevator Services, a firm that can repair, maintain and modernise elevators and escalators, as well as Unicharm, a company that manufacturers nappies, as well as disposable hygiene and cleaning products. Long-standing investment Asahi Intecc has also been reduced. The team continue to admire the business, but conviction has fallen more recently, so have decided to recycle the proceeds into other areas of opportunity.

Culture

We like the culture and philosophy that's been cultivated at First State Stewart Asia (FSSA, part of the broader First Sentier Investors group). Their philosophy is founded on stewardship – when they make an investment, they see themselves as part-owners of the business and engage with companies to make sure they're run in a way that'll benefit all shareholders.

FSSA also places emphasis on recruiting and maintaining great people. Every manager and analyst advocates the team's overriding philosophy. At the same time, their individual personalities are allowed to shine, and they're encouraged to bring their own ideas to the table. Fund managers are also incentivised in a way that aligns their interests with long-term investors.

First Sentier Investments was acquired by Mitsubishi UFJ, a Japanese bank, in 2019. Takeovers can sometimes lead to disruption and corporate change, though positively FSSA remains an independent investment team. That said, we will continue to look out for potential further change.

ESG integration

FSSA, alongside the broader First Sentier Investors group, place responsible investing at the heart of what they do. They believe identifying the companies that are driving sustainable outcomes, and whose management have the highest governance standards, are key for long-term returns and keeping shareholder interests aligned.

Every investment team across FSSA has full autonomy to develop their own approach to ESG (environmental, social and governance) integration. The team has integrated ESG considerations into the investment process for decades. Their philosophy is founded on stewardship – when they make an investment, they see themselves as part-owners of the business and engage with companies to make sure they're run in a way that'll benefit all shareholders.

Li places a particular emphasis on engagement as Japanese companies, historically, have lagged in certain areas of ESG. Li engages with each company to help improve things like information disclosure. Alongside this each company should cause little, if any, harm to the environment or the labour they employ. If Li and her team don't think a business meets these standards or is doing enough to address a particular problem, they won't invest.

Cost

The standard annual ongoing charge for this fund is 0.80%, which we think is reasonable for an actively managed Japan fund. The HL platform fee of up to 0.45% per year also applies.

Performance

Since the fund launched in October 2015, it’s returned 114.97%, while the average fund in the IA Japan sector has delivered a return of 74.05%*. Our analysis suggests that the managers’ ability to select outstanding companies, regardless of their size or what sector they’re in, has provided a boost to performance. On top of this, Li’s growth-focused investment style has largely remained in favour over the period, which has also helped performance. Remember past performance isn't a guide to the future.

While Li’s style has worked well in the past, more recently this has not been the case. Over the last two years, we’ve witnessed a sharp market rotation away from Li’s preferred growth style to one known as value investing.

Companies and sectors that are typically more sensitive to the health of the economy, including financials, rallied. The fund has very little exposure to these areas, but has more invested in sectors, like technology, which struggled amid the rotation. It therefore hampered performance and over the last 12 months, the fund fell 0.35%* versus a positive return of 6.15% for the IA Japan sector.

Olympus Corporation, a business that manufactures healthcare machinery and equipment, detracted from performance. The company has historically been mismanaged, and a lot of the different business arms haven’t performed well. There has been some improvement more recently, but positive changes will take time to reflect in the share price.

It’s not all bad news though, towards the end of 2022, and so far this year, performance has improved. Li’s growth style of investing has come back into favour at times over this period, which has helped boost returns from companies in the technology sector, including Rakus, Lasertec and Tokyo Electron. On top of this, insurance company Tokio Marine Holdings has performed well. It’s one of the very few ‘financial’ companies the fund invests in, although its categorisation in financials could be argued given how many things the company does.

Past performance is not a guide to the future. Source: *Lipper IM to 31/05/2023.

Find out more on FSSA Japan Focus, including charges

FSSA Japan Focus Key Investor Information