18 Feb 2022
In early February I resumed travelling to the UK to meet fund managers and was surprised how quiet Dublin Airport was. On the morning of the 1st February, after 11am, there were only 14 Aer Lingus flights for the rest of the day, seven of these were to North America and three to the holiday destination of the Canaries. With less flights operating, getting in and out of Heathrow was much quicker, and the typical descent to the airport involved tracking the River Thames westward with, on this occasion outstanding views of the City of London Financial District with the Shard Hotel which opened in 2013 - the glass clad pyramidal tower has 72 bedrooms and an open-air observation deck on the 72nd floor with a height of 310m. Just behind it is the Fenchurch Building which opened in 2015, known as the ‘Walkie-Talkie’ as it resembles a two-way radio handset.
The financial district is very historic as it contains most of the London which formed the original Roman settlement and also much of London’s medieval history including remnants of the original walls and the Tower of London. Today it remains the heartland for the UK’s financial services industry. Development throughout the 19th Century has led to London becoming the world’s leading business centre, employing close to 1 million workers and housing around three quarters of the jobs in the financial, professional, and associated business services sectors. Much of the old City of London was destroyed in the 1666 Great Fire and then suffered heavily during World War II in the Blitz but this millennium has seen the city scape transformed by the development of a number of huge office buildings which dominate the skyline today.
London itself continued to be quiet, which made getting around easy, and I caught up with Goldman Sachs Asset Management to get an update on the Japan Equity Partners portfolio where the aftermath of the pandemic has left a very different economic landscape to that of the West. While the focus in most of the developed economies has been on rising inflation, this remains subdued in Japan due to demographics and other local factors. Japanese companies are less open to hiking prices than their Western counterparts, as they believe consumers would resist. Furthermore, wages are not seeing upward pressure, and although the past 5-6 years has seen modest levels of wage growth, this seems unlikely to accelerate in an environment where workers are given jobs for life and most government policies continue to be deflationary. Most businesses believe that if they did raise prices, sales would fall as many domestically orientated sectors suffer from over supply and as a result there is a fear that raising prices would simply end in market share loss.
Despite the different domestic economic outlook, the market environment in Japan has been dominated this year by macro factors. Foreign investors own less than 20% of the Japanese equity market but they often account for 50-70% of trading levels and follow global rather than local trends. As a result, banks in Japan have performed well to date in 2022 but Goldman remain negative on the longer-term prospects of the sector. They believe that Fintech presents a challenge, and the low interest environment will not change any time soon. The Bank of Japan will remain well behind other developed nation central banks in raising rates or tightening monetary conditions with inflation still way below the 2% target level. One of the negative fundamental factors for banks is that loan demand is low, and with 75 listed banks in Japan and most corporates having excess cash, the loan market is extremely competitive and consequently, profit margins on loans to corporates are extremely poor. Consolidation in the banking sector would help rectify this, but local factors and culture with banks providing both employment and services in rural areas makes this politically unacceptable. So, despite the short-term rally in bank share prices, Goldman remain cautious over the longer-term.
Japan has been closed to inward tourism for much of the pandemic and has suffered from the dearth of Chinese tourists as travel bans for Chinese citizens remain in place. As well as hitting certain sectors in Japan which rely on Chinese visitors, including cosmetics businesses, some Japanese companies had been expanding sales within China. Retail stocks such as Nitori and Fast Retailing have suffered as the Chinese economy, and especially anything relating to the property sector, has slowed.
During 2021 the fund increased exposure to several businesses involved in the semiconductor space in its broadest sense including suppliers into this industry such as Ajin Omoto and JSR Corporation. Within the retail sector, there are still niche opportunities such as ASICS, a sports apparel business, which has recognised it cannot compete globally with names such as Nike, but by a careful focus on certain parts of the market can deliver growth.
While domestic demand in Japan remains sluggish, hindered by negative demographics, there are some secular growth stocks in the market which have delivered strong results even when looking at international competitors with names such as Hoya, OBIC, Shin-Etsu Chemical, and Chugai Pharmaceuticals delivering strong absolute gains. Perhaps surprisingly, e-commerce in Japan has been a relatively slow grower compared to the West and there is a dearth of listed investible companies. Within the e-commerce sector it is generally global names such as Amazon that dominate and IT spend on the corporate side has also lagged the West.
In 2022 key market drivers will be the ongoing domestic economic recovery as Japan emerges from the pandemic, helped by resilient global levels of cyclical activity, that has favoured the strong manufacturing base in Japan which is focused on high-end products. Despite sluggish wage growth, the labour market in Japan remains relatively under supplied and Recruit Holdings (HR services) has been a long-term winner for the fund, with this company operating staffing and information services in Human Resources, both in Japan and globally. Automation companies will also continue to see strong demand for their products and with corporate management in Japan relatively upbeat, despite the sluggish domestic environment, strong stock pickers should continue to be able to deliver positive returns to investors over the medium-term.
A fund taking a very different approach to investment is the BNY Mellon Global Equity Income Fund which focuses on out of favour companies as it only purchases stocks when they have a 25% minimum yield premium to the overall market. This approach is longer-term in nature as the stocks held are often seeing some form of short-term difficulties, otherwise they would not be trading at valuation levels at a significant discount to market averages. The approach looks to deliver an above average income stream to investors together with some level of capital growth and avoids the most popular sectors in the market by automatically selling any stocks where the yield falls to below the market level on a forward-looking basis.
The focus of the fund is on both troubled compounding machines delivering high returns on capital with good cash conversion but have temporary problems that the market mistakes for permanent impairment and cash generative businesses where the market believes companies have gone ex-growth, but where the dividend pay outs are sustainable over the longer-term. The fund management team utilise the strong global research resource at BNY Mellon where there are career industry specialist analysts and combine this with finding businesses that sit favourably with the long-term trends or investment themes, highlighted by the research team looking to identify companies with a favourable tailwind. These look at things such as population dynamics and something of increasing importance in today’s world, Earth Matters. Other themes that have been within the fund for several years include Smart Revolution, Net Effects, and demand for health services.
This fund takes a value orientated approach so has had a difficult three years but, with the change in interest rate outlook, has seen a revival in performance in 2022. Due to the strict yield discipline, it cannot hold leading technology companies such as Apple, Microsoft, Alphabet, Amazon, or electric vehicle company Tesla with favoured names Cisco, Infosys, RELX, PepsiCo, British American Tobacco, Munich Reinsurance, and Emerson Electric. This fund takes a specialised approach to investment and is particularly suitable for investors needing an above average income or yield, and when value investing is in favour, has the potential to perform strongly, but likewise suffers when the market is focused on higher growth companies.
When staying in London I was fortunate enough to have a room looking out over Apsley House which is currently lived in by the 9th Duke of Wellington, the great-great-great Grandson of the 1st Duke of Wellington. Arthur Wellesley, the 1st Duke, was one of the leading military and political figures of the 19th Century, renowned for his victory over Napolean Bonaparte in June 1815. His childhood was actually spent at Dungan Castle, Ireland, the family seat. After the Battle of Waterloo, Wellington retired from active service, settling into civilian life, and bought Apsley House in 1817 from his brother and set out to make a name for himself in politics, becoming Prime Minister in 1828. His unpopularity in this role led to Apsley House being twice attacked by mobs. The house was given the popular nickname of Number 1 London, sitting on Hyde Park corner as it was the first house visitors to the city came across, sitting next to the main turnpike or toll into central London. It remains lived in by the current title holder to the present day and is a landmark building in London and unsurprisingly Grade I listed. It is open to visitors throughout the year.
Graham O'Neill, Senior Investment Consultant
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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