The year 2021 was a difficult year for growth investors. With the development of COVID-19 vaccines, there were expectations that the economy would become normal. So, market sentiment changed from growth to value stocks such as economic sensitives, cyclicals and large-cap manufacturers, which business had been battered.
2021 in Review
Last year, the Topix in GBP went up +2.2%, but the Index (TSE) Mothers, which represent small / mid-cap growth stocks, Index was down 25.1%. Our Fund was down 16.3%. Industry sector breakdown also shows a clear picture of the market trend in 2021. The best performing sector was Marine transportation, up 208.2%, followed by Mining, up 69.8%, Rubber products, up 40.1%, Iron & steel, up 34.0% and Wholesale trade, up 25.7%. The Fund performance in 2021 was mainly affected by this change in market characteristics. It was also partly driven by reaction to the strong performance over the last 2 calendar years, during which the Fund outperformed the Topix by as much as 48%. Over the last decade, the Fund experienced two instances of sentiment driven sell-offs, in 2014 and 2018. Each time, the Fund underperformed the Topix after 2 to 3 consecutive years’ significant outperformance. So, the drawdown in 2021 was not surprising. From 2010, when structural changes became more apparent, to 2021, the Fund appreciated 842%, as against 174% delivered by the Topix. We believe long-term returns are only available with a great patience and by tolerating short-term pains / volatility.
We believe long-term returns are only available with a great patience and by tolerating short-term pains / volatility.
Majorities of companies in our portfolio operate their business in new growth industries benefiting from changes in Japan’s economic and social structure. As shown below, they are showing continuing high growth in sales and profits. As structural changes accelerate, we expect their growth potential will become even larger in the future.
Portfolio Positioning
I would like to give you a quick review on the current positioning of our Fund. We have held broadly the same companies over many years, so there have not been major changes on the portfolio breakdowns.
Nearly 97% of our companies are listed on TSE 1st section and all of them are going to Prime market, which is new classification of market segments by TSE starting from this April. TSE will tighten the listing requirements and companies listing on Prime market will be oriented to companies which centre their business on constructive dialogue with global investors in order to boost listed companies’ sustainable growth and mid-to long term corporate value creation.
All our companies predominantly operate business in Japan with some expanding their business overseas mainly through M&A. As mentioned earlier, we have focused on investing with three main themes over many years.
We have been largely investing in the Healthcare & medical service and it accounts for over 30% of the portfolio. In this sector, one of our largest and longest holdings, M3 who operates integrated medical digital platform has been greatly contributed to the Fund’s performance over long term with the share having appreciated nearly 30 times since we purchased in 2005. Recently, the shares have seen a valuation correction following a rally of 200% in 2020, when the company’s earnings rose sharply on the back of demand for digital healthcare services due to the pandemic. The company expects to deliver consistent growth through an expansion plan into existing and new market, as the acceleration of the structural shift to online marketing for the pharmaceutical businesses remains unchanged.
The second largest theme is consumption related sector including ecommerce companies, which account for 19% of the Fund. Offline retail companies are challenging to diversify their store formats in the face of structural changes in consumption amid the pandemic. For example, one of our long-term holdings, Pan Pacific International plans to increase digital-related investment to improve productivity at stores by improving its mobile app for payment options and providing product information. We expect this efforts will contribute to increase customer traffic and number of items purchased per visit. When COVID 19 situation will turn better and people start to spend monies, we believe retail sector will be one of the best performing sectors in the Japanese market as we have seen the trend in U.S. Also, with a concept of a “Japan-brand" speciality store that carries made-in-Japan and made-for-Japan products, it has been expanding their store operations overseas and they are showing better-than-expected revenue growth. It currently accounts for over 10% of total revenues and the company expects an annualised growth of 20% for the next few years. This is one of the examples we invest in and our companies in the sector are leading companies in their industry, so we expect the shares will perform better in the latter of this year.
The exposure into Human Resources & Outsourcing sector has increased over a year as shares in this sector have recovered sharply due to expectation of a recovery in recruitment activities. Important to note that Japan is facing with the structural labour shortage, so we expect that these companies will continue to benefit from the structural changes and show sustainable growth for mid to long term.
At the end of year 2021, the Fund held 41 stocks and the top 10 accounted for over 55% of the Fund. Among the top 10, there are 2 new companies that were not in the top 10 a year ago. They are Fujifilm Holdings and BayCurrent Consulting, both initially invested about two years ago.
Shares in Fujifilm performed strongly in 2021 appreciating 56% on the back of consistent strong fundamentals following dull movement in 2020 when we purchased. The strong performance of its share price last year owes in part to the better than expected earnings from its diversified operations developed from its mainstay camera and filming business and also to growth expectations for the healthcare segment, which has grown to account for over 20% of the total revenues. We take a positive view on the company’s proactive business portfolio management strategy, for example, of turning its healthcare segment into the largest growth driver with aggressive investments and focusing more on organic growth.
BayCurrent Consulting is one of leading companies to support the Japan’s digital transformation. It provides mobility, IoT, and IT human resources training services to Japanese corporation in order to improve productivity.
The company has been showing strong fundamentals, driven by increasing demand for its IT solutions service and the shares rose nearly 8 times in the last two years. Despite the strong fundamentals, the shares have recently been weak due to the shift of market sentiment changed from growth to value stocks as well as reaction to a substantial strong performance in the past few years. We believe profit growth will remain strong on the back of high-capacity utilization and we expect the shares will perform better in coming years.
The rest of our top 10 holdings have remained the same and majorities of them are showing sustained earnings growth. As for Nihon M&A Centre, a leading provider of M&A advisory services to small and mid-size companies in Japan and one of our longest holdings, the shares were negatively affected by sentiment and some corporate news towards the end of last year. It announced that it had launched an internal investigation into the booking of revenues over the last few years, which management expects would impact the timing of booking quarterly sales. Due to the investigation, the announcement of Q3 business results will be delayed to mid February. We, however, believe that this is unlikely to have a major impact on their long-term growth potential as increasing demands for their M&A services in Japan should support its sustained growth. As a matter of fact, Q2 results proved its strong momentum and they have secured large numbers of deals on hand. We know the chairman well and we expect he will take a leading to strengthen the corporate governance especially auditing function. So, we intend to stay with the company.