What do the next 10 years hold in store for Japanese equities?

The Baillie Gifford Japan Trust is now 40 years old. When it was launched, the Japanese stock market index, the TOPIX, was at 570 points*. It has risen to around 1,990* today – an increase of just under 250%. In contrast, the trust has returned 4,200%** turning an initial investment of £1,000 into a pot of money worth £43,000.

Here, manager Matthew Brett tells us more about the trust and makes a few predictions about what the future might hold over the next 10 years.

Japan will be a decent place to invest

“Japan is a well-established, liberal democracy that respects the rule of law. It also has some of the strongest protections for shareholders globally. For example, in Japan it is possible to remove a company president through a simple majority shareholder vote,” said Matthew.

“Today’s Japanese stock market is well placed to deliver for shareholders. The major index constituents are increasingly technology-focused and Japan’s legendary manufacturing prowess means roughly half of the major global robotics companies are listed there. Additionally, and completely differently from the late 1980s, the overall price of the market does not seem in any way excessive.”

Technological progress will drive returns

“Moore’s law suggests exponential growth in computing power,” he explained. “5G creates far better connectivity and, within a decade, routine deployment of machine learning and AI is quite plausible. Exponential progress implies that the situation in a decade won’t simply be the sum of 10 single years.”

To quote Bill Gates:

“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next 10”.

“Within the Baillie Gifford Japan Trust there are many businesses that we hope will benefit from disruptive technology, from SoftBank to Rakuten, who are challenging telecoms companies with their network roll-out,” continued Matthew. “An additional benefit is that we also access Japan’s excellent manufacturing companies, which we believe could experience rapid growth as the increases in computing power create opportunities in automation: whether that is FANUC with its green-painted collaborative robots or Kubota automating agricultural mechanisation.”

The journey won’t be smooth

“It is important that we’re transparent: sometimes our investments don’t show the growth we hoped for,” he continued. “Sometimes we will not buy something that goes on to deliver exceptional growth. But we will try to find businesses with a large growth opportunity ahead of them, and the competitive advantages to profit from it. By being honest about inevitable mistakes we can focus our energies on seeking successful investments. One successful investment can deliver a return many times more than one mistake.

“It would be lovely to deliver a good outcome for shareholders in a straight line but it’s never going to happen. Looking at the past 40 years there have been six occasions when the share price has declined by over 30 per cent, so it shouldn’t be a huge surprise if another such dip happened over again. The returns that are available to shareholders from long-term investment in good quality companies are only available at the price of toleration of shorter-term volatility.”

We will focus on delivering value to shareholders after fees

“Our primary aim is to find attractive growth businesses, invest clients’ money in them, and patiently wait to benefit from their growth over time. If we can do this well, we believe we can compound our clients’ wealth over time. Additionally, we try to keep costs down. Ongoing charges fell from 1.27 per cent to 0.66 per cent over the past decade***, mainly due to fee reductions and the trust’s increasing scale, which means shareholders keep more of the return,” said Matthew.

“When the shares have traded at a premium to the asset value the board has been prepared to issue shares and, on the rare occasions they have fallen to a meaningful discount, to buy them back. Both actions help enhance shareholder value over time.”

Dividends should grow significantly

“The combined effect of the Japan Corporate Governance Code and Japan Stewardship Code is to make boards more thoughtful about traditional practices, such as crossholdings and large cash holdings. They are more likely to pay a dividend based on a percentage of profits. However, given the large amounts of cash still on Japanese balance sheets, it is likely that dividend growth can outpace profit growth over the next decade,” continued Matthew.

“The Baillie Gifford Japan Trust paid its first dividend for many years in 2018 and it has increased every year since. We think it highly likely that dividends per share will be higher in a decade’s time.

“We believe that the most fertile ground for growth investment in Japanese companies still lies ahead of us,” concluded Matthew. “We encourage shareholders to look to the long-term, and show fortitude during the inevitable setbacks, so that the long-term rewards can be theirs to enjoy.”

*Source: Japan Exchange Group, 26 January 2022
**Source: FE fundinfo, price returns in sterling, 26 August 1981 to 25 January 2022
***Ongoing charges as at 31 August 2021. Calculated in accordance with AIC.
Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The investment trusts managed by Baillie Gifford & Co Limited are listed on the London Stock Exchange and are not authorised or regulated by the FCA.
A Key Information Document is available by visiting bailliegifford.com