INvESTINg IN JAPAN: ATTRACTIvE valuations, STRONg EARNINgS AND RISINg ShAREhOlDER RETuRNS EASTSPRINg INvESTMENTS JAPAN DYNAMIC FuND MARCh 215 FUND INSIGHTS Japan is more widely becoming recognised for its attractively valued companies with sound fundamentals and strong balance sheet health. The concerted restructuring effort of many Japanese companies is now helping to deliver strong earnings growth, which we believe is yet to be reflected in higher share prices. These are drivers of longer term sustainable earnings which may also contribute to a longer term re rating in Japan. As seen in Fig.1, for fiscal year ending March 215, third quarter net income for TOPIX companies posted aggregate earnings that exceeded consensus estimates by 7.6% 1. This is now the ninth consecutive quarter of earnings exceeding consensus in Japan. A trend towards increased dividends and buybacks provides further evidence that the attractiveness of Japanese equities is structurally increasing. Financials are good examples of stocks shunned by the broader market in 214 and being rediscovered on the back of strong results after years of restructuring. Mitsubishi ufj Financial group (MuFg) is Japan s largest bank. Its third-quarter profit for the fiscal year ending March 215 unexpectedly rose 37% to JPY349 bn 2, led by income from loans abroad and investment banking. MuFg has a strong and diversified balance sheet and Fig.1. historical Quarterly Earnings Surprise for TOPIX (%) 14 12 1 8 6 4% 4 2-2 -4-6 -4% -2% 7% 1% 13% 13% 4% 11% 8% 8% 8% Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 F3/12 F3/13 F3/13 F3/13 F3/13 F3/14 F3/14 F3/14 F3/14 F3/15 F3/15 F3/15 Source: Bloomberg, Morgan Stanley. Timeline is based on Japanese corporate fiscal year calendar. Data as at 16 February 215. has diversified away from the domestic interest rate and credit cycle. Offshore loans represent approximately 4% of total loans compared with 2% in 25 3. Foreign loans may re-price as the us rate cycle normalises, which could be supportive for net interest margins. MuFg has surplus capital which meets Basel III requirements and has ample scope to pay dividends or share buybacks. 1 Source: Morgan Stanley Research. Japan Strategy. Earnings Final Cut Ninth Straight Quarter of Earnings Beat; Full-year guidance up. 17 February 215. 2 JP Morgan Asia Pacific Equity Research, 3 February 215. 3 Eastspring Investments, March 215.
Investing in Japan: Attractive valuations, strong earnings and rising shareholder returns Page 2 The company has already spoken of its intention to prioritise return on equity (ROE) as part of the new medium-term plan. Mitsubishi ufj Financial group is the largest position in our flagship Japan Equity Fund, the Eastspring Investments Japan Dynamic Fund (the Fund ). MuFg represents 6.7% of the Fund s NAv (as at 28 February 215). STRONg CORPORATE EARNINgS ARE NOT REFlECTED IN STOCK valuations As most market commentators remain focused on short term macro economic data points, many investors are not paying enough attention to ongoing changes taking place at the corporate level driven by economic imperative. Institutional investors in fast-aging Japan face growing pension liabilities, which challenge them to realise higher investment returns. At the same time, the breakdown of corporate cross-shareholdings is among the factors forcing companies to increase capital efficiency and boost shareholders return. While the market still underestimates the staying power of the changes in Japan s corporate governance and corporate leadership attitude, those changes are beginning to be reflected in earnings. As a result, Japanese equities valuations continue to be cheap both relative to their own history and relative to other developed equity markets (refer to Fig.2 and Fig.3). valuation dispersion remains wide in Japan. There are many stocks which trade at a significant discount to the market, which offer the best potential value. CORPORATE ChANgES ARE DRIvINg EARNINgS growth AND ShAREhOlDERS RETuRN Although the structural reforms under Abenomics will require many years to come to fruition, structural changes in corporate Japan have been underway for many years. It has already translated into concrete behavioural shifts on the part of Japanese corporate managements, including a multi-year high in share buybacks which totalled JPY4.2 trillion for calendar 214, up 86% from 213 4. The trend should continue into 215, and initial signs are encouraging as banks and other companies that have been reluctant to increase payouts have started to act. Fig.2. Japan equity Price-to-book 3 2.5 2 1.5 1.5 Fig.3. Japan equity Price-to-earnings versus World 3 25 2 15 1 5-5 Jan '15 Jan '13 Jan '11 Jan '9 Jan '7 Jan '5 Jan '3 Jan '1 Jan '99 Jan '97 Jan '95 Jan '93 Jan '91 Jan '15 Jan '13 Jan '11 Jan '9 Jan '7 Jan '5 Jan '3 Jan '1 Jan '99 Jan '97 Jan '95 Jan '93 Jan '91 MSCI Price-to-book ratio Average +1 Std Dev -1 Std Dev Source: Eastspring Investments, Datastream, 3 January 215. MSCI Price-to-earnings relative to World Average +1 Std Dev -1 Std Dev Source: Eastspring Investments, Datastream, 3 January 215. 4 Source: JP Morgan Asia Pacific Equity Research. Japan Equity Strategy Q3 Earnings, Buybacks, & Dividends - Ongoing Improvement. 3 February 215.
Investing in Japan: Attractive valuations, strong earnings and rising shareholder returns Page 3 Japan s listed firms are expected to pay record high dividends of JPY7.4 trillion 5, up 7.5% from the previous record reached in last fiscal year ended March 214. Fig.5. Eastspring Investments Japan Dynamic Fund Performance Class A (%) 16 A number of companies have announced dividend hikes especially companies in the technology sector. Among the stocks we own in the Eastspring Investments Japan Dynamic Fund, current dividend per share (DPS) guidance is up 13% for TDK Corp. and 5% for Advantest 6. As profits continue to trend higher, dividend growth is also expected to remain strong. 14 12 1 8 6 4 3.2 8.7 5.2 7.9 13.6 8.9 1. 12.2 9.3 5.1 6.6 4.5 Fig.4. Dividends and share buybacks (JPY bn) 2 16, 14, 6 months 1 year 3 years (p.a.) Since inception (p.a.) 12, 1, 8, 6, 4, 2, 21 22 23 24 25 26 27 28 29 21 21 213 214e 215e Offer-Bid Bid-Bid MSCI Japan (Net) Index Source: Eastspring Investments, 28 February 215 in USD. Based on the retail share class (A) of the representative portfolio. Performance calculated in USD with net income reinvested. Offer-bid includes 5% Initial Sales Charge w.e.f. 1 August 12 and 5.75% Initial Sales Charge prior to 1 August 12; Inception Date: 7/2/211. Prior to 1 May 212, benchmark returns were on a Gross Dividend basis. With effect from 1 May 212, the benchmark returns are on a Net Dividend basis. The two series are chainlinked to derive the longer period benchmark returns. The chart above is included for illustrative purposes only. Past performance is not necessarily indicative of the future or likely performance of the Fund. Benchmark is MSCI Japan Index (Net). Dividends Share buybacks Source: Eastspring Investments, Datastream, 3 January 215. Eastspring Investments Japan Dynamic Fund (the fund ) The Fund is a concentrated portfolio of our best investment ideas, built from the bottom up. We focus our in-depth fundamental research on attractively valued companies paired with sound fundamentals that have yet to be fully recognised by the market. Many of the stocks we own have seen significant balance sheet and earnings improvements after meaningful restructuring. Our track record is the proof statement of the relevance and disciplined execution of our investment approach. A strong imperative to enhance shareholder returns Improvements in Japan s shareholder culture have been happening over many years since Japan s economic crash of the early 199s. The real estate and stock bubble burst forced banks and corporates into a long balance sheet healing process which fostered greater dependency on disintermediation for financing purposes. Combined with pension funds growing liabilities, both Japanese companies and institutional investors now have strong reasons to improve corporate behaviour and achieve higher returns. 5 Nikkei Asian Review. 15 February 215. 6 Source: JP Morgan Asia Pacific Equity Research. Japan Equity Strategy Q3 Earnings, Buybacks, & Dividends - Ongoing Improvement. 3 February 215.
Investing in Japan: Attractive valuations, strong earnings and rising shareholder returns Page 4 The shareholder stewardship Code for institutional investors was introduced in 214 to enhance fiduciary responsibility and promote accountability and proactive engagement between investors and their investee firms. This year, the Financial Services Agency (FSA) is taking another step in the right direction with Japan s first ever Corporate Governance Code (the Code ), taking effect from 1 June 215. The aim of the Code will be to establish best practice guidelines of governance behaviour for companies. Fig.6. Five basic principles New Corporate Governance Code draft Protection of shareholders rights The new Corporate Governance code is likely to spur more behavioural shifts benefiting shareholder value going forward, adding further impetus to long term changes initiated before Abenomics top down policies. As a way of highlighting this, Japan s largest bank Mitsubishi UFJ Financial Group has gone from two outside directors to five and voluntarily adopted board committees. Reasons to invest in Japan We see many cheap opportunities in Japan a good starting point for investment Corporate health is very strong pointing to sustainability of earnings Strong earnings are being delivered Returns to shareholders are now on the rise Comunication/ engagement with shareholders Corporate Governance Code Recognition of other stakeholders We see a strong investment case for Japan equities as attractive valuations combined with improving sustainable returns drives longer term re-rating in Japan. Responsibility of board of directors Fair disclosure and transparency We focus on what matters most and see investment opportunities from the bottom up stock by stock. Ultimately our long term performance track record is the proof statement of the abilities of our investment team and approach. Source: FSA, as at December 214. Specific requirements of the Code that will be particularly impactful for companies include the need to appoint at least two independent outside directors and, where appropriate, aim to achieve a one-third independent board director ratio in line with global standards. Additionally, greater scrutiny will be placed on cross-shareholding. Listed firms will be required to disclose the economic rationale for cross-shareholdings and establish and disclose their proxy voting policies for cross-held shares.
Investing in Japan: Attractive valuations, strong earnings and rising shareholder returns Page 5 Disclaimer This document is issued in: Singapore by Eastspring Investments (Singapore) Limited (UEN: 19947631H). Eastspring Investments (Singapore) Limited is the appointed Singapore Representative and agent for service of process in Singapore. Hong Kong by Eastspring Investments (Hong Kong) Limited. United Arab Emirates by Eastspring Investments Limited which has its office at Precinct Building 5, Level 6, Unit 5, Dubai International Financial Center, Dubai, United Arab Emirates. Eastspring Investments Limited is duly licensed and regulated by the Dubai Financial Services Authority (DFSA). This information is directed at Professional Clients as defined by the Conduct of Business rulebook of the DFSA and no other person should act on it. Luxembourg by Eastspring Investments (Luxembourg) S.A., Grand-Duchy of Luxembourg. United Kingdom by Eastspring Investments (Luxembourg) S.A. UK Branch, 125 Old Broad Street, London EC2N 1AR. This document has not been reviewed by the regulators of the above entities such as Securities and Futures Commission, Hong Kong, Monetary Authority of Singapore, Dubai Financial Services Authority etc. The Fund is a sub-fund of Eastspring Investments ( the SICAV ), an open-ended investment company with variable capital (Société d Investissement à Capital Variable) registered in the Grand Duchy of Luxembourg, which qualifies as Undertaking for Collective in Transferable Securities ( UCITS ) under relevant EU legislation. All transactions into the Fund should be based on the latest available prospectus, Key Investor Information Document (KIID), and any applicable Fund or share class offering document of the SICAV. Hong Kong investors should refer to the Hong Kong Summary Prospectus and Product Key Fact Statements ( KFS ). Singapore investors should refer to the Singapore Prospectus and Product Highlights Sheet ( PHS ). Such documents, together with the annual and semi-annual financial reports and the articles of incorporation of the SICAV, may be obtained free of charge from Eastspring Investments (Luxembourg) S.A. at 26, Boulevard Royal, L-2449 Luxembourg, Grand-Duchy of Luxembourg, or at relevant Eastspring Investments business units/ website and their distribution partners. This document is solely for information and does not have any regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. This document is not intended as an offer, a solicitation of offer or a recommendation, to deal in shares of securities or any financial instruments. Please refer to the offering documents for details on fees and charges, dealing and redemption, product features, risk factors and seek professional advice before making any investment decision. An investment in the Fund is subject to investment risks, including the possible loss of the principal amount invested. The value of shares in the Fund and the income accruing to the shares, if any, may fall or rise. Where an investment is denominated in a currency other than your base currency exchange rates may have an adverse effect on the value price or income of that investment. You should not make any investment decision solely based on this document. Investors may wish to seek advice from a financial adviser before purchasing units of the Fund. In the event that he chooses not to seek advice from a financial adviser, he should consider carefully whether the Fund in question is suitable for him. Past performance and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the funds managed by Eastspring Investments. There are limitations to the use of indices as proxies for the past performance in the respective asset classes/sector. The Fund may use derivative instruments for efficient portfolio management and hedging purposes. The Fund may, at its discretion, pay dividends out of capital or gross income while charging all or part of its fees and expenses to its capital, resulting in higher distributable income. Thus, the Fund may effectively pay dividends out of capital. Payment of dividends out of capital (effective or not) amounts to a return or withdrawal of part of an investor s original investment or from any capital gains attributable to that original investment, which may result in an immediate reduction of the net asset value per share/unit. The distributions, including amounts and frequency, are not guaranteed and are subject to the discretion of the Fund. Past dividends declared are not a forecast or projection of future distributions. The preceding paragraph is only applicable if the Fund intends to pay dividends / distributions.
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