FSSA Japan Focus Fund: July 2022 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 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.

Li can draw upon the support of First Sentier’s well-resourced and experienced teams to help with things like idea generation and challenge, including Martin Lau who she’s worked closely with for a number of years.

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 also want these companies to be run by reputable management teams that don't take unnecessary risks in the pursuit of short-term gains.

Turnover is usually low, but over the last 12 months there have been a few changes to the portfolio. Some of the companies that performed well during the pandemic have struggled more recently and fallen in price. The team thinks some of these pandemic beneficiaries still offer good growth potential over the long run so have decided to take advantage of the more attractive price and invest.

Recent investments include chemical and material manufacturer Fuso Chemical. The company boasts a strong balance sheet and is dominant in its industry, so the team feel it could be a long-term winner. Another addition to the portfolio is technology and electronics company Sony. The team believe it’s at a more attractive price than it’s been historically, has a strong global presence and is run by a high-quality management team.

They’ve also sold a few companies over the last 12 months. Healthcare manufacturer Sysmex was sold following a period of good performance but also due to lower conviction in the company’s long-term prospects. Kao Corporation, a business that develops and sells a variety of cosmetic products, was also sold because the team felt it would face difficulty passing on rising raw materials costs to customers through price rises. They also believe Kao can no longer demonstrate dominance amongst its competitors.

The team tends to invest in relatively few companies, meaning each one can contribute significantly to returns, although it's a higher-risk approach.

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. Historically Japanese companies have lagged in certain areas of ESG, so Li places an emphasis on engaging with each company she meets or invests in to help improve things like information disclosure.

Each company should also 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 0.83%, 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 96.42%, while the average fund in the IA Japan sector rose 56.23%*. Li’s growth-focused investment style largely remained in favour over the period, which helped performance. Our analysis suggests the managers’ ability to select outstanding companies, regardless of their size or what sector they’re in, provided a further boost. Remember past performance isn't a guide to the future.

When we look at the past year though, the performance story isn’t as positive. Towards the end of 2021, we saw a sharp market rotation from growth investing to a style known as value investing. Companies and sectors that are typically more sensitive to the health of the economy, including financials, rallied. Areas like technology which have been in the spotlight over the last few years, and those that surged during the pandemic, are now struggling.

The fund invests more in these areas and has less exposure to the types of cyclical companies and sectors that are doing well currently. This has hampered performance and over the last 12 months the fund’s fallen 27.54% compared to the IA Japan sector’s fall of 11.79%. Though this is a very short timeframe when looking at performance and we think the fund can still perform well over the long term.

Some of the weaker performers over the year included online medical services provider M3, and Raskul a printing company. In contrast, medical equipment manufacturer Olympus Corporation and confectioner Kotobuki Spirits Company delivered some of the best returns.

Past performance is not a guide to the future. Source: *Lipper IM to 30/06/2022.

Find out more on FSSA Japan Focus, including charges

FSSA Japan Focus Key Investor Information