Investment Universe, Process, Strategy and Benchmark – How does the Fund Manager invest? (ISIN: LU0204987902)
The investment process is focused on stock selection, rather than being driven by top down or macroeconomic factors. The investment universe comprises all quoted Japanese equities.The narrowing down of the universe starts first and foremost with the balance sheet. The managers are looking for financially sound companies with strong balance sheets. All balance sheet items are scrutinised but particular attention is paid to cash & marketable securities, property, short and long term debts, pension funding and goodwill. The aim of the management team is to perform a thorough analysis of the risk held in the balance sheet and thus to make sure there are no black holes. Generally speaking companies with high levels of cash and securities and low levels of debt are selected for investment. The quality of the franchise is also considered at this stage.
The second part of the process focuses on valuation and the potential for upside, which can come from profit growth, asset sales, corporate restructuring, M&A or higher payouts to investors. The managers typically look for a lower-than-market P/B ratio and a low EV/EBIT ratio. Enterprise value is very important in the managers’ mind.
To assist them in their analysis the management team uses Pacific Data, a database of Japanese companies’ balance sheet and P&L data going back to 1984. This database is updated on a quarterly basis. The management team then uses internally customized spreadsheets to analyse these data.
Liquidity is an important element of the screening process. The managers limit a holding to a maximum of 5% across all the funds (i.e. at the group level).
These criteria enable the investment universe to be reduced to a list of financially strong, attractively valued stocks for further analysis. The manager endeavours to meet investment candidates and existing holdings on a regular basis. All the managers travel to Japan once or twice a year, regular conference calls are held with companies and many are seen in London. Qualitative criteria include management track record, disclosure, attitude towards shareholders, the company’s positioning, franchise and strategy. Following each company contact, a report is written and shared in a common database and discussed by the team. Each member of the team is a generalist and can look at or visit any stock in the portfolio.
The managers will then invest in those companies identified whose share price offers the potential to show significant growth over a period of up to 5 years. Every investment decision is taken on a consensus basis and all investments are based on the team’s own analysis. All the fund managers sit in the same room which provides an ideal setting for constant dialogue and communication for any investment ideas. Share prices and relevant news items are monitored daily so all of the fund managers are aware of changing circumstances. Relevant company news can include earnings, share buybacks and dividends announcements as well as general newsflow.
The fund benchmark is the Topix Total Return index. However, the fund is not subject to any constraints relative to the benchmark as the strategy is entirely bottom up. Sector allocations are a result of stock selection, although from a risk perspective the fund manager ensures there is a reasonable diversification among different sectors. Performance Review 2005
Tom Mermagen: "The Oyster Japan Opportunities was due to be launched at the beginning of the year but was unfortunately delayed until the end of the first quarter. The fund manager enjoyed a very strong first quarter with other similar funds over 7% ahead of Topix and the Oyster fund missed out on the benefit of this strong performance early in the year. Towards the end of the year, the Japanese market enjoyed a strong rally as foreigners invested heavily particularly in large capitalisation stocks. The fund saw large inflows to the fund at this time which did take time to invest given a more mid- to small-cap emphasis. In December the fund manager did deliberately let the cash build up in the fund as it was felt that with valuations were getting quite high and the managers did not want to chase the stocks according to their value investment philosophy. Hence, a sizeable cash portion in the fund in an up market explains the fund underperformance."
Performance Review 2006
Tom Mermagen: "The fund underperformed the index by -476bp in 2006. The managers’ approach of selecting stocks with low valuations and strong restructuring potential led to a strategic positioning towards domestically-oriented companies within the small-mid cap segment (over 80% of the portfolio). Unfortunately, in 2006, the small cap performed relatively poorly as it was partly affected by the Livedoor scandal and the subsequent demise of the activist Murakami fund. The yen also remained weak through the year which meant that more export oriented areas of the market continued to perform well during the year. It is worth noting that within the Japanese small-mid cap peer group, Oyster Japan Opportunities ranked no3 out of 22 funds."
Performance Review 2007
Tom Mermagen: "In 2007 Japan was a disappointment to the managers. In spite of having relatively little exposure to the emergence of credit problems and difficulties in the US housing market, the Japanese stock market seemed to suffer nonetheless. The disappointment was apparent in the small to mid cap area which suffered a second year of negative returns. In 2006 it was exporters driving the market and in 2007 it was largely cyclical stocks, which did not meet the manager’s investment criteria (steels, metals and mining etc.) that outperformed the market.
Furthermore, the Japanese housing market was very weak in 2007 for very different reasons from the US. There was a change in the regulatory procedure for the approval of new houses which resulted in a dramatic fall in the number of newly built houses. The fund had exposure to housing stocks and these performed poorly during the year."
Performance Review 2008
Tom Mermagen: "The market sold off heavily during the year largely because of selling by foreign investors. The fund’s strong outperformance resulted from low exposure to stocks widely held by foreigners and from a high exposure to financially sound domestic stocks which were less affected by the global financial turmoil. This result was almost entirely attributable to the quality of the bottom up stock picking as the fund generated a better performance than the benchmark in 7 out of the 8 invested sectors, and in each of the 3 market cap ranges.
For example the financial sector was one of the worst performing sectors and the fund had relatively little exposure to the sector. The stocks that it did own in the financial sector were the well capitalised regional banks which performed relatively well compared to the sector and the market as a whole. Overall the high weighting in small- and mid-cap stocks and the low weighting in large cap stocks was the strongest contributing factor to fund."
Performance Review 2009
Tom Mermagen: "The fund ended the year on a positive note, both on absolute and relative terms. This performance came on the heels of an impressive outperformance in 2008. Towards the end of 2008 and at the beginning of 2009, some larger, more blue chip stocks had fallen back to valuation levels which the manager considered to be very attractive. The fund therefore purchased a number of such larger stocks which met the criteria in terms of strength of balance sheet and franchise but were also felt to have considerable recovery potential. This view came about because of the significant levels of restructuring implemented by may companies across many different sectors in response to the financial crisis. This strategy worked well, particularly in the first half of the year when a number of the stocks, notably those which had cut costs aggressively and those with high exposure to Asia, performed strongly
Once again the quality of the bottom up stock picking made the difference as the fund outperformed its benchmark in 6 out of the 8 invested sectors, and in each of the 3 market cap ranges."
Performance Review 2010
Tom Mermagen: "There was little difference between the performance or large and small cap stocks and there was little obvious sector leadership during the year. For example, amongst exporters the auto sector performed poorly but electrical machinery performed well. The strength of the market was concentrated in the fourth quarter when companies reported interim results and most of them showed themselves to be well on track to meet or beat expectations for the full year. The better earnings picture gave many companies sufficient confidence to raise dividends or announce share buybacks. The fund performed well in Q4 and underperformance was concentrated in Q3. The main reason for the underperformance then was due the poor performance of two specific holdings (Fuji Media Holdings and Nippon Television Network), both of which were among the top 10 holdings. The two TV companies were and sold off on concerns about the prospects for advertising revenues. The fund added to both positions during the quarter which subsequently rebounded nicely in Q4."
Performance Review 2011
Tom Mermagen: "Last year the fund fell by 15.9% against a decline in Topix of 17.0%. The devastating earthquake in March 2011 had a huge impact on the stock market as well as the country, leading to a sharp divergence between the performance of larger and smaller companies. The Topix Core 30 index fell by 25.4% over the year, while Topix Smaller Companies index was down by 7.8%. Some of this difference reflects the poor performance of Tokyo Electric Power (Tepco), which fell by 91% after the disaster at its Fukushima nuclear plant. The fund benefitted from not holding Tepco and Olympus, the shares of which fell by 59% after an accounting scandal was revealed. The fund also invested in several shares that performed very well, including Pola Orbis, a cosmetics company that listed in December 2010. Logistics companies Seino Holdings, Hitachi Transport and Yamato Holdings were also standout performers."
Performance 2012 - Year-to-Date
Tom Mermagen: "In the first quarter of 2012 the fund rose by +14.9%, which compares with +18.5% for the Topix index. Large capitalization stocks performed best: the Topix Core 30 index surged +22.4% in comparison to +14.3% for the Topix Mid 400 index. Export-related stocks performed well, in expectation that they would benefit from the weaker yen. Given the fund’s domestic mid cap focus it underperformed."
Performance since 2007
Tom Mermagen: "The last 5 years (March 2007 – March 2012) has been characterized by a challenging market environment. During this period the fund has outperformed its benchmark by over 7%, down -37.6% vs -45.0% for the Topix index; over the same time period, its peer group was down -49.3%, placing the fund in the 6th percentile.
In 2008 the fund avoided the worst of the financial crisis by holding domestic stocks with strong financial positions, which were less affected by the crisis. Following the bankruptcy of Lehman Brothers in autumn 2008, the valuation of the overall market fell below book value presenting the fund managers with many new opportunities. The fund was able to capture the upside in the market by switching into some slightly larger domestic and global stocks with strong balance sheets and high quality franchises which recovered along with the global economy. Stock picking was the main driver of the fund outperformance as the fund outperformed its benchmark in 7 out of the 8 invested MSCI sectors, and in line in the remaining one. As the fund investment process is entirely bottom up, stock picking is the main source of alpha generation over time."
