Fidelity Japan Trust Plc - Half-year Report

FIDELITY JAPAN TRUST PLC

Half-Yearly Results for the six months ended 30 June 2022 (unaudited)

Financial Highlights:

• The Company remains the second best performer in the peer group over five years, outperforming the Reference Index by 4.8% despite recent short-term headwinds

• At the end of the review period, seven unlisted names were held in the portfolio, (representing 8% of total holdings) and there was a moderate increase in the level of gearing, reaching 24.7%, up from 21.6%

• The Company is focusing on defensive/sustainable growth names and services companies that can grow their earnings in a more testing environment, as well as those that can positively surprise the market on mid-term growth.

Contacts

For further information, please contact:         

Smita Amin

Company Secretary

01737 836347

FIL Investments International

Portfolio Manager’s Review

Market Review
The first half of the year has been difficult for investors, with prices declining across regions and asset classes. While the Japanese market has fallen only modestly in yen terms, the reality is that, under the surface, style trends have been extreme. This is the result of aggressive action by the US Federal Reserve to address inflation, supply chain disruptions due to COVID-19 and the war in Ukraine. Growth stocks have underperformed their value counterparts by more than 20% over the past six months, which has created performance headwinds for the Company.

Against this backdrop, high valuation stocks in sectors such as Electric Appliances, Precision Instruments and Services have faced compression in price-to-earnings multiples amid rising bond yields. Exporters in general have been weak as concerns over a recession in the US and lockdowns in China outweighed the benefits of a weaker yen. Conversely, the Mining and Oil & Coal sectors have been among the strongest performers over the past six months, reflecting tightness in commodities. Rate-sensitive Financials also did well, and Utilities outperformed on the prospect of further nuclear restarts.

Despite ongoing supply disruptions and rising input costs, Japanese companies delivered strong earnings results for the year to March 2022. On an all-industry basis, sales increased by 11% from the previous year and net profits jumped by 38%. The largest contributions came from Manufacturing, Commodities and Shipping. Total dividends and share buybacks for the fiscal year reached record highs, with cheap valuations and cash-rich balance sheets seeing buybacks accelerate to unprecedented levels in the month of May.

On the macroeconomic front, the Japanese economy experienced a decline in the first three months of 2022, with real GDP coming in at-0.5% annualised. The Omicron hit to consumer spending was relatively mild, but supply constraints held back capital expenditure and various stages of production. Subsequent economic indicators underscored the constraints on the Manufacturing sector from rising input prices and the lockdowns in China, while domestic services and consumption continued to recover as the pandemic receded. Meanwhile, the Bank of Japan maintained its existing monetary policy and the Japanese government passed a supplementary budget, centred on measures to counter rising prices.

Portfolio Review
In the six months to 30th June 2022, the Company’s net asset value (“NAV”) declined by-31.7% in sterling terms, underperforming the Reference Index, which returned-10.0%. The share price return was-34.9% over the same period, which reflected a widening of the discount from 4.9% to 9.4% as at 30th June. The 6% fall in the value of the yen against the pound since the end of last year weighed on the sterling-based returns of the Company’s NAV, its share price and the Reference Index. This stems largely from the widening policy divergence between the Bank of Japan, which maintains an accomodative monetary stance, and the Bank of England, which is raising interest rates.

The new year brought with it an extreme style rotation that led to the outperformance of value names and sharp declines for long-duration growth stocks that are vulnerable to changes in interest rates. In this environment, holdings in mid/small-cap growth stocks in the Information & Communication sector were among the most significant detractors from performance. In particular, software-as-a-service (SaaS) related names corrected from the end of last year, as the prospect of further monetary tightening in the US and Europe led to a sharp compression in valuation multiples. Key examples here are Sansan, Raksul and Coconala. However, as these companies shift from investment to growth mode and as Japan continues to reopen, we expect the market to reappraise them based on improvements to their bottom-line.

At the same time, companies tied to secular growth trends such as factory automation (FA) and electric vehicles (EV) that did well last year were subject to profit taking. For example, FA components supplier MISUMI Group experienced a temporary slowdown in earnings due to supply chain disruptions and procurement difficulties. However, it remains a highly differentiated FA-related company with a strong digitalised business that is trading on attractive valuations.

On a positive note, holdings in domestic-oriented companies that benefit from economic reopening as the pandemic recedes contributed to performance. Confectionary company Kotobuki Spirits and theme park operator Oriental Land added value. Since the Japanese government ended the quasi state of emergency in March, there have been burgeoning signs of improving mobility and consumer demand. Elsewhere, shares in medical equipment maker Olympus jumped to a record high following the announcement of its fiscal 2021 earnings. The company reported strong results and forecasted that profits would reach new highs in fiscal 2022 (twelve months to March 2023), driven by the growth of its core endoscopic solutions business. Further progress in restructuring and the prospect of higher shareholder returns also supported its share price.

Portfolio Positioning
There has been no significant change in terms of sector level positioning. The Company remains overweight in the Services and Information & Communication sectors, albeit with a reduced weighting in the latter due to negative price movements. At the opposite end of the scale, Transportation Equipment and Banks remain underweight. There was a moderate increase in the level of gearing to 24.7% from 21.6% and is, as always, dependent on bottom-up conviction in the available investment opportunities and valuations.

We turned a bit more cautious towards the end of last year (inventories were on the rise in the Manufacturing sector and there were signs of a post-COVID-19 shift from Goods to Services) and started to look towards companies that can grow sustainably through the second half of 2022 and 2023. Against this backdrop, we have been focusing on defensive/sustainable growth names and services companies that can grow their earnings in a more testing environment, as well as those that can positively surprise the market on mid-term growth. Key active positions such as NOF, Olympus and Oriental Land are prime examples. We are also looking at oversold growth names that are globally competitive and trading on compelling valuations. Gas water heater maker Rinnai is a recent example. Some small-cap growth names have become value stocks, so there is a good opportunity for multiple expansion in the future.

At the same time, we have been keeping a close eye on the spike in commodity prices, especially oil, as this will exert a further squeeze on manufacturing margins. On the flip side, there are opportunities in companies that supply equipment to the Energy sector (beneficiaries of energy diversification in Europe) and are at the bottom of their respective cycles. Plant engineering company JGC Holdings is an example of a stock that we added to the portfolio. Efforts to secure alternative energy sources globally are driving new liquefied natural gas (LNG) plant orders for the company.

Conversely, we reduced the Company’s exposure to Manufacturers that are susceptible to a correction in demand as overseas consumers’ spending patterns change and disposable incomes come under pressure from rising prices. Positions in electronic components maker TDK and auto parts supplier Koito Manufacturing were reduced.

Unlisted Positions
Following shareholders’ approval of increasing the Company’s unlisted limit to 20%, we remain highly active in this domain. From a bottom-up perspective, we continue to see significant entrepreneurial activity in Japan, more so compared with five to ten years ago. While new listings (both in Japan and globally) are coming under pressure amid heightened geopolitical and inflationary risks, new growth companies are still coming through, which will create future opportunities in the pre-initial public offering (IPO) market. Being on the ground in Japan, and seeing many different companies, means that we are well-placed to help entrepreneurs in the latter stages of their pre-IPO journey. At the end of the review period, seven unlisted names were held (representing 8% of the portfolio), including a new position in Studyplus, a company that operates Japan’s leading learning management platform for high school students and associated services for educational institutions. We continue to evaluate new opportunities, while maintaining a disciplined approach towards valuation.

Sustainability and Engagement
In the first six months of 2022, the investment team in Tokyo, led by our Head of Engagement, conducted 70 engagement meetings (in addition to our fundamental research meetings), covering 29 names held by the Company. Themes that formed part of these Environmental, Social and Governance (ESG) engagements include board composition and executive remuneration, climate change and environmental opportunities, and gender diversity.

Mitsui High-tec is a good example of a company that we hold in the portfolio and with which we have consistently engaged. It is a key enabler of automotive electrification and is the leading global supplier of motor cores for electric and hybrid vehicles. Our engagement centred mainly around corporate governance, but also covered climate change. On governance, we highlighted board members’ low approval rate at the previous annual general meeting (AGM) and urged the company to increase its independent outside directors and to establish nomination and remuneration committees. We also encouraged the company to become a signatory to the Task Force on Climate-Related Financial Disclosures (TCFD). Subsequent meetings with Mitsui High-tec revealed that it had made good progress in implementing our proposals, including making amendments to its board structure, increasing the number of external directors, and establishing a sustainability committee with a view to signing up to the TCFD. The company’s efforts were recognised externally, and MSCI upgraded its ESG rating in May 2022.

Outlook
Markets will remain susceptible to a high level of macroeconomic uncertainty, centred on global inflation and interest rates, and attendant concerns about the risk of recession. While we are closely monitoring the impact that imported costs are having on companies and consumers in Japan, inflation is much lower than in other regions and the country is starting to get back to normal as the pandemic recedes. In this environment, we are focusing on domestic reopening names and oversold, consistent growers. There are also a lot of opportunities in the mid/small-cap space, where valuations have come down significantly and made it a bargain sale for mid-term investors.

As noted in last year’s Annual Report, the average price-to-earnings ratio (PER) of the holdings in the Company’s portfolio has come down quite considerably, to a level that is closer to the market average. The PER for the current year still shows a premium versus the index, as some COVID-19 reopening plays have yet to fully recover. However, the multiple for 2023 is in line with the market, yet with a significantly higher rate of earnings growth and returns. Looking forward, we expect the companies held in the Company to do well in terms of relative earnings growth and thereby support future performance.

Japan continues to offer a wealth of under-researched mid/small-cap growth companies. Active managers such as myself, based here on the ground, have the opportunity not only to invest in established global leaders, but also to unearth less well-known companies (including pre-IPO), where lower levels of analyst coverage can often create some great mispriced opportunities. In an uncertain environment, our in-depth research and on-the-ground knowledge are invaluable when looking at the micro level and speaking to company management to fully understand the prevailing dynamics.

NICHOLAS PRICE
Portfolio Manager
2 August 2022

Twenty Largest Holdings as at 30 June 2022

The Portfolio Exposures shown below measure exposure to market price movements as a result of owning shares and derivative instruments. The Fair Value is the actual value of the portfolio and is the value shown on the Balance Sheet. Where a contract for difference (“CFD”) is held, the Fair Value reflects the profit or loss on the contract since it was opened and is based on how much the share price of the underlying share has moved. Where the Company only holds shares, the Fair Value and the Portfolio Exposure will be the same.

FAIR VALUE AND PORTFOLIO EXPOSURE OF INVESTMENTS AS AT 30 JUNE 2022

1   Portfolio Exposure is expressed as a percentage of Shareholders’ Funds.

2   Gearing is the amount by which the Portfolio Exposure exceeds Shareholders’ Funds expressed as a percentage of Shareholders’ Funds.

Interim Management Report

Discount Management, Share Repurchases and Treasury Shares
The Board has an active discount management policy, the primary purpose of which is to reduce discount volatility. The discount has widened from 4.9% at the start of the year to 9.4% at the end of the reporting six month period. It has remained in line with the Company’s policy of managing the discount so that it remains in single digits in normal market conditions. The Board has authority to repurchase up to 14.99% of the Company’s shares to be either cancelled or held in Treasury.

As part of the discount management policy, 50,000 ordinary shares were repurchased for holding in Treasury on 9 May 2022. Since the end of the reporting period and as at the date of this report, no further shares have been repurchased.

Principal Risks and Uncertainties
The Board, with the assistance of the Manager (FIL Investment Services (UK) Limited), has developed a risk matrix which, as part of the risk management and internal controls process, identifies the key existing and emerging risks and uncertainties faced by the Company.

The Board considers that the principal risks and uncertainties faced by the Company fall into the following categories: geopolitical and natural disaster risks; performance and gearing risks; discount control and demand risks; key person risk; market, economic and currency risks; cybercrime risk; environmental, social and governance (ESG) risks; operational resilience risk (including third party service providers operational risks); and tax and regulatory risks. Information on each of these risks is given in the Strategic Report section of the Annual Report for the year ended 31 December 2021. A copy of the Annual Report can be found on the Company’s pages of the Manager’s website at www.fidelity.co.uk/japan.

While the principal risks and uncertainties are the same as those at the previous year end, the uncertainty has been heightened by the ongoing Russia and Ukraine conflict. The quantum of risks has changed and continues to change. The Board remains vigilant in monitoring the risks.

A key emerging risk that the Board has identified is climate change. It is one of the most critical emerging issues confronting asset managers and their investors. The Board notes that the Manager has integrated ESG considerations, including climate change, into the Company’s investment process. The Board will continue to monitor this.

Risks from the emerging new variants of COVID continue, but the defence against the virus gets stronger with each passing year as vaccination and booster rates increase and treatment for those affected improves. Investors should be prepared for market fluctuations and remember that holding shares in the Company should be considered to be a long-term investment. These risks are somewhat mitigated by the investment trust structure of the Company which means that no forced sales need to take place to deal with any redemptions. Therefore, investments in the Company’s portfolio can be held over a longer-time horizon.

The Manager carries on reviewing its business continuity plans and its operational resilience strategies on an ongoing basis. It continues to take all reasonable steps in meeting its regulatory obligations and to assess operational risks, the ability to continue operating and the steps it needs to take to serve and support its clients, including the Board. The Manager has appropriate business continuity plans in place and the provision of services has continued to be supplied without interruption during the pandemic and continues to do so.

Investment team key activities, including those of portfolio managers, analysts and trading/ support functions, have continued to perform well despite the operational challenges posed when working from home or when split team arrangements were in place during the peak of the pandemic, and more recently disruption from the rail strikes.

The Company’s other third party service providers have also implemented similar measures to ensure that business disruption is kept to a minimum.

Transactions with the Manager and Related Parties
The Manager has delegated the Company’s portfolio management and company secretariat services to FIL Investments International. Transactions with the Manager and related party transactions with the Directors are disclosed in Note 12 to the Financial Statements below.

Going Concern Statement
The Directors have considered the Company’s investment objective, risk management policies, liquidity risk, credit risk, capital management policies and procedures, the nature of its portfolio and its expenditure and cash flow projections. The Directors, having considered the liquidity of the Company’s portfolio of investments (being mainly securities which are readily realisable) and the projected income and expenditure, are satisfied that the Company is financially sound and has adequate resources to meet all of its liabilities and ongoing expenses and can continue in operational existence for a period of at least twelve months from the date of this Half-Yearly Report.

This conclusion also takes into account the Board’s assessment of the ongoing risks from COVID and evolving variants as set out above.

Accordingly, the Financial Statements of the Company have been prepared on a going concern basis.

Continuation votes are held every three years and the next continuation vote will be put to shareholders at the Annual General Meeting in 2025.

By Order of the Board
FIL Investments International
2 August 2022

Directors’ Responsibility Statement

The Disclosure and Transparency Rules (DTR) of the UK Listing Authority require the Directors to confirm their responsibilities in relation to the preparation and publication of the Interim Management Report and Financial Statements.

The Directors confirm to the best of their knowledge that:

·      the condensed set of Financial Statements contained within the Half-Yearly Report has been prepared in accordance with the Financial Reporting Council’s Standard FRS 104: Interim Financial Reporting; and

·      the Portfolio Manager’s Review and the Interim Management Report above include a fair review of the information required by DTR 4.2.7R and 4.2.8R.

In line with previous years, the Half-Yearly Report has not been audited or reviewed by the Company’s Independent Auditor.

The Half-Yearly Report was approved by the Board on 2 August 2022 and the above responsibility statement was signed on its behalf by David Graham, Chairman.

Financial Statements

Income Statement for the six months ended 30 June 2022

The Company does not have any other comprehensive income. Accordingly the net return/(loss) on ordinary activities after taxation for the period is also the total comprehensive income for the period and no separate Statement of Comprehensive Income has been presented.

The total column of this statement represents the Income Statement of the Company. The revenue and capital columns are supplementary and presented for information purposes as recommended by the Statement of Recommended Practice issued by the AIC.

No operations were acquired or discontinued in the period and all items in the above statement derive from continuing operations.

Statement of Changes in Equity for the six months ended 30 June 2022

Balance Sheet as at 30 June 2022
Company Number 2885584

Notes to the Financial Statements

1 Principal Activity
Fidelity Japan Trust PLC is an Investment Company incorporated in England and Wales with a premium listing on the London Stock Exchange. The Company’s registration number is 2885584, and its registered office is Beech Gate, Millfield Lane, Lower Kingswood, Tadworth, Surrey KT20 6RP. The Company has been approved by HM Revenue & Customs as an Investment Trust under Section 1158 of the Corporation Tax Act 2010 and intends to conduct its affairs so as to continue to be approved.

2 Publication of Non-statutory Accounts
The Financial Statements in this Half-Yearly Report have not been audited by the Company’s Independent Auditor and do not constitute statutory accounts as defined in section 434 of the Companies Act 2006 (the “Act”). The financial information for the year ended 31 December 2021 is extracted from the latest published Financial Statements of the Company. Those Financial Statements were delivered to the Registrar of Companies and included the Independent Auditor’s Report which was unqualified and did not contain a statement under either section 498(2) or 498(3) of the Act.

3 Accounting Policies
(i) Basis of Preparation
The Company prepares its Financial Statements on a going concern basis and in accordance with UK Generally Accepted Accounting Practice (“UK GAAP”) and FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland, issued by the Financial Reporting Council. The Financial Statements are also prepared in accordance with the Statement of Recommended Practice: Financial Statements of Investment Trust Companies and Venture Capital Trusts (“SORP”) issued by the Association of Investment Companies (“AIC”) in April 2021. FRS 104: Interim Financial Reporting has also been applied in preparing this condensed set of Financial Statements. The accounting policies followed are consistent with those disclosed in the Company’s Annual Report and Financial Statements for the year ended 31 December 2021.

(ii) Going Concern
The Directors have a reasonable expectation that the Company has adequate resources to continue in operational existence for a period of at least twelve months from the date of approval of these Financial Statements. Accordingly, the Directors consider it appropriate to adopt the going concern basis of accounting in preparing these Financial Statements. This conclusion also takes into account the Board’s assessment of the continuing risks arising from COVID-19 and evolving variants.

4 Income

A special dividend of £42,000 has been recognised in capital during the period (six months ended 30 June 2021 and year ended 31 December 2021: £nil).

5 Investment Management Fees

*    For the calculation of the variable management fee element, the Company’s NAV return was compared to the Reference Index return on a daily basis. The period used to assess the performance was from 1 July 2018 until a three year history was established. From 1 July 2021 the performance period is now on a rolling three year basis.

FIL Investment Services (UK) Limited is the Company’s Alternative Investment Fund Manager and has delegated portfolio management to FIL Investments International (“FII”). Both companies are Fidelity group companies.

FII charges base investment management fees at an annual rate of 0.70% of net assets. In addition, there is a +/- 0.20% variation fee based on performance relative to the Reference Index. Fees are payable monthly in arrears and are calculated on a daily basis.

The base investment management fees have been allocated 80% to capital reserve in accordance with the Company’s accounting policies.

6 Finance Costs

Finance costs have been allocated 80% to capital reserve in accordance with the Company’s accounting policies.

7 Taxation on Return/(LOSS) on Ordinary Activities

8 Return/(Loss) per Ordinary Share

The return/(loss) per ordinary share is based on the net return/(loss) on ordinary activities after taxation for the period divided by the weighted average number of ordinary shares held outside of Treasury during the period, as shown below:

9 Fair Value Hierarchy
The Company is required to disclose the fair value hierarchy that classifies its financial instruments measured at fair value at one of three levels, according to the relative reliability of the inputs used to estimate the fair values.

Categorisation within the hierarchy has been determined on the basis of the lowest level input that is significant to the fair value measurement of the relevant asset. The valuation techniques used by the Company are as disclosed in the Company’s Annual Report for the year ended 31 December 2021 (Accounting Policies Notes 2 (j) and 2 (k) on pages 59 and 60). The table below sets out the Company’s fair value hierarchy:

10 Share Capital

*    Ordinary shares held in Treasury carry no rights to vote, to receive a dividend or to participate in a winding up of the Company.

The cost of ordinary shares repurchased into Treasury during the period was £77,000 (year ended 31 December 2021: £1,503,000 and six months ended 30 June 2021: £1,499,000). This amount was charged to the Other reserve.

11 Net Asset Value per Ordinary Share
The calculation of the net asset value per ordinary share is based on the following:

It is the Company’s policy that shares held in Treasury will only be reissued at net asset value per ordinary share or at a premium to net asset value per ordinary share and, therefore, shares held in Treasury have no dilutive effect.

12 Transactions with the Manager and Related Parties
FIL Investment Services (UK) Limited is the Company’s Alternative Investment Fund Manager and has delegated portfolio management services and the role of company secretary to FIL Investments International (“FII”), the Investment Manager. Both companies are Fidelity group companies. Details of the fee arrangements are given in Note 5 above.

During the period, fees for portfolio management services of £892,000 (six months ended 30 June 2021: £1,390,000 and year ended 31 December 2021: £2,877,000) and secretarial and administration fees of £25,000 (six months ended 30 June 2021: £25,000 and year ended 31 December 2021: £50,000) were payable to FII. At the Balance Sheet date, fees for portfolio management services of £104,000 (31 December 2021: £245,000 and 30 June 2021: £227,000) and secretarial and administration fees of £13,000 (31 December 2021: £25,000 and 30 June 2021: £13,000) were accrued and included in other creditors. FII also provides the Company with marketing services. The total amount payable for these services during the period was £77,000 (six months ended 30 June 2021: £63,000 and year ended 31 December 2021: £130,000). At the Balance Sheet date, fees for marketing services of £15,000 (31 December 2021: £4,000 and 30 June 2021: £11,000) were accrued and included in other creditors.

As at 30 June 2022, the Board consisted of four non-executive Directors (shown in the Directory in the Half-Yearly Report), all of whom are considered to be independent by the Board. None of the Directors have a service contract with the Company. The Chairman receives an annual fee of £38,500, the Audit Committee Chairman an annual fee of £31,500 and each other Director an annual fee of £27,500. The following members of the Board hold ordinary shares in the Company: David Graham 78,489 shares, Sarah MacAulay 181,340 shares, David Barron 19,366 shares and Dominic Ziegler 16,000 shares.

The financial information contained in this Half-Yearly Results Announcement does not constitute statutory accounts as defined in section 435 of the Companies Act 2006. The financial information for the six months ended 30 June 2022 and 30 June 2021 has not been audited or reviewed by the Company’s Independent Auditor.

The information for the year ended 31 December 2021 has been extracted from the latest published audited financial statements, which have been filed with the Registrar of Companies, unless otherwise stated. The report of the Auditor on those financial statements contained no qualification or statement under sections 498(2) or (3) of the Companies Act 2006.

Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) is incorporated into, or forms part of, this announcement.

A copy of the Half-Yearly Report will shortly be submitted to the National Storage Mechanism and will be available for inspection at www.morningstar.co.uk/uk/NSM

The Half-Yearly Report will also be available on the Company's website at www.fidelity.co.uk/japan where up to date information on the Company, including daily NAV and share prices, factsheets and other information can also be found.