SJG Schroder Japan Trust Plc

Half Year Report

Schroder Japan Trust plc hereby submits its Half Year Report for the period ended 31 January 2024 as required by the Financial Conduct Authority's Disclosure Guidance and Transparency Rule 4.2. 

The Half Year Report is also being published in hard copy format and an electronic copy of that document will shortly be available to download from the Company's webpages www.schroders.com/japantrust. Please click on the following link to view the document:

http://www.rns-pdf.londonstockexchange.com/rns/8654K_1-2024-4-16.pdf

The Company has submitted its Half Year Report to the National Storage Mechanism and it will shortly be available for inspection at https://data.fca.org.uk/#/nsm/nationalstoragemechanism.

Enquiries:

Half Year Report and Accounts
for the six months ended 31 January 2024

CHAIRMAN'S STATEMENT

Performance

I am pleased to report that during the six-month period to 31 January 2024, the Company produced a NAV total return of 10.3%, outperforming the Benchmark total return of 9.1%. The share price also produced a positive total return of 5.8% during the period. Our Investment Manager, Masaki Taketsume, continues to manage a high conviction, balanced portfolio of large and smaller companies with a strong emphasis on valuation.

Performance over the period was helped by strong stock selection across machinery, glass and ceramics, and information and communication. From a style perspective, holdings of value stocks outperformed the growth portion of the portfolio. The use of financial leverage was also helpful to performance over the period.

Further comment on performance and the investment policy can be found in the Investment Manager's review.

Discount management

During the period under review, the Company's shares continued to trade at a discount to NAV, and the Board utilised its buy-back authority to purchase 1,381,226 shares for cancellation at an average discount of 10.3%. Although the discount widened during the reporting period from 7.2% to 11.1%, this was broadly in line with the move in the average discount for the AIC Japan Sector as a whole over the same timescale. The Board continues to monitor the Company's discount actively and to authorise the Company to purchase shares when appropriate. In addition, in February 2024, the Company appointed J.P. Morgan Securities plc (which conducts its UK investment banking business activities as "J.P. Morgan Cazenove") as the Company's sole corporate broker. J.P. Morgan Cazenove is actively working with the Board to consider discount mechanics and other strategic initiatives.

Gearing

The Investment Manager actively used gearing throughout the period. The Company's term loan remained fully utilised, and the revolving credit facility was drawn down. The average gearing during the six months to 31 January 2024 was 9.5% and, as at 15 April 2024, the gearing was 11.6%.

At the 2023 AGM, shareholders approved a change of the Company's investment policy to allow it to use contracts for difference to provide exposure to Japanese equities on a geared basis as an alternative to utilising bank borrowings. The onboarding process for the implementation of this facility is currently in progress.

The Company intends to continue to use leverage.

Conditional tender offer

As I stated in my last year-end Chairman's Statement, the Board continues to monitor the Company's performance against its tender performance target each year.

The Company has a target to deliver NAV total return performance of at least 2% per annum above the Benchmark over a four-year period starting from 1 August 2020. Should this target not be met, the Board will put to shareholders a proposal for a tender offer of 25% of the issued share capital at a price equal to the prevailing net asset value less costs. This would be contingent on the next continuation vote of the Company at this year's AGM being successful.

The Investment Manager has continued to deliver strong outperformance during the fourth year of the performance target, delivering a NAV total return for the period from 1 August 2020 to 31 January 2024 of 4.4% above the Benchmark on an annualised basis. Over three and a half years, the Company has now returned 12.8% on an annualised basis, which compares favourably to the annualised 8.4% return from the Benchmark.

Outlook

The Japanese equity market has enjoyed a strong start to 2024 and, symbolically, the Nikkei 225 Index has recently exceeded its previous high achieved in 1989.

The Board remains very positive on the long-term equity market outlook because corporate Japan is in the middle of a major transformation which is already resulting in improved shareholder returns. This transformation has been a long time in the making: it is now ten years since the introduction of the Japanese government's Stewardship Code and nine years since the publication of its Corporate Governance Code, so it is not surprising that it has slipped under the radars of many international investors. But the speed of change is now accelerating. In January, the Tokyo Stock Exchange announced that half the companies listed on its Prime Market had developed plans (within a few months of being requested to do so) to boost their capital efficiency and improve returns on capital. Cross-shareholdings are being unwound. Dividend payouts and share buybacks are at record highs. More takeovers, management buyouts, and private equity deals are taking place. Greater capital efficiency and improvements in shareholder value will result. In addition, as detailed in the Investment Manager's Review, the recent launch of an enhanced Nippon Individual Savings Account or "NISA" (originally modelled on the UK's ISA) should encourage additional demand from domestic retail investors. At the macro level, deflation has finally given way to moderate inflation, making it easier for companies to raise prices, and early results of this year's "Shunto" (the annual wage negotiations between labour unions and employers) are suggesting a base pay rise of 3.7% - the highest since 1991. This combination of real wage improvement and subdued inflation should lead to increased demand from Japanese consumers. Finally, the recent end to the Bank of Japan's 8-year-long negative interest rate policy represents a watershed moment since the normalisation of Japan's monetary policy will, we believe, be a net positive for the Japanese equity market.

All these developments should result in improved shareholder returns and higher valuations and provide exciting opportunities for the high-conviction stock-picking strategy of the Schroder Japan Trust.

As I mentioned in my last Chairman's statement, there have been many false dawns when the performance of the Japanese equity market has failed to live up to investor expectations. But your Board believes that, this time, there are real positive structural shifts in motion. We remain very positive on the long-term outlook for the Japanese market and are firmly of the view that the Company is the best vehicle through which to capitalise on the opportunities presented by corporate change and an improving fundamental backdrop. The Company has delivered solid outperformance of its Benchmark over the three and a half years since its conditional tender offer was implemented and yet still trades at a discount to NAV, providing considerable upside.

Philip Kay

Chairman

16 April 2024

INVESTMENT MANAGER'S REVIEW

Over the first six months of the Company's financial year to 31 January 2024, the Company's NAV produced a total return of 10.3%, while its Benchmark produced a total return of 9.1%. Before we delve into the drivers of recent performance, we would like to explain the investment philosophy and approach that sits behind our decision-making. This should provide some important context to help you understand why the portfolio is positioned the way it is, and what you should expect in terms of future performance.

Our investment approach

We believe that the Japanese equity market ultimately acts efficiently in reflecting the intrinsic value of companies. However, in the short to medium-term considerable inefficiencies are frequently evident in individual stocks. These inefficiencies provide repeatable opportunities to identify and invest in undervalued stocks, with the aim of delivering a better return than the market as a whole on a rolling three-to-five year view.

Our investment resource is entirely devoted to this aim, focusing on individual company fundamentals to understand the true worth of a stock and investing in a portfolio of 60-70 of the highest conviction ideas. These then tend to be held for the long term, with value being realised as the market gradually reflects their true value more efficiently.

Portfolio holdings tend to fall into three categories of inefficiency:

1.  Market misperception - companies with self-improving credentials, with management initiatives to sustainably enhance operational performance being under-appreciated by other investors.

2.  Market oversight - undervalued companies, especially among small and mid-caps where research coverage is less widespread, with strong and defendable business franchises in niche product areas.

3.  Short-term overreaction - ideas arising from abrupt but transitory events which push valuations of quality companies temporarily to unsustainably low levels.

Outside these three categories, the balance of the portfolio represents "best in class" stocks with reasonable valuations. The weighting given to each of these segments evolves over time, but a reasonable exposure to each category ensures a good level of diversification for the portfolio as a whole. Meanwhile, the approach tends to result in a bias towards value stocks¹ and smaller companies, as well as an overall focus on quality.

The portfolio tends to exhibit a high "active share", which means that its constituents deviate significantly from the Benchmark. Gearing (financial leverage) typically ranges between 10% and 17.5%, allowing shareholders to potentially benefit even more as the inefficiencies we have identified become more appropriately priced by the market.

1   The term 'value stocks' refers to shares of a company that appears to trade at a lower price relative to its fundamentals, such as dividends, earnings, or sales, making it appealing to value investors.

Portfolio strategy

So, what does this mean for current portfolio strategy and positioning? Currently, the biggest category within the portfolio is market misperception which accounts for almost 40% of assets. This includes companies such as industrials conglomerate Hitachi and metals and mining business Nippon Steel. In both cases, we see management teams pursuing strategies that should deliver a transformative and sustainable improvement in returns, the effects of which are not yet reflected in valuations.

Almost 30% of the portfolio is in market oversights, such as industrial cooling business Fukushima Galilei and powder processing specialist Hosokawa Micron, where we find highly competitive smaller businesses trading at a significant discount to their large cap and global peers. Less than 10% of the portfolio is invested in short-term overreactions, including out-of-favour opportunities such as IT services business Nomura Research Institute and food packaging specialist FP Corporation. These businesses are beneficiaries of long-term structural tailwinds, but their shares have recently been sold down aggressively - in our view, too aggressively, hence the opportunity to add them to the portfolio.

The remaining 20% of the portfolio is invested in what we consider to be "best in class" operators, such as the financial services company Sumitomo Mitsui Financial and the insurance business Tokio Marine.

From a sector perspective, this means a bias towards machinery, glass and ceramic products, and information and communication. As is typical, the portfolio is also leaning towards small and mid-sized businesses, where valuations look particularly attractive as the domestic Japanese economy continues to recover.

Recent performance drivers

The Japanese stock market was strong throughout the period, buoyed by growing global interest in the structural changes that are occurring in Japan as a result of continuing corporate governance reforms. The recent return of inflation has also helped to improve sentiment towards Japanese equities, as has a period of robust earnings growth from Japanese companies.

Overall, the Company performed well over the six months to 31 January 2024, as reflected in the positive NAV return and the modest outperformance of the Benchmark. Value stocks continued to outperform growth stocks during the period, which was generally helpful to the portfolio's performance, as was the Company's gearing which helped to amplify returns. This was partly offset by the under-performance of smaller companies, which lagged in a rally that was driven mainly by large-cap stocks.

In terms of stock specifics, we saw positive corporate earnings developments at several individual companies. Niterra, a mid-cap automotive component manufacturer that specialises in spark plugs and other ceramic parts, was the largest individual contributor to performance. The business is enjoying very strong earnings growth, as the recovery in Japanese automotive production that we had anticipated continues to play out positively.

Hitachi, the large-cap industrials conglomerate, also provided a solid performance, supported by strong financial results and its continuing transformation. Management has shifted the company's focus towards digital solutions, IT services and sustainable energy, in an ongoing effort to sustainably improve shareholder returns. It is encouraging to see the stock market start to recognise the power of this transformation, but we believe there is significant further upside potential as the company's financial performance continues to improve and as the shares attain a more appropriate market rating.

By contrast, some of the portfolio's technology companies saw share price declines after strong performance in the previous period. In some cases, including electronic component makers Ibiden and Rohm, financial results also fell short of expectations, due to continued cyclical weakness in the semiconductor industry.

Top 10 contributors and detractors

Six months to 31 January 2024

Source: FactSet, GBP, 1TOPIX. Stocks mentioned are show for illustrative purposes only and should not be viewed as a recommendation to buy/sell. Past performance is not a guide to future performance and may not be repeated. The value of investment can go down as well as up and is not guaranteed. The return may increase or decrease as a result of currency fluctuations.

Portfolio activity

We initiated a position in a new market misperception idea: Nippon Steel, Japan's largest and the world's leading steel maker. The starting valuation looks highly attractive, and we foresee the potential for a much higher multiple in the future, supported by management efforts to improve the stability and growth profile of its earnings. The business has become increasingly focused on profitability through price discipline, and the strategy of expanding the business into new territories, such as India, holds significant future potential. Ultimately, the strategy being pursued by Nippon Steel's management team should allow the business to become much more resilient, even in the event of a cyclical downturn in its core markets. This development is under-appreciated by investors and comes at a time when the Asian steel market appears poised for a cyclical upswing. Hence, we view this as an opportune time to build an exposure, before improving fundamentals can be fully reflected in market prices.

We also initiated a position in food packaging manufacturer, FP Corporation, as a new short-term overreaction opportunity. The company saw increased operational volatility during the COVID years, but we have subsequently seen a stabilisation of growth rates, and the business has been steadily increasing its market share. We are also impressed by management's ability to control costs and raise prices in response to inflation, which should continue to support improvements in returns, margins, and growth. Nevertheless, the share price hit a six-year low in 2023, giving us the opportunity to build a position at a very attractive valuation. We see significant potential for a revaluation of the shares in 2024.

In terms of exits, we sold out of several positions including Yokowo, Astellas Pharma, Aeon Financial Services and Toho, mainly due to weaker-than-expected earnings progress. We used the proceeds to build positions in opportunities in which we have increasing confidence, such as those outlined above.

Outlook

The Japanese equity market has shown encouraging strength this year, with the Nikkei 225 Index finally exceeding the bubble-era high seen in December 1989. The conditions are now in place for a bold new era of prosperity for the Japanese stock market.

Importantly, the market's rise has been supported by strong and improving corporate fundamentals. Profits from Japanese companies are generally heading in the right direction, with the most recent quarterly earnings season seeing plenty of upwards revisions of profit estimates. The performance of domestically-oriented companies has been particularly impressive, with many companies demonstrating strong demand and displaying signs of regained pricing power. After years of entrenched deflation, the importance of this last point should not be underestimated.

Meanwhile, thanks to the ongoing efforts of the Tokyo Stock Exchange, corporate governance reforms have continued. After a long period of overseas apathy towards Japanese equities, these reforms are now resulting in growing interest from the global investment community. The unwinding of cross-shareholdings is progressing and there has been an increasing number of Japanese companies involved in corporate actions. According to the Nikkei newspaper, the number of take-over bids in Japan was 65 in 2023, up by 35% year on year and the highest figure since 2000. Notably, share buy-backs have continued to increase, and by the end of February 2024, the share buy-back plans announced by Japanese companies for the fiscal year to March 2024 had already exceeded the level of the full preceding fiscal year to March 2023. We would expect these trends in corporate activity to continue as more and more companies are compelled to take steps to improve their returns and address persistent under-valuations.

There has also been an increase in the level of Japanese retail participation in the equity market as a result of the revised tax-exempt scheme for individual investors, known as NISA. The revised NISA scheme now allows individual investors to invest more assets with tax exemptions for an unlimited period of time. The changes in the NISA scheme came at an ideal time, just as retail investors started to recognise a shift towards a more inflationary environment in Japan and thus the need for the retail investor to move money out of their bank deposits and to rotate it towards investment in the equity market.

To conclude, there are many reasons to believe that we are in a period of sustained outperformance from the Japanese stock market. The overall valuation of the market looks reasonable, but this masks a considerable divergence between larger companies that have become relatively fully-priced, and smaller companies to which the Company is currently biased, where valuations are, in general, much more appealing. We believe that the Japanese market as a whole can make good long-term progress from here, but this represents a particularly exciting environment for active, high conviction stock pickers. By focusing the portfolio towards undervalued businesses with strong growth prospects and the potential to improve returns, we are confident in the opportunity that lies ahead for investors in the Company.

Masaki Taketsume

Portfolio Manager

16 April 2024

INTERIM MANAGEMENT STATEMENT

Principal risks and uncertainties

The principal risks and uncertainties with the Company's business fall into the following risk categories: strategic; investment management; financial and currency; custody; gearing and leverage; accounting, legal and regulatory; service provider; and cyber. A detailed explanation of the risks and uncertainties in each of these categories can be found on pages 23 and 24 of the Company's published annual report and accounts for the year ended 31 July 2023.

These risks and uncertainties have not materially changed during the six months ended 31 January 2024. However, the Board undertook a review of principal and emerging risks for the Company while reviewing these accounts. The Directors noted that geopolitical risk and climate change risk in particular continue to develop and will be reported on in the next annual report as appropriate.

Going concern

Having assessed the principal risks and uncertainties, and the other matters discussed in connection with the viability statement as set out on page 25 of the published annual report and accounts for the year ended 31 July 2023, the Directors consider it appropriate to adopt the going concern basis in preparing the accounts.

Related party transactions

There have been no transactions with related parties that have materially affected the financial position or the performance of the Company during the six months ended 31 January 2024.

Directors' responsibility statement

In respect of the half year report for the six months ended 31 January 2024, we confirm that, to the best of our knowledge:

-   the condensed set of Financial Statements contained within have been prepared in accordance with IAS 34 Interim Financial Reporting and give a true and fair view of the assets, liabilities, financial position and profit and loss of the Company as at 31 January 2024, as required by the Disclosure Guidance and Transparency Rule 4.2.4R;

-   the half year report includes a fair review as required by the Disclosure Guidance and Transparency Rule 4.2.7R, of important events that have occurred during the six months to 31 January 2024, and their impact on the condensed set of Financial Statements, and a description of the principal and emerging risks for the remaining six months of the financial year; and

-   the half year report includes a fair review of the information concerning related party transactions as required by the Disclosure Guidance and Transparency Rule 4.2.8R.

The half year report has not been reviewed or audited by the Company's auditors.

The half year report for the six months ended 31 January 2024 was approved by the Board and the above Responsibilities Statement has been signed on its behalf.

STATEMENT OF COMPREHENSIVE INCOME

for the six months ended 31 January 2024 (unaudited)

The "Total" column of this statement is the profit and loss account of the Company. The "Revenue" and "Capital" columns represent supplementary information prepared under guidance issued by The Association of Investment Companies. The Company has no other items of other comprehensive income and therefore the net return/(loss) after taxation is also the total comprehensive income/(loss) for the period.

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

STATEMENT OF CHANGES IN EQUITY

for the six months ended 31 January 2024 (unaudited)

STATEMENT OF FINANCIAL POSITION

as at 31 January 2024 (unaudited)

Schroder Japan Trust plc

Registered in England and Wales as a public company limited by shares

Company Registration Number: 02930057

NOTES TO THE FINANCIAL STATEMENTS

1.         Financial Statements

The information contained within the accounts in this half year report has not been audited or reviewed by the Company's independent auditor.

The figures and financial information for the year ended 31 July 2023 are extracted from the latest published accounts of the Company and do not constitute statutory accounts for that year. Those accounts have been delivered to the Registrar of Companies and included the report of the auditors which was unqualified and did not contain a statement under either section 498(2) or 498(3) of the Companies Act 2006.

2.         Accounting policies

Basis of accounting

The accounts have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice, in particular with Financial Reporting Standard 104 "Interim Financial Reporting" and with the Statement of Recommended Practice "Financial Statements of Investment Trust Companies and Venture Capital Trusts" issued by the Association of Investment Companies in July 2022.

All of the Company's operations are of a continuing nature.

The accounting policies applied to these accounts are consistent with those applied in the accounts for the year ended 31 July 2023.

3.         Taxation on ordinary activities

The Company's effective corporation tax rate is nil, as deductible expenses exceed taxable income. The tax charge comprises irrecoverable overseas withholding tax.

4.         Return/(loss) per share

5.         Dividends paid

No interim dividend has been declared in respect of the six months ended 31 January 2024 (2023: nil).

6.         Creditors: amounts falling due within one year

The bank loan is a yen 6.0 billion three-year term loan from SMBC Bank International plc, expiring on 17 January 2025 and carrying a floating interest rate, calculated at the daily Compounded Risk Free Rate, plus a margin. The bank loan also includes a yen 2.0 billion credit facility with SMBC Bank International plc, repayment date in 10 May 2024 (2023: undrawn).

7.         Creditors: amounts falling due after more than one year

8.         Called-up share capital

9.         Net asset value per share

Net asset value per share is calculated by dividing shareholders' funds by the number of shares in issue of 118,522,739 (31 January 2023: 121,624,872 and 31 July 2023: 119,903,965).

10.       Financial instruments measured at fair value

The Company's financial instruments that are held at fair value comprise its investment portfolio. At 31 January 2024, all investments in the Company's portfolio were categorised as Level 1 in accordance with the criteria set out in paragraph 34.22 (amended) of FRS 102. That is, they are all valued using unadjusted quoted prices in active markets for identical assets (31 January 2023 and 31 July 2023: all valued using unadjusted quoted prices in active markets for identical assets).

11.       Events after the interim period that have not been reflected in the financial statements for the interim period

The Directors have evaluated the period since the interim date and have not noted any significant events which have not been reflected in the financial statements.

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.