Hennessy Japan Small Cap Fund Q4 2014 Comments and Opinions (Q&A)

Author's Avatar
Mar 31, 2015

In December 2014, Prime Minister Shinzo Abe was reelected by a landslide, securing up to four more years of a stable political environment and giving the government time to implement the “Three Arrows” program. In the discussion below, the portfolio management team of the Hennessy Japan Fund and Hennessy Japan Small Cap Fund (Trades, Portfolio) addresses the country’s economic progress and potential prospects over the coming year.

1. Would you please summarize the accomplishments from the implementation of the first two arrows?

The first two arrows, consisting of quantitative monetary easing and fiscal stimulus, led to an increase in inflation and yen depreciation. In fact, the yen depreciated against the U.S. dollar by nearly 40% from the beginning of 2013 through the end of 2014, sending earnings for Japanese exporters to all-time highs. In fiscal 2013 and 2014, corporate profits increased by roughly 80%; if the yen stabilizes at its January 2015 level, we believe earnings per share could grow 15% in fiscal 2015.

We believe a weaker yen will have a long-term positive economic effect on the exporting sector. These companies are generating far more cash flow compared to a few years ago, with most of the cash being spent on research and development and capital expenditures. This capital deployment should strengthen the competitive edge and increase global market share of these companies with positive momentum filtering through the domestic economy.

2. The third arrow includes initiatives to encourage Japan’s long-term economic growth. What have been the key developments so far?

While the first two arrows were implemented to restart the Japanese economy, third arrow initiatives were designed to help promote a healthy economy over the long-term. Initiatives include the following:

··Reduce corporate taxes

··Promote equity investments among corporations and individuals

–Improve corporate governance

–Increase Japanese equity ownership

··Reform the labor market

··Create new industries

Progress has been made over 2014, but it’s important to note that because these changes are long-term, patience is required.

One key development is the Nippon Individual Savings Accounts (NISA) program. Japanese citizens can now invest up to approximately $50,000 tax-free for a maximum of 10 years. The number of new accounts, as well as the amount of investments being held, has been rising steadily. While the equity culture is still in a nascent stage, these accounts appear to be changing the investing mindset of the Japanese people.

Another development is that the Government Pension Investment Fund (GPIF), the world’s largest with $1.2 trillion assets under management, announced it will increase its Japanese equity allocation from 12% to 25%. This should create additional equity purchases of 8-10 trillion yen, or approximately 2% of Japan’s total market capitalization. In a show of strong support for new investor guidelines under Japan’s Stewardship Code, the GPIF also plans to allocate funds to managers who recognize the importance of corporate governance and have detailed policies on the exercise of voting rights. Corporate pension funds are expected to follow suit.

To improve farming productivity, Japan’s agricultural co-op law will be revised to give farmers more discretion and fewer subsidies. Japan also offers a fast track approval process for regenerative medicine.

In aggregate, these early-stage initiatives make a compelling argument that Japan is changing for the better.

For further detail regarding Abenomics and the factors that could lead Japan to a period of sustained, robust growth, please read our updated white paper, “Japan’s Rising Opportunity.”

3. Tokyo will host the Olympics in 2020. What impact will the games have on the domestic economy over the next couple of years?

We believe the economic impact of the 2020 games will be significant. In preparation to host the Olympics, approximately $22 billion is estimated to be spent on transportation infrastructure within the Tokyo metropolitan district, including the renovation of a highway, extension of railways, and construction of a new airport runway. In addition, capital investment, including hotels, offices, and commercial complexes is expected to be approximately $100 billion.

4. Would you please discuss the investment criteria for the Hennessy Japan and Japan Small Cap Fund?

The Hennessy Japan Small Cap Fund (Trades, Portfolio) invests in companies with a market capitalization in the bottom 15% among all Japanese companies. Since SPARX is based in Japan, we believe our “feet on the street” approach to researching Japanese companies provides us with a competitive advantage. This local focus has enabled us to uncover hidden gems and add value to investors.

The Japan Fund seeks to own a concentrated portfolio of mid- to large-cap companies with a higher return on equity, strong cash flow generation, and above average, sustainable earnings growth. Our goal is to hold high-quality, globally-oriented Japanese companies with smart management and time-tested business models.

Continue reading here.