Prudential Japan Smaller Companies Fund is a new feeder fund that invests in small
capitalization stocks in the Japanese equity market (click here
to read the factsheet). The lead manager is Kenichi Ura, whose been running the
mother fund, the M&G Japan Smaller Companies Fund, since January 2000. He
has 17 years of investment experience and has been with Prudential Fund Management
since 1999. As a rule, small cap funds tend to outperform large cap stocks during
a market rally, which has been the case for the past year in Japan. The mother
fund has been a prime beneficiary and in the 1-year period ending 31 August 2004,
the fund returned 60.7% against a benchmark performance of 58.2% (see table below).
Prudential Asset Management (Singapore)
Japan Smaller Companies Fund
TSE 2nd Section Index
*figures calculated using bid-to-bid
prices and in SGD, with income re-invested
Despite this run-up,
the fund house believes that the growth cycle for small cap stocks in Japan is
not over. In an interview, Kevin Gibson, Chief Investment Officer (Japan) for
Prudential Fund Management talks more about the fund.
Q: What is the
rationale behind investing in small-to-mid cap companies as opposed to larger
A: Smaller companies stocks can be more attractive
as they have higher growth potential. This can be a decided benefit during a market
upturn when investors' risk appetites increase. In the 1999/2000 rally for example,
Tokyo's smaller company second board rose 193% whereas the main board rose "only"
76%. In the 2003/2004 rally, the same pattern was evident with the smaller board
rising 109% against the main board's 34%. Smaller companies stocks are also often
under-researched, so pricing anomalies abound. These anomalies present opportunities
to the disciplined and valuation focused investor.
Q: The Japanese equity
market did undergo a strong rally this year. Will that fizzle out, or do you think
there is real strength in this rebound? Why?
A: We remain confident
about the long-term prospects for the stock market which should be supported by
continued low interest rates and easy money. What is exciting this time is that
many economic indicators are pointing to the return of structural growth in Japan.
Corporations have increasingly restructured, and that is boosting profitability.
That, in turn, is providing the working capital companies need to grow. For the
past decade, economic upturns were being snuffed out as neither the banks nor
the companies themselves could provide the working capital needed for expansion.
That companies now have access to this money is a major step forward in our view.
the market has paused recently as economic growth is consolidating, the outlook
is encouraging. An additional support will likely be found in the changing dynamics
of share transactions - changes that are for the better. In recent years, for
example, banks and corporations have been net sellers as they unwound their cross
shareholdings. This selling will virtually come to an end this fiscal year. Indeed,
corporations are now actively buying back their shares.
In our view, the
market could well move in a similar fashion to both 1971-72 and 1986-87. During
these periods, the market more than doubled despite weakness in the underlying
economy. We would not be surprised to see the TOPIX move significantly higher
over the next few years.
The issue for investors is, of course, timing.
Investors remain swayed by trends in the domestic and US economies. Both economies
have hit "soft spots" to quote Federal Reserve Board Chairman Greenspan. The fundamental
economic drivers suggest that both economies will transverse these "soft spots".
When they do, there is ample excess liquidity to drive the market higher. In our
view, though, this will take at least six months. With recent market setbacks
due mainly to profit-taking by hedge funds, our view is that "buy on the decline"
is the best advice.
Q: What are the main criteria for companies in the
fund? Are many of the companies geared towards local demand, or are they export
A: We look for companies that exhibit qualities such
as growth potential (illustrated by innovative products, high market share and
natural barriers to entry); strong cash flows and under-valuation (price to earnings
ratio, price to book, the return to equity, yield and enterprise value).
of the themes we consider are:
- Merger & Acquisition Opportunities
- China related stories
- Revival of International
For example, there are several small companies
in Japan whose net cash holdings are higher than their respective market capitalizations.
Such companies are attractive M&A targets. We hold, for example, management consultants,
Tanabe Management. The company has ¥4.3 billion of cash with no debt. In contrast,
its market capitalisation is a much lower ¥3.2 billion. The dividend yield is
3.8% against a background of virtually zero interest rates. Whilst we do not expect
the company to grow in the manner of Honda or Sony, there is almost no possibility
of bankruptcy. In our view, this company's fair value is around 2.5 times the
Q: How will movements in the Yen affect the fund?
A stronger yen makes Japan's exports more expensive. Japanese companies understand
this risk well and are gearing themselves not only by setting up manufacturing
activities outside Japan but also by moving into higher technology, higher margin
products. For example, Toyota and Honda supply the Singapore market from their
Thailand based manufacturing plants.
Q: Going forward, what are some
of the factors that will drive the equity market? (i.e corporate restructuring
etc). Companies in Japan have been undergoing restructuring and cleaning up their
balance sheets for some time. Has this news been completely factored in, or will
it still be a growth driver for the market going forward?
Valuations as at September are up with events. There is tremendous longer term
valuation upside however. Even though the economy has hit a "soft spot", various
economic indicators are pointing to an economic "breakthrough". New orders are
rising, the yen is extremely cheap on a trade weighted basis (and thus unlikely
to stymie growth this time around) and machine tool investment is rising. Furthermore,
both corporate net and operating profits are rising.
The picture that is
emerging is one in which the market has paused to take breath while awaiting the
benefits of the slowly emerging underlying structural recovery.
restructuring is continuing. This is being felt in the banks with the recent takeover
of UFJ by the Mitsubishi Tokyo Group. The underlying dynamics affecting individual
shareholders referred to above has also to fully run its course.
What are some of the main risks for the Japanese equity market?
Clearly, deflationary forces are difficult to squeeze out - this was evident
in the second quarter economic growth data. The risk that China miscalculates
and slows its economy by more than it intends (thus slowing Japan's exports) is
a risk. Sustained higher oil prices would also restrain growth. The biggest risk,
however, is probably that today's export and investment led recovery does not
feed through into domestic demand. The transition is occurring, but it is much
slower than many would like.
'No investment decision
should be taken without first viewing a fund's prospectus. Any advice herein is
made on a general basis and does not take into account the specific investment
objectives of the specific person or group of persons. Past performance and any
forecast is not necessarily indicative of the future or likely performance of
the fund. The value of units and the income from them may fall as well as rise.
Opinions expressed herein are subject to change without notice. Please read our