Eastspring’s Japan equities team identifies investment opportunities by starting with a quantitative screen with a focus on relative valuation, Wolley explained to FSA.
The model takes a long-term approach to valuation, aiming to identify large deviations of financial ratios and indicators with respect to a stock’s own history and its peers. It also takes into account price performance and broker sentiment.
The most mispriced stocks are then subject to fundamental analysis in order to understand the reasons behind the mispricing and to confirm that value exists. On average, each year the team assesses 40-50 new investment ideas for inclusion in the four portfolios, out of the investment universe of 2000 Japanese companies.
The six-person management team, led by Kevin Gibson, CIO, and team leader Dean Cashman, has been structured in a way that aims to reduce the risks of behavioural biases. “We’re just as biased as anyone else,” said Woolley.
A small team of generalist peers and collective decision-making help mitigate behaviours seen in larger teams of specialists, according to Woolley.
Narrow sector specialisation sometimes leads to analysts promoting their own segments, to less collaboration and scrutiny by peers. Specialists in larger teams may be wary of promoting contrarian ideas for fear of being wrong and solely responsible, or – on the contrary – overconfident in their decision-making abilities.
By sharing sector coverage and making collective decisions “we mitigate those emotions,” said Woolley. “We want to avoid inertia in decision making, and career risk [by] collectively deciding whether as stock is high conviction, and that’s unanimous,” he added. “We’re either right or wrong together.”
The focus of the strategy is long term. Stocks can be held for, on average, three to five years.
“Typically we are very patient,” said Woolley. “We make sure we’re compensated for the time we may wait for each stock in the valuation upside.”
Under and over
The long-term focus leaves the strategy vulnerable to short-term, theme-driven market moves. In early 2016, the market was focused on defensive stocks. This drove up the prices of consumer staples, rail companies, pharmaceuticals and utilities. The fund didn’t participate in the rally, on the basis of valuations, which resulted in underperformance.
As the market beliefs in a prolonged low-interest environment and slow growth was challenged in the second half of 2016, fortunes turned and the fund’s focus on cheap, out-of-favour stocks paid off.
The team’s location in Singapore, away from its focus market, presents both advantages and disadvantages. While logistics of meetings with company management can get complicated, the relative isolation from the daily news flow helps mitigate the risk of emotion-driven reactions.
“Being away from the noise actually helps us to focus on what matters most, valuation and testing of the drivers of earnings,” said Woolley.
Investor behaviour
Eastspring’s Japan equity team subscribes to the behavioural finance school of thought. It believes that investors are driven by emotions, seek comfort, have imperfect judgment, succumb to biases, and tend to follow the crowd. Fund managers who are aware of these influences, can identify them and, most importantly, avoid succumbing to them, stand to exploit market inefficiencies this behaviour creates.
Investors’ behaviour, influenced by emotions, a flood of daily news and propensity to follow the crowd, results in commonly-shared short-term beliefs that move markets.
“Those beliefs quite often drive prices to both extremes of expensive and cheap,” Woolley said.
This phenomenon may become amplified with the growing popularity of ETFs and other forms of passive investing. Flows into passive funds, when driven by themes such as low volatility, will often result in price distortions of selected market segments, said Woolley.
“We are potentially able to exploit those opportunities by remaining true to label around valuation,” he said.
Eastspring’s Japan equity team manages four funds, including Japan Dynamic Fund and Japan Smaller Companies Fund, both of which are high-conviction, benchmark-agnostic.
All are managed exclusively through bottom-up stock selection without making conscious sector allocations or considering macro-economic environment, except in fundamental analysis of individual stocks.
Performance of Eastspring Investments’ Japan Dynamic Fund and Japan Smaller Companies Fund, compared to MSCI Japan Index
