To be considered for the portfolio, which currently has 80 holdings, stocks first have to fit into one of two categories, Ciganer said. The first is stocks with a high probability of long-term growth, such as those driven by technological or demographic changes.
The second is companies that are undergoing transformation. For example, one year ago the fund bought Mitsubishi Motors after Nissan had acquired a 34% stake in the company.
“Now Mitsubishi is being restructured by Nissan and that is likely going to lead to massive improvement in profitability,” he said.
Four attributes
Once he finds companies that fit into one or both categories, he then makes the decision about weighting in the portfolio, based on four attributes.
He looks first at the quality and long-term franchise value. “This means, does the company have a bright future? If you are a steel manufacturer in an uncompetitive market like Japan, you might be running the company very well but you always have the wind in your face.”
The second is the trend in the company’s fundamentals. Is the company getting worse or improving? The third is his expectations relative to market expectations. “If an analyst says you should buy this stock, but my estimates are well below market consensus, then I am unlikely to buy it.”
Lastly is the valuation. Ciganer looks at short-term metrics like price-to-earnings and long-term metrics like discounted cash flow or dividend discount model.
Archibald Ciganer, T Rowe Price
Any stock choice needs to have some of these factors in its favour and those that have several pluses will receive a high weighting in the portfolio. “If only a few boxes are ticked, then I will have small position or I don’t own the stock at all,” Ciganer said.
The selection process starts with research done by his team of analysts based in Tokyo. It can be as short as two weeks to decide whether to buy a stock, but depends on management meetings.
He avoid investments in companies which decline meetings. For example, Japanese furniture company Nitori had strong performance but he did not take a position because the company does not meet with investors, he said.
He also avoids Japanese biotech stocks (which some peer funds hold) because “most people don’t have an edge with regards with fundamentals, and they are sort of speculating”.
Top ten
Following this criteria, the top holding is Miura, Japan’s leading boiler manufacturer, which has 2.9% weighting in the portfolio. It is followed by Suzuki Motor and Daio Paper, each of them with a 2.3% allocation.
Ciganer explained that the attraction of Miura is that it fits into both initial categories.
“It is a mid-cap with a growth angle in China because they benefit from stricter environment regulations there. And it has a bit of a transformation angle too because until very recently it was a purely domestic company and now it is expanding overseas.”
On a cumulative basis, the top ten holdings, which account for 20%-33% of the total portfolio, would tend to drive most of the alpha, he said.
The largest positions never exceed 4%, mainly because he has not yet found a stock that has all four of his required attributes, he said.
He tends to hold positions for five years on average. “It is a lot easier to make a good return if you are aiming for a three-to-five year period because the market always looks one-to-two years ahead.”
Ciganer said he doesn’t invest his own money into his fund because it is not registered in Japan and capital gains would be subject to double taxation.
“But when it gets registered later this year I will put my money in it,” he said. “I will invest not only because it is the right thing to do, but because I believe Japanese equities are quite attractive – much more than they used to be.”
The fund vs its sector and benchmark
