Platinum Japan (PLA0003AU) Report & Performance

The Fund (C Class) delivered a solid 6.9% return during the quarter, boosted by general strength in the Japanese equity market.1

The rise in the broader market was primarily driven by a rebound in growth stocks, particularly in technology-related areas. Meanwhile, financials reversed much of their gains from the December quarter as the issues in the US banking system stoked recession fears and led to downward pressure on rates globally. This reduced pressure on the yen and thus makes it less likely the Bank of Japan will be forced to abandon its controversial yield curve control policy, which in turn reduced hopes of Japanese banks being able to invest their low-cost deposits at higher rates of return.

The issues in the US likely also caused investors to turn their eyes to the asset side of the balance sheets of Japanese financial institutions and to note their large holdings of low-yielding government bonds. The danger here is that should rates rise, the market value of these holdings will fall. These assets are not required to be marked-to-market unless sold, but if depositors withdraw funds in large enough numbers, capital positions can begin to look precarious as assets are sold to meet withdrawals, thus crystallising losses and stimulating more withdrawals and a disastrous feedback loop; exactly what happened with Silicon Valley Bank (SVB). This outcome seems much less likely in the Japanese context as the deposit base is diversified, whereas SVB’s clients were typically lossmaking, venture capital-funded corporates, which had account balances that were rapidly declining as the normal source of replenishment, the venture-funding market, had dried up. Nevertheless, the change in investor perceptions of this risk factor sent financials stocks, particularly regional bank stocks, lower. The Fund had minimal exposure to this area, so was only slightly aff ected.

Strong contributors to the Fund’s performance in the quarter included semiconductor equipment maker Tokyo Electron (+24% in the quarter) and silicon wafer producer Sumco (+13%), as well as memory chip makers SK Hynix (+18%) and Samsung Electronics (+16%). These stocks all rebounded in line with the broader technology sector.

Japanese equities rallied during the quarter, at first in line with other developed markets, then likely on news that China, Japan’s close neighbour and major trading partner, was exiting its zero-COVID policies, which has positive implications for the return of Chinese tourists and the demand for Japanese goods. The rally persisted even as the yen strengthened, until late in the quarter, when the Bank of Japan (BOJ) surprised the market by announcing it would increase its target band for the 10-year bond rate, causing the yen to strengthen further and equities to sell off . Overall, for the quarter, the combination of rising equities and a rebounding yen helped the Fund (C Class) deliver solid performance, returning 2.8% for the period.

Unfortunately, this was below the market’s return, due primarily to our currency positioning and low exposure to financial services stocks, which rallied due to the prospect of stronger profits as a result of higher interest rates. Regular readers may recall our discussion of yen weakness in the September quarterly report and our use of hedging to mitigate some of the eff ects of that move on investors in the Fund. By September, we viewed the yen as cheap and removed our hedging, with the decision aided by a form of backstop in terms of the expressed intention of the Japanese government to intervene in the currency market to prevent further rapid depreciation. That backstop was not tested rigorously because the pressure on the currency from an appreciating US dollar (USD) reversed as US bond yields fell on expectations of less aggressive rate increases in the face of cooling inflation. In November, we did move some currency exposure back to the Australian dollar (AUD) as we saw continued prospects for widening interest rate diff erentials that would make the AUD relatively more attractive to investors.

However, this has not yet played out as anticipated due to the Reserve Bank of Australia’s persistence with small 0.25% hikes at its November and December meetings, despite rampant inflation, as well as falling yields at the longer end of the AUD curve, which reduced the longer-term rate diff erential with the yen. These dynamics were further compounded by the BOJ’s decision near the end of the quarter.

Japanese stocks fell slightly in the quarter, having initially followed global markets higher before declining in the second half of the quarter.

The Fund (C Class) returned 3.1%, driven by the performance of several core holdings. The market shook off the shocking event of the assassination of former Prime Minister Abe, despite the potential longer-term implications of his absence possibly opening the door for a reversal of corporate governance reforms. Several members of our Japan team were in Tokyo on the day of his controversial state funeral, and were awed by the crowds that turned out to mourn his passing.

Near term, at least, his legacy seems likely to be respected, while it appears that Prime Minister Kishida is a politician who tries to sail with the winds rather than set a clear new course. This may make the current path the one of least resistance. Currency fluctuations were again a major influence on markets, with the yen briefly crossing 145 to the US dollar (USD). The rapid pace of depreciation forced a reaction from the Ministry of Finance (MoF) and Bank of Japan (BoJ), with the latter intervening in the currency market, selling almost US$20 billion. Japan has huge USD reserves, amounting to almost US$1.3 trillion, so retains significant scope to intervene further. That said, if it is required to significantly reduce its USD bond holdings, this could put further upward pressure on US interest rates, with potentially sizeable implications for global liquidity. It is not that the authorities believe a weak yen is bad per se, but more that the rapid pace of depreciation creates instability. In the words of the BoJ Governor Kuroda, it…

The Fund (C Class) returned -5.6% for the quarter and -7.7% for the year.¹

Japan’s stock market (-4% in local currency terms) did not escape unscathed from the equity market pain felt in the Western hemisphere, but fared considerably better than its US (-17%) and European (-9%) counterparts,² helped in part by the weakness in the yen and the ongoing loose monetary policy of the Bank of Japan (BOJ).

The Fund saw strong performance from a selection of stocks driven by idiosyncratic factors. Ship Healthcare (+21%) rebounded as investors warmed to its respectable new mid-term plan, driven by government policy to reduce hospital numbers via consolidation and reconstruction, which is benefi cial to Ship’s consulting and medical equipment supply business. Technology systems integrator Fuji Soft rallied 26% as an activist investor increased its stake to more than 20% after its shareholder proposals were rejected at the Annual General Meeting in March, and bathroom fi xtures and window sash manufacturer Lixil gained 11% with a decline in the price of aluminium, a key input.

Our selective short positions against a number of very overvalued and/or challenged businesses contributed 1.1% to the Fund’s return in the quarter.

Detractors from performance included semiconductor the increasing likelihood that major Russian producer VSMPO’s products will be excluded from high-grade

aerospace applications. We exited our position in Oracle Japan, as we assessed the competitive position of Oracle’s growth engine, the enterprise resource planning software business, to be much less robust in Japan than elsewhere.

equipment maker Tokyo Electron (-30%) and semiconductor wafer manufacturer SUMCO (-13%), as the outlook for semiconductor demand weakened. Doosan Bobcat, owner of the Bobcat small earth-mover brand, declined 26% due to its exposure to a weakening US housing cycle.

Changes to the Portfolio

We made only a few minor tweaks to the portfolio during the quarter, adding to our positions in Fuji Soft and elevator maker Fujitec, as activist actions appeared likely to gain more ground with both companies. We also increased our stake in Toho Titanium, as the outlook for its business improved with the increasing likelihood that major Russian producer VSMPO’s products will be excluded from high-grade

aerospace applications. We exited our position in Oracle Japan, as we assessed the competitive position of Oracle’s growth engine, the enterprise resource planning software business, to be much less robust in Japan than elsewhere.

Japanese equity markets continued their decline in the first quarter of 2022, falling -9.6% in Australian dollar (AUD) terms. The pockets of strength in the market were positively exposed to either the upward move in global interest rates (banks, insurers) or commodity prices (trading companies, energy producers/explorers/services, materials). The combination of increasing interest rate differentials with the US and the implications for Japan’s trade balance of higher prices for its commodity inputs caused the yen to weaken. From 115 to the US dollar (USD) at the start of the quarter, it touched 125 briefly, before settling back in the 121-122 region. The Fund benefited from the yen weakness as we had shifted our currency exposure into USD last quarter and at the beginning of this quarter, leaving us with around 25% of the Fund exposed to the yen at the time it resumed its downward march.

Later during the quarter, we moved some of that exposure to AUD, as inflating resource prices implied more buoyant times for the AUD on a relative basis. Overall for the quarter, the Fund (C Class) returned -6.4% with a positive contribution of 2.6% as a result of currency positioning. A weaker yen typically supports the Japanese economy and stock prices given its export orientation, however, the rising costs for Japanese companies implied by the current scenario have so far more than offset any gains from the weakening currency.

A number of our positions were hurt by the prospect of cost increases and broader supply chain issues, including household fixtures manufacturer Lixil (-25% over the quarter), miniature ball-bearings producer MinebeaMitsumi (-17%), and sensor provider Nippon Ceramic (-13%). Semiconductor chip shortages continue to have wide-ranging impacts up and down the supply chain. Much like Minebea and Nicera’s automotive customers have not been able to produce the vehicles demanded, Ship Healthcare’s (-27%) medical equipment production and sourcing faced signifi cant disruption, leading the company to downgrade its full-year profi t outlook.

The Fund (C Class) returned 0.8% over the quarter and 18.3% over the year.

The Japanese equity market was broadly flat for the quarter in Australian dollar (AUD) terms, as the cyclical rally in the stocks of beneficiaries of stronger global growth and higher interest rates took a time-out, with the current elevated levels of consumer price inflation increasingly being viewed as transitory by market participants (please see our Macro Overview). Given the Fund’s exposure to growth cyclicals and deep value plays, it was pleasing that the Fund delivered a similar return to the broader market.