Baillie Gifford Japan benefits from biotech and robots

The yield on 10-year Japanese government bonds, which was negative last summer, has now risen to low positive levels and, with the Japanese economy steadily expanding, Sarah Whitley, manager of Baillie Gifford Japan Trust, says 2017 could see the deflation that has gripped Japan for years come to an end, providing another boost for Japanese equities. With most of Japanese domestic savings held in cash or bonds, demand for equities might rise because they offer better inflation-proofing than other investments.

She adds that Japanese companies "are cashed up to their eyeballs" and could increase their dividends significantly or pay out special dividends to shareholders. The number of independent directors appointed at companies is increasing and a greater focus on shareholders is likely to emerge as boards develop.

"The reasons why people haven't invested in Japan have gone," says Ms Whitley. "In sterling terms, since 2009 Japan's been a good bull market. Companies are now more shareholder focused, the market is cheap relative to other international markets, corporate earnings have gone up but the market ratings haven't, and Japan is well represented in future growth areas."

These areas include robotics, biotech and internet companies. Baillie Gifford Japan Trust's holdings in these areas include Cyberdyne (7779:TYO), which makes advanced mind-controlled robots to help rehabilitate those suffering from spinal injury or strokes. This company is still at an early stage of development, but already has agreements for treating patients in Germany and Saudi Arabia - as well as in Japan.

"This technology senses the signal that you send to your leg to move your muscle, which moves the robot," Ms Whitley explains. "It looks like the company is about 10 to 15 years ahead of others. We know that robotics companies in Edinburgh are working on similar mind control technology, but [Cyberdyne founder Dr Yoshiyuki Sankai] has been working on this for 25 years."

Another recent robotics addition is Keyence (6861:TYO), which produces sensors and is one of the leading factory automation companies in Japan. The trust also owns industrial robotics company Yaskawa Electric (6506:TYO), one of the best performers over the past six months.

Other holdings that performed well during this period were trading companies Toyota Tsusho (8015:TYO) and Itochu (8001:TYO), and Disco (6146:TYO), which provides cutting equipment for semiconductor manufacturing.

The trust recently bought regenerative medicine company Healios K.K (4593:TYO) and PeptiDream (4587:TYO). PeptiDream is a drug discovery platform that recently signed a deal with a Johnson & Johnson (JNJ:NYQ) affiliate Janssen Pharmaceuticals, causing PeptiDream's share price to rise 20 per cent.

The trust's largest holding is telecoms and internet company SoftBank (9984:TYO), which last year bought UK microchip company Arm, and is investing heavily in internet technology. SoftBank also recently created one of the largest technology investment funds - SoftBank Vision. This is based in London and will be seeded with $25bn from SoftBank and up to $45bn from Saudi Arabia's sovereign wealth fund, Public Investment Fund, over the next five years. "We think SoftBank is undervalued relative to the prospects of the various businesses," says Ms Whitley.

Another of the trust's internet-related holdings is online clothing retailer Start Today (3092:TYO), which was one of its best performers over the past 12 months. But holdings that underperformed over the past six months include Rakuten (4755:TYO), Japan's largest e-commerce company, online medical portal M3 (2413:TYO) and Sysmex (6869:TYO), a haematology company. Subaru (9778:TYO) (formerly called Fuji Heavy Industries) and Mazda (7261:TYO), car manufacturers with large exports to the US, underperformed due to fears about increased tariffs in the US.

But Ms Whitley takes comfort from the fact that Japan's prime minister Shinzo Abe was the first foreign leader to meet US President Donald Trump. And any policy that hits foreign car manufacturers with increased tariffs would raise the average cost of car prices in the US, which would not go down well with consumers.

"I think Trump wants to deal with North Korea and China, so he's highly unlikely to attack the trade deficit with Japan," she says. "We've already seen companies like Toyota (7203:TYO) say they will invest more in America and, in any case, Japanese companies have been internationalising their production for 20 years, so they may speed that up a bit to be politically expedient."

When looking to add new investments Ms Whitley seeks four different styles of shares:

■ Secular growth - stocks that can generate growth regardless of economic conditions.

■ Growth stalwarts - stocks that can continue growing over the very long term.

■ Special situations - stocks where a catalyst of some kind offers a growth opportunity.

■ Cyclical growth - stocks that do well when the economy is strong.

The majority of the trust's 68 holdings fall into the secular growth category and over the past six months the proportion of companies in this area has increased due to good performance and a number of new buys.

In February the trust moved from trading at a discount to net asset value (NAV) to a premium, which at time of writing was about 4 per cent. To meet continued investor demand for shares, the trust issued 100,000 new ordinary shares in April.

Source: Winterflood Securities as at 19/04/17, *Baillie Gifford as at 31/01/17, **The Association of Investment Companies

Performance

Source: Morningstar as at 18/04/17

Top 10 holdings as at 31/03/17 (%)

Source: Baillie Gifford

Sector breakdown as at 31/03/17 (%)

Source: Baillie Gifford