‘Despite the strong performance, I’m still very wary. I’m sorry to be ultra-cautious but I am so scarred by the last three years, I think if someone writes something positive it will create a period of underperformance,’ jokes the London-based investor.
Salter is well ahead of the Topix on a one-year basis, having returned 30.5% in Japanese yen terms over the 2017 calendar year against a 22.2% from the benchmark.
However, he says the impact of his longer-term underperformance has hit home, even though he’s only down 0.1 percentage points on the index over three years, see graphs.
‘Everything I had done in my career up to 2013 had turned to gold. Then I had a two standard deviation event, which has been incredibly humbling.
‘It has also been very cathartic. I’ve done a lot of soul searching over how much money I want to manage and how I want to achieve very good returns for the team.’
When he featured in Performance Clinic in 2015, Salter said his value style was blown away by a sudden grasp for growth. However, there was worse to come. ‘The nadir for the fund was probably June 2016. We had a really rough first quarter that year which was disastrous.
‘We had been on the wrong side of the growth/value trade for a long time. Then we stabilised in April-May 2016 but then Brexit happened and we had another lurch down. There were a lot of redemptions in April and July that year, which coincided with the bottom of relative performance.’
The slide in redemptions was eye-watering. The Ucits-compliant version of the strategy went from a peak of around $5 billion in early 2014 to below $1 billion in the years that followed.
The scale of the problem was significant enough to make it into Polar Capital’s financial report at the end of 2016.
In a letter to markets, the company said: ‘We have continued to experience net fund outflows over the period [as a company], predominantly from our Japan Ucits fund, although we also experienced outflows in a number of other funds particularly in July in the immediate aftermath of the Brexit vote.’
Keeping a lid on it
With performance improving, the fund’s assets have since reached $1.15 billion but Salter remains wary. ‘There is no indication there won’t be redemptions in the future,’ he says.
He also realises that he is no longer viewed alongside some of the other top players he used to be measured against. ‘We have had some of our fund ratings taken away, so we can’t be compared to some of our peers in that light even though this fund has been running for 17 years now.’
For Salter, one of the takeaways from this experience concerns asset levels and he intends to impose tougher restrictions once the fund nears the $2 billion mark again.
‘One of the lessons I have learned is we need to control the size of the fund better. In 2012, when Abe came to power, we were on about 28 buy-lists as people buy funds off three to five-year returns.
‘We had an unbelievable track record, it was a “once in a career” environment then. Buyers in our fund who were at $100 million prior to Abenomics, went to $500-600 million, so we soft-closed it.
‘We have since decided the fund will as good as hard-close when it reaches $2 billion, with a series of front-end charges which will effectively shut it.’
So what has Salter done to help his fund turn the corner? For one thing, he has taken advantage of a supportive backdrop for smaller companies, as the Japanese market became flooded with liquidity, and set his sights on market leaders within niche areas of the market.
While large-cap names such as Mitsubishi UFJ Financial and Dai-ichi Life Insurance appear in the fund’s top 10 holdings, there are also several smaller companies filling marginal positions but producing much-needed outperformance.
For example, residential real estate firm Open House was the fund’s strongest contributor in monthly data to the end of November 2017.
In our previous discussion in 2015, Salter was near his 40% historic high on small-cap exposure, but more recently his portfolio has topped this level. Salter says this is due to the increasing opportunities among small and mid-cap stocks at a time when many domestic investors are focused on large-caps.
‘We are currently about 28% in large-caps, mid-caps are roughly 38% and small-caps are about 42 or 43%. The fund is smaller now and my expertise is in mid and small-cap, so we can say the fund has found its mojo again, possibly because we are lot more disciplined about what assets we should be managing.
‘What I have said to my investors, and potential investors, is give it another 18 months and then we can see whether the changes I’ve made are working. It is still too early to take a positive view on the fund.’
Investors behaving badly
Salter has faith in his investors but is critical of Japan’s domestic market participants and how their behaviour affected previously steady foreign asset allocators.
‘The general investor base within the Japanese market has become poorer as the years have gone on. In the 1990s institutional foreign investors were very good in the Japanese markets.
‘You would expect them to be long-term and rational but what has transpired contradicts that. Many foreign investors are also mis-reading the Japanese market.
'They either pile in towards the end of a panic or withdraw as soon as things improve and then come back in and out again. It makes things tough for longer-term investors.’
Salter evidently wants investors to return to a longer-term approach rather than quarter-to-quarter returns, three-year numbers or ratings agency views. ‘In the near-term we have had more outflows than inflows, we had $250 million taken out of the fund last year.
‘It has been a very tough period but the fund has outperformed the Topix consistently since inception. Nevertheless, very few investors have said: “here is a great manager with a long-term record, so I am going to buy in”.
‘What increasingly drives investors are three-year records and ratings, while 17 to 20-year numbers are less relevant than ever.
‘It’s an exciting time because this is a very contrarian fund and I have no major backers from rating agencies, which is a good thing. I am keeping my head down and assuming conditions will remain bad. It is very dangerous to write off somebody with my experience,’ he says.
This article originally appeared in the February edition of Citywire Selector magazine.