Citywire A-rated Richard Kaye has emerged as a leading light in Japanese equity over the past three years but he says it is what he does not hold, as much as what he does, that is driving performance.
For example, Comgest’s Kaye has zero exposure to energy and utilities, which he said has helped the fund continue to progress. Speaking to Citywire Selector, Kaye highlighted the three reasons why he doesn’t allocate to the sector and also offers up an alternative.
#1 - Forecasting earnings
While Kaye seeks to be fully invested where possible, he has 3.5% cash at present, he is not averse to having zero exposure to set sectors when necessary. The Topix has 1.3% and 1% allocations to utilities and energy, respectively, but Kaye has nothing in either.
‘With energy, we have a hard time forecasting earnings because of the volatility of commodity prices. We like to make five-year earnings projections on which we premise our valuation work, by doing a dividend discount model.
‘We just can’t do that with a great deal of comfort in the energy sector, because the price is ultimately too volatile and too hard to predict as it is driven by global commodities and the energy market.’
#2 – Regulation
The second problem Kaye has with the two sectors is lack of regulation in the utility industry in Japan. ‘In our humble view, they don’t really own their own businesses.
‘Companies in Japan are very much subject to the regulator's decisions of tariffs, capacity allocation and in fact, even on capital expenditure decisions.
‘For us to be invested in those companies, it’s a little bit hard to have the confidence that the government of Japan is going to be on the side of shareholders all of the time in the regulatory decisions that it makes.’
#3 – Growth
The third and final problem, Kaye said is the Japanese economy as a whole. ‘The economy is probably not going to have stellar performance or growth in the coming years. I think individual sectors will do very well, but overall the economy is probably not going to do spectacularly.
‘Therefore, it’s hard to see why the long-term outlook for utilities and energy would be very exciting, so we have stayed away from those sectors as a whole,’ he added.
Despite not having any allocations to the two sectors, Kaye said he is invested in one company which is engaged in the regulation of electricity supply.
‘It has gone through a similar situation to that of British Gas when Margaret Thatcher was UK Prime Minister. At the time, British Gas privatised and allowed almost any operator to get into the resell of gas and the resell of electricity.
‘Well Japan has now done the same. While it’s a fair way behind the UK, there are a few companies that have tried to get into electricity resell, but most have had limited success.’
Kaye currently has a 3.2% position in Hikari Tsushin, a company Kaye said has been successful in this area.
‘They have built a robust business which is reselling electricity to small corporates, they are not a utilities company but they are a firm which is leveraging a big change in the utilities market, mainly with the regulation of electricity provisions,’ he added.
At present, Citywire tracks 168 fund managers in the Equity Japan space. Kaye sits 12th over a three-year period, returning 58.5% in Japanese yen terms. This is on the Comgest Growth Japan fund, which he runs with Citywire AA-rated Chantana Ward and Makoto Egami.
The average manager returned in 37.1% over the same period. The Topix TR rose 47% over the same period to the end of October 2017. All figures in Japanese yen terms.