Summary
- The abrdn Japan Equity Fund offers investors a relatively low-cost, actively managed vehicle to access Japanese equities.
- Despite a high active share measurement, the fund has underperformed through the last decade, justifying the persistent NAV discount.
- With the portfolio also likely to suffer amid the weak manufacturing/strong services trend, it's hard to justify buying the fund here.
Having underperformed its benchmark TOPIX Index (i.e., the Tokyo Stock Price Index) by a fair bit over the last decade, the abrdn Japan Equity Fund ( JEQ ) has given the market few reasons to close the persistent discount to its underlying NAV. While Japanese equities are off to a good start this year, the outlook isn't quite as bright following recent economic data indicating weakness in goods demand globally. Continued disappointments here would mean potential downward revisions to the earnings outlook of the many Japanese exporters within the JEQ portfolio.
Also concerning is the path of the Bank of Japan's (BoJ) monetary policy following its governor reshuffle. A more hawkish turn, including an end to the BoJ's 'yield curve control' and other policy normalization efforts, could well be on the cards heading into the April meeting. Should the Fed also follow through with an extended rate hike cycle following the strong employment data, the tech sector, the largest allocation in the JEQ portfolio, could underperform. Net, the fund's discount to NAV seems appealing, but given its tech/export-heavy stock portfolio, I would hold off on a position pending signs of fundamental improvement, as well as incremental visibility into the path of US and Japanese long-term rates.
Fund Overview - A Relatively Low Cost, Actively Managed Japan Equities Fund
The US-listed abrdn Japan Equity Fund, actively managed by the abrdn Asia Pacific Equity Team, seeks to outperform the TOPIX Index (net of dividends) on an absolute return basis. The fund's investment philosophy is consistent with the abrdn group's research-driven, bottom-up stock selection process. The CEF held $90.6m of net assets at the time of writing and charged a 0.85% expense ratio. Per the latest factsheet, ~30bps of annual expenses went to management fees, with ~45bps allocated to other expenses and the remainder going to leverage costs. Despite a relatively high active share measurement of 73.6 per the latest disclosures, the fund is one of the more cost-effective options available to US investors. A summary of key facts about the fund is listed in the graphic below:
As reflected in the chart below, the fund's sector allocation is heavily concentrated on six sectors, led by Information Technology at 16.9%. The rest of the portfolio is allocated to Consumer Staples (14.6%), Industrials (14.3%), Consumer Discretionary (14.0%), Health Care (11.9%), and Financials (11.8%). On a cumulative basis, the top six sectors accounted for a combined 83.5% of the total portfolio.
As highlighted by the fund's disclosure of its latest top-ten holdings, it is relatively diversified from a single-stock standpoint. The largest single-stock exposure is leading insurer Tokio Marine ( TKOMY ) (6.1%), followed by tech giant Sony Group Corporation ( SONY ) (3.6%), and Japanese real estate company Tokyu Fudosan ( TTUUF ) (3.3%). Other notable holdings include factory automation leader Keyence ( KYCCF ) at 3.1% and construction company SHO-BOND Holdings ( SBHCF ) at 3.0%. All in all, the top ten holdings accounted for ~33% of the overall portfolio, with only 1.1% held in cash.
Consistent Underperformance Justifies NAV Discount
On a YTD basis, the fund has declined by 3.2% in market price terms compared to its benchmark TOPIX Index at +6.5%. Even over long timelines, the fund has underwhelmed on a relative basis - in market price terms, the fund has compounded at 4.8% over the last decade vs. the TOPIX at +5.7%. Also worth noting is that since its inception in 1992, the fund has only compounded at +1.7% in NAV terms and +1.1% in market price terms, hardly sufficient compensation for taking on equity risk.
Since the 2021 peak, fund distribution has also dropped off; while the total percentage yield is in the high-single-digits on a trailing-twelve-month basis, the income portion (excluding capital gains) is closer to ~1%. As a result, the fund trades at a persistently wide NAV discount (currently ~15%) despite the buyback authorization.
A Less Than Ideal Near-Term Setup for Japanese Equities
Given many of the Japanese corporates within the JEQ portfolio tend to be exporters, the underwhelming global manufacturing data over the last few months doesn't bode well for the outlook. Of note, manufacturing PMIs showed leading weakness in new orders across Europe and China , as well as in Japan .
Inversely, it appears that service demand has been the source of economic strength thus far - in the US, for instance, the ISM non-manufacturing index posted a rebound to 55.2 in January (a reading >50 implies expansion) from 49.6 in December. Alongside the surprisingly strong January jobs report in the US, which was also driven by services vs. goods, Japanese equities are poised to lose both ways. On the one hand, weakness in goods demand will weigh on earnings at Japanese multinationals. On the other hand, stronger services demand offers limited benefits for the manufacturing-heavy JEQ portfolio. Instead, the services strength could drive more Fed tightening, presenting downside to the JPY (note JEQ isn't hedged) and overall equity valuations.
Fade the NAV Discount
Amid the deteriorating goods demand globally, the abrdn Japan Equity Fund could underwhelm in the coming months, given its tech/exporter concentration. Adding to the uncertainty is the risk of a hawkish turn by the new BOJ governor; alongside the Fed's increasingly hawkish tone post-jobs data, a normalization of the 'yield curve control' and other policy initiatives at the upcoming monetary policy meeting could weigh on Japanese equity valuations. The JEQ portfolio composition offers little reprieve from these headwinds and could see further underperformance ahead. Given the fund's lackluster track record as well, the ~15% NAV discount seems unlikely to narrow anytime soon.
For further details see:
Japan Equity Fund: Fade The NAV Discount