Japan All Cap Q4 investment update

As with any investment, your capital is at risk. Past performance is not a guide to future returns.

Sarah Clark (SC): Welcome to this quarterly update for the Japan All Cap Strategy. My name is Sarah Clark, an investment specialist, and I'm joined by Jared Anderson, the newly appointed co-manager for the strategy. As a reminder, Japan All Cap is looking to invest in some of Japan's best growth companies. And we do that by taking a flexible approach and constructing a portfolio of 45 to 65 companies across the market cap range. Now, the plan for today is to touch on performance, positioning, and also our outlook for the year ahead. Welcome, Jared.

Jared Anderson (JA): Hi, Sarah.

SC: So let's start with performance. The strategy underperformed over the quarter. And when looking at the macro backdrop, it's recently been dominated by monetary policy, the weak yen. We've also seen a flurry of corporate reform activity. What's your thoughts on all of this?

JA: Yes, so maybe just taking a step back, 2024 was a strong year for the Japanese stock market, albeit with some notable blips along the way. That's obviously helpful for performance in an absolute sense, but as you point out, less so in a relative sense. So there's a few things to call out there. First, we've seen a continued period of weakness with the currency. That's really helped some of the more cyclical sectors like autos, where we have quite strong reservations about the competitive position of some of the Japanese manufacturers, as evidenced by the recently proposed merger of Honda and Nissan. Clearly, that's a defensive move. And similarly, sectors like banks, again, macro-sensitive, that's been an area that has been unhelpful for relative performance with rising interest rate expectations filtering through to profit forecasts and share price performance.

SC: So fair to say it's been a continuation of what we saw last year with that tough macro backdrop that's really fuelling performance for Japan's large cyclical companies that we don't own.

JA: Yeah, I think that's right. And just as a reminder, we construct our portfolios based on bottom-up company fundamental analysis rather than top-down macro views. So, we're much more interested in secular growth drivers, themes like automation, healthcare, gaming. We care about the economics these companies are doing. We care about the competence of the management teams. That's really what we think matters for long-term share price performance. And we're investing in companies that are growing faster, that are more profitable, that are less indebted than the market as a whole. And it's really that that underpins our confidence from here.

SC: Thanks, Jared. So, let's turn to portfolio attribution over the quarter. Eisai, the pharma company, was a detractor over that period. What's been happening there?

JA: Yes, so this is a pharmaceutical company that's developed a pioneering drug to treat Alzheimer's disease. So this is a really horrible disease that afflicts a percentage of the elderly population. And sadly, that percentage is growing. And a disease for which, to date, there's been relatively limited slash no therapeutic option to get at the root cause of the disease. Eisai is changing that, it's had the first FDA approved drug to market and a really good example of innovation being alive and well in Japan. Now, as you point out, the share price performance has been relatively weak and there's a few reasons for that. So, uptake of the drug has been slower than expected and there's been some regulatory challenges in geographies like Europe. But we think the stock market response here is an example of short-sightedness in action. This is a breakthrough drug that will be iterated upon. And of course, you need some patience to build out the required infrastructure to diagnose and treat patients. This is a multi-decade problem that is going to require a fine balancing act amongst the many different stakeholders involved. But in the whole, this is a company that we're really excited about over the next five, ten years.

SC: I think Eisai is a good example as well of a company that is early on in its growth journey. And from here, it's unlikely to be completely plain sailing. But the opportunity that it's trying to address is huge and very exciting, as you say.

JA: Yeah, absolutely.

SC: So let's move on to what has been doing well. So Recruit, the online HR platform, was a contributor over the period. What's been driving its share price performance?

JA: Yes, so this is a HR technology business that's behind platforms like Glassdoor. These platforms help match employers with prospective employees and these platforms are global in reach. So, for example, a big chunk of Recruits revenues and profits come from the United States. Now, the recruitment area is one that we're really excited about because it's a very big market, but it's also a market that remains quite sort of dated and old-fashioned. Recruit is trying to change this by imbuing technology and analytics into a process that to date has been fairly analogue in nature. And so in a similar vein to what we've seen in the advertising industry, we think value is going to accrue here to those who can offer tools that allow for more automated, more precise targeting and ultimately make the job search process more effective. for both sides. So, really attractive prospects here. Recruit is investing behind some of these trends. And of course, as the working population ages and labour shortages become more acute, these tools only become more valuable. So, the recent share price performance really reflecting all of these factors.

SC: Okay, let's move on to positioning. So turnover for the portfolio remains low. We had one new buy over the quarter, which was Tokyo Metro. We participated in the IPO, which is an area where we're starting to see more activity again in the market. Can you talk us through what attracted you to this company?

JA: Yeah, sure. So, this is an IPO that's been in the works for a while. It was the biggest IPO in Japan in six years and I think a good indication of general investor sentiment. So, it's a really unique asset, part of the fabric of Japan's capital city. It's been around since the 1920s, carries almost 7 million passengers per day across the metro area and it's the quickest and cheapest way to get around Tokyo for residents and tourists alike and of course well known for its punctuality and its cleanliness. The attraction here is really we see a wedge between the value that Tokyo Metro generates for commuters and the value that it generates for shareholders. So, for example, there's been one price increase in almost three decades and it's that latent potential combined with inelastic demand that we think underscores the potential for long-term shareholder returns, more so when we think about technology and automation augmenting day-to-day operations. And important to make a distinction between the demographics of Japan and the demographics of the Tokyo area, which is continuing to see inward migration amongst the working age population. So all these things considered, it's really the growth here that we think is maybe a little bit underappreciated, and the longevity of that growth. Those are the attractions.

SC: I think it's also a good example that it adds something different to the portfolio and also illustrates the flexible approach to growth that we take. OK, final question from me. What lies ahead this year? What are you excited about?

JA: Yeah, so look, I think there's lots of reasons to be optimistic about Japan in 2025 and beyond. This is a stock pickers market that continues to offer high quality growth companies at attractive prices. And it's a market which has continued momentum on things like corporate governance and shareholder returns. More specifically, in 2025, we've got a new console coming from Nintendo. We've got SoftBank with one of the most exciting collections of AI-related investments, and Rakuten, which is finally starting to reap the rewards of its ambitious mobile network build-out. So, lots of reasons to be optimistic and a great time to be invested in Japan's best growth companies.

SC: Well, I think that's a very positive note to finish on. And thank you, Jared, for your time today.

JA: Thanks, Sarah.

SC: To recap on the main points, the macro backdrop remains challenging for performance. And it's still a case that the companies that we don't own are impacting our relative performance. Despite this, the portfolio remains in good shape. The companies are growing their sales and earnings faster than the market and are underpinned by structural growth drivers that we think will help to grow share prices over the long term. We hope you find this a useful update today. Please do get in touch if you have any questions and we'll speak to you next quarter.

Annual past performance to 31 December each year (net%)

Annualised returns to 31 December 2024 (net%)

Source: Revolution, Japan Exchange Group. US dollars. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite. 1 year figures are not annualised.

Past performance is not a guide to future returns.

Legal notice: The TOPIX Index Value and the TOPIX Marks are subject to the proprietary rights owned by Tokyo Stock Exchange, Inc. and Tokyo Stock Exchange, Inc. owns all rights and know-how relating to the TOPIX such as calculation, publication and use of the TOPIX Index Value and relating to the TOPIX Marks. No Product is in any way sponsored, endorsed or promoted by Tokyo Stock Exchange, Inc.

Risk factors

This communication was produced and approved in January 2025 and has not been updated subsequently. It represents views held at the time and may not reflect current thinking.

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this communication are for illustrative purposes only.

Financial Intermediaries

This communication is suitable for use of financial intermediaries. Financial intermediaries are solely responsible for any further distribution and Baillie Gifford takes no responsibility for the reliance on this document by any other person who did not receive this document directly from Baillie Gifford.