Hiroshi Tateda believes reforms in Japan bode well for future of small caps
Merrill Lynch's offshore Japan fund is focusing on small cap stocks with management committed to Western concepts such as corporate governance and shareholder value.
Hiroshi Tateda, manager of the Mercury Offshore Sterling Trust Japan Opportunities fund, said: 'Our style is bottom-up stock selecting with a thematic overlay,' he said. 'What happened in the US and the UK will happen in Japan in the next 10 years.'
Tateda runs a bottom-up fund. It is described as a theme fund but those themes are actually a function of the stockpicks and are used as a risk overlay rather than a stockpicking tool.
He looks for the ability of firms to assert pricing power but in a deflationary environment this is difficult and requires consistent innovation. Even being able to sustain prices is an impressive feat in an environment where many companies are lowering theirs, he said, noting increasing consumer sophistication also means there is less room for mistakes.
He said: 'In the old economy, firms would push out products, now they have to follow consumer needs.'
The fund tries to find possibilities in a period of turmoil. For example, Tateda said the healthcare system is essentially bankrupt but deregulation of the system over the next three to five years should provide plenty of opportunity to develop and pursue new investment ideas.
The unpopularity of the asset class in which the fund invests means there are only a small handful of analysts that cover the universe in which he invests so Tateda sends his team in for intensive company visits.
He invests mostly in stocks with a market cap of $300m- $3bn, with a 30% annual turn-over. Tateda is concerned about stock liquidity, which is generally poor, but does not want to take more than two weeks to establish or sell a position. The maximum position in any one holding is 5%. He aims to have 50-80 holdings and currently has 64.
A big part of the fund's three-year track record came in late 1999, when Tateda took a strong tech position during the boom and then took off his position at the end of the year. Although he has a lot of freedom, Tateda claims this kind of single-focus is a rarity. Under normal conditions the fund will be diversified throughout many sectors.
The near-term future for Japan is ugly, with increasingly bad economic prospects for several years as reform trickles down into corporate governance and banking, he said. In his view firms that have always been modern, keen to show transparency and add shareholder value, are going to show strong growth and provide good opportunities.
'In new Japan, the balance sheet is very clean ' there is no debt,' Tateda said.
Tateda looks for companies that appeal to domestic-oriented demand. 'Because they will lead the Japanese economy for the next 10 years,' he said. Economists have been expecting reforms in corporate Japan for more than 10 years, and have always been disappointed.
But Tateda pointed out that changes have been happening, but to a larger extent in manoeuvrable small-cap stocks rather than the large-cap market.
The reforms promised by the new prime minister form the basis for much of Tateda's future confidence. Although details are sketchy, it is likely that there will be a shift of resources from the public to private spheres, including a move from an indirect financing system to a direct financing system.
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