Denis Clough's Japan performance has had a tough time over the past 12 months. The frAAA-rated Schro...
Denis Clough's Japan performance has had a tough time over the past 12 months. The frAAA-rated Schroder Tokyo unit trust he runs was downgraded to frAA and over one year it was ranked 61 out of 76 with returns of 25.7%, on a bid to offer basis, compared to sector average returns of 36.3%.
Even so, in the short term things seem to be improving. Over three months, bid to bid, the fund is ranked five out of 77.
Clough, a director of Schroder Investment Management, is also manager of the Schroder Japan Growth investment trust.
He talks with Leo Bland about his investment management style going forward.
What is your background in fund management?
I joined Schroders in 1983 straight from university and I have always worked on the Japanese side.
I started as an analyst based in the UK and in 1987 I was seconded to Tokyo where I spent three years. I started in fund management in 1985 after taking over the Schroder Tokyo unit trust.
What are the arguments for investing in Japan?
For me, the most persuasive reason for investing in Japan is that we are at a very different stage of the profit cycle.
In other markets profits are very high but if you look at Japan on an ongoing basis what we see is that profitability is depressed and therefore the market follows suit.
The argument for investing in Japan is there is a potentially greater upside.
How many stocks do you run in Schroder Tokyo and Schroder Japan Growth and why?
There are about 90 stocks in the Tokyo fund and 74 in Japan Growth at the moment. There are more stocks in the Tokyo fund because it is a bigger fund.
In the case of Tokyo, which is a £750m portfolio, it is pretty diversified in its mid and small cap holdings for liquidity reasons. If the Tokyo fund was the same size as Japan Growth I would expect to hold a similar number of stocks in it.
How differently do you run Schroder Tokyo and Schroder Japan Growth?
Japan Growth is a bit more biased towards small and medium sized companies.
We already have a specialist smaller companies fund on the unit trust side but on the investment trust side we do not have the same sort of product.
We think the investment trust should have more of a bias towards small stocks to add more variety to our fund range. The only other difference is the ability to use gearing on Japan Growth.
How much do you plan to make use of gearing on Japan Growth?
The fund is currently 16% geared. We look at how much it is going to cost to borrow money and whether we believe we can make money from investing it.
The borrowing cost is currently around 1.5% and you do not have to be that optimistic about what is happening in Japan to want to gear.
We believe we can deliver more than 1.5% in returns from our investments in the fund.
What is your investment process on the two portfolios?
It is the same for both funds and we start with a lot of company visits. We have 17 analysts in Tokyo and they are doing much of the company visiting.
We also have another 13 fund managers split between London and Tokyo and I see around 150 companies a year.
The main input is our visits to companies and the views that we draw from that. We use company visits to help us make our long term earnings forecasts - we want strong earnings three years out.
When we are looking at taking a view on a company we look at five factors, which determine what sort of valuation we put on the business.
Firstly, there is the long term underlying growth of the company. Secondly, we look at the management's ability to run the business.
Thirdly, we examine the quality of the balance sheet for example the level of debt and also less obvious factors such as pension provision arrangements and whether there might be a large pension liability.
We then look at shareholder focus. A management team could be good at running the business but not care about shareholders. There have been a lot of companies in Japan which have run the business well but are not concerned about shareholders.
Finally, it is how confident we feel about our earnings forecasts. The more confident we feel, the higher we are prepared to rate the earnings. That is a key part of how we think, we are trying to look a long way out.
For some one may not be so confident because it is a cyclical business. We are trying to find businesses that can give us confidence about the long term, companies where if we could not change the portfolio for three to four years we would still be relaxed.
The analysts know they have got to answer these questions and this feeds directly into giving us a way of saying that a stock is cheap or expensive.
Schroder Tokyo underperformed its peer group last year and has been downgraded by Standard & Poor's to frAA, what do you put this down to? What changes have you made in the portfolio to address this?
Last year was an awful year for the Tokyo fund - it was probably the first really bad year. There are two things we have learnt from this.
One is that we have learnt not to be as quick on profit taking on businesses that we like. One of the key mistakes we made last year was the good technology companies that we held we cut back on much too early in 1999.
I do not think that we paid enough attention to the international developments in terms of the valuations of technology stocks and more importantly the earnings momentum that was developing.
On the other hand I think that towards the end of the year, after a lot of fierce discussion, we came to the view that we would continue to position the fund in the same way it was positioned and that it was the wrong time to change.
We have been correctly positioned in 2000 and that has benefited the performance this year.
The one clear lesson was that we were not paying attention to global trends in terms of earnings.
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