For the first half of 2022, the
Matthews Japan Fund (Trades, Portfolio) returned -29.15% (Investor Class) and -29.10% (Institutional Class), while its benchmark, the MSCI Japan Index, returned – 20.10% over the same period. For the quarter ending June 30, 2022, the Fund returned -15.50% (Investor category) and -15.46% (Institutional category), while the benchmark returned -14.60%.
Japanese stock markets for the first half of 2022 were dominated by two of the biggest moves in decades. The Japanese currency reached 135 yen against the US dollar towards the end of the second quarter, a level last seen in early 2002 and the biggest movement between currencies since the early 1990s. by the US Federal Reserve and the dovish stance of the Bank of Japan translate into a widening of the bond yield differential between the US and Japan. High energy prices are also adding pressure on the yen, as Japan’s energy self-sufficiency rate remains one of the lowest among Organization for Economic Co-operation and Development (OECD) countries. Due to the weakening yen, Japanese equity markets traded in line with their global developed market peers in US dollar terms, despite outperforming in local currency.
Second, the speed at which the performance gap between value stocks and growth stocks has widened has been the fastest in two decades. In the first quarter, the spread was 1,556 basis points (15.56%), and in the second quarter it widened further by 730 basis points (7.30%). While this performance gap between value and growth is visible around the world, it is particularly large in Japan. In the first quarter, it was more of a rate hike leading to a multiple stock squeeze on growth stocks, while the second quarter was dominated by fears that multiple rate hikes to contain inflation would cause fall the world economy into a recession.
Performance contributors and detractors:
The first six months of the year were an amplified version of the first three months of 2021, as our focus on high-quality growth continued to suffer from a surge in US 10-year bond yields. From a sector perspective, stock selections in the key areas of information technology and industrials were the main detractors from the portfolio’s relative performance in the first half of the year. Industries were particularly hard hit due to the inclusion of commodity-price sensitive trading companies and cyclical transportation firms, businesses that have been challenged by soaring fuel prices and disruption of the Supply Chain. On the other hand, our overweight and stock selection in consumer staples were the main contributors to relative performance in the first six months.
From a market capitalization perspective, our overweight to small caps, those under $3 billion, also detracted from performance in the first half. Our underweight and stock selection in mega-caps and our overweight and stock selection in mid-cap companies were also significant detractors.
As for the individual titles, Shin-Etsu Chemical (EAST: 4063, financial) and Tokyo Electron (EAST: 8035, Financial) were among the biggest detractors in the first half. Shin-Etsu Chemical is a leading global supplier of electronic materials (silicon wafers) and PVC (polyvinyl chloride), but its trading multiple has compressed sharply amid signs of slowing state housing starts. -United. Tokyo Electron, Japan’s largest supplier of semiconductor production equipment, was hit by concerns over falling demand for consumer electronics and rising semiconductor inventories.
On the positive side, the pharmaceutical company Daiichi Sankyo (EAST: 4568, Financial) was one of the main contributors, after publishing a positive result from the DESTINY-Breast04 (DB04) trial for the anti-cancer agent Enhertu, as announced by the American Society of Clinical Oncology (ASCO) in June. P&C insurance company Tokio Marine Holdings (EAST: 8766, Financial) was also one of the main contributors in the period. Annual results for March 2022 and forecasts for March 2023 on our investment thesis. We consider the stock to offer a mid-teens compound annual growth rate (CAGR) of dividends coupled with earnings per share (EPS) growth driven by both earnings and buybacks.
Notable portfolio changes:
An important adjustment within our portfolio is the increase in defensive sectors such as consumer staples. While we continue to see a recovery in economic growth as the world recovers from the pandemic, the continued uncertainty over the war in Ukraine, coupled with inflation risks and rising interest rates, justifies our view a more balanced approach to growth. We have also reduced our portfolio weighting in areas of cyclical growth as the global manufacturing PMI is beginning to peak and rate hikes to manage inflation pose recession risks.
In the second quarter, we reset a position in Tokio Marine Holdings. We’ve always viewed the company as a cautious allocator of capital, with its lucrative domestic damages business among the top three players controlling 90% of the auto insurance market. The company is also expanding its presence in insurance specializing in foreign mergers and acquisitions.
We initiated a position in Mazda Motor (EAST: 7261, Financial), as our research suggests that 2022 is a key launch year for the company’s next-generation products and the company is at a turning point in profitability.
We also added Toho (EAST: 9602, Financial), a motion picture producer and distributor in Japan, while we remain bullish on its movie division’s earnings recovery and longer term, we strongly appreciate Toho’s untapped potential in monetizing its core IP assets. .
In order to make positions for new names, we left AGC (EAST: 5201, Financial), Kadokawa (TSE;9468), Koito Manufacturing (EAST: 7276, Financial), Morinaga Milk Industry (TSE:2264), NTT Data (TSE:9613), Persol Holdings (TSE:2181), Raksul (TSE:4384) and Sumitomo Bakelite (TSE:4203).
The first half of 2022 has proven to be a much worse external environment for high-quality growth strategies, even compared to the first three months of 2021. The speed of widening growth-to-value gaps has made it difficult to rapid adaptation of our strategy. With the extremely loose monetary policy of all major central banks ended and the Federal Reserve officially beginning to tighten, the long value/short growth trade is now fully relaxed at pre-pandemic levels. and valuations of some growth names are well below pre-pandemic levels. That said, annual earnings results in May showed that Japanese growth stocks continued to improve their margins and strengthen their cash-generating capabilities.
So, while we take a more balanced view of growth stages and valuation levels, we believe that the earnings power of Japanese companies has improved significantly over the past economic cycle. This has been facilitated by improvements in productivity, better corporate governance, innovation and a greater focus on capital efficiency.
Japan has yet to open its borders like other developed countries did coming out of the pandemic, but once it does, it will provide a tailwind to the economy. As the Federal Reserve continues to tighten and tries to stage a soft landing for the world’s largest economy, tough times lie ahead. But we believe that Japan’s flexible domestic monetary environment, as well as the strong fundamentals and profitability of its companies, will provide good investment opportunities.
View the Fund’s Top 10 Holdings as of June 30, 2022. Current and future holdings are subject to change and risk.
Average annual total returns – MJFOX as of 06/30/2022