Sparx Asset Management’s Japan long/short equity fund may be on the rebound after having lost money in 2006 and 2007. Three-year performance figures have improved and the firm is back on the road seeking to raise new assets.
The long/short strategy and related separate accounts now have $830 million of assets under management, well down from the 2006 peak of around $3 billion.
The fund manager is looking to raise assets back to $1.5 billion, which is the new capacity threshold following a restructuring completed in late 2007, says Shinji Naito, head of the institutional marketing team.
Performance problems in 2006 and 2007 led Sparx to re-assess portfolio construction and risk management. It has not changed its fundamental stock-picking process, but has learned to be more diversified. The result is improved performance, with more control over downside risk and higher gains from both long and short stock calls, versus Topix beta, over the past three years.
While the firm is now confident about its three-year track record and retooled investment process, the hard part is convincing investors to consider a Japan equities strategy.
Sparx argues the best way to approach Japanese equities is through a long/short fund, because the market has plenty of outdated laggards that make attractive shorts.
Japan is going through a gradual transition away from ‘old Japan’, export-orientated companies that benefited from the old Liberal Democrat Party nexus of bureaucrats and politicians, such as steel, autos, construction and consumer electronics. The economy is moving towards new areas of growth, including healthcare, domestic services, green tech and infrastructure -- an agenda supported by the ruling Democratic Party of Japan.
But this transition may be too slow for investors, and many of the more appealing companies are small and mid-sized, which therefore face liquidity issues.
Moreover, the macro story keeps getting in the way. This includes an expensive yen, a 20-year struggle against deflation and loss of competitiveness in traditional sectors to Asian competitors. Moreover, the inability of the DPJ to consolidate its political position, and the lingering problems of 50 years of LDP rule, are hobbling the transition to the ‘new Japan’ economy.
Naito argues that some of these negatives are overdone. In particular, Sparx data suggests the impact of a strong yen on earnings growth is less severe than widely believed. For domestic investors, equities may be more appealing because the dividend yield spread is positive versus government and corporate bonds.
Although investors would welcome more political clarity and some coordination of fiscal policy in respect of Bank of Japan actions to support ‘new Japan’ industries, there is at least the comforting thought that politics offers the chance of an upside surprise. The DPJ’s willingness last year to let Japan Airlines go bust was an encouraging sign that the new ruling party is willing to cut the support to sunset companies that was an LDP hallmark, adds Naito.
The long/short fund is generally long-biased, with a net exposure of zero to 60%. Today net exposure is around 15%. The fund manager uses shorts both to hedge big long bets, as well as to enhance alpha.
In the mid-2000s, Sparx’s managers got a little too carried away. They went net long as much as 80% and took highly concentrated bets, including on smaller-cap companies. This led to problems. In 2006, the fund lost -5.44% while the Topix rose 1.90%. In 2007, the fund lost -14.22%, while the Topix fell by only by -12.22%.
This led Sparx to boost its risk management capabilities, particularly with regard to portfolio construction. It now has a more diversified portfolio and limits on sectors and market cap, for example. The stock-picking process did not change, however, and Naito says the current two biggest holdings are in comfortably positive territory today, while the general market is down.
Performance has also improved. In 2008, the fund lost -4.32%, but this was the year when most hedge funds lost money and the Topix fell by -41.77%. In 2009, the fund made money, 3.59%, albeit below the Topix's gain of 5.63%. Year-to-date the fund is up 1.85%, versus the Topix decline of -6.40%.
From inception, the fund is up 40.07%, versus the Topix loss of -28.98%.