is Head of Japanese Equities at Aberdeen Asset Management Asia
Ltd. and runs the Aberdeen Japan Absolute Return Fund, a Japan
only equity long/short hedge fund which launched in October
2002. Aberdeen Asia runs approximately US $5 billion in long
only assets. It is based in Singapore. Mr. Sinclair wrote the
following article on the Japanese markets and the Aberdeen Japan
Absolute Return Fund.
"Now, news of a massive stock market fall", announced
the BBC, one cheerless morning. "Not Tokyo", I whispered
to myself under the bedclothes. "Over to Tokyo where
the stock market closed down another six percent
That was in November 1993. Since then the Japanese market
has certainly provided challenging work for fund managers.
A series of economic recessions and political scandals, falling
stock, real estate and land prices, deflation, a volatile
currency and a technology boom and bust, have ensured the
main indices have mainly moved in one direction: down.
Still, portfolio managers have been able to generate positive
returns in Japan over this period through effective stock
picking. But these gains have come despite policymakers' disagreement
- and thus collective inertia - over how to address the country's
underlying economic problems.
The measure of that failure is huge. Whole areas of the economy
are dominated by the living dead - companies that survive
because of zero interest rates and the indulgence of banks.
Businesses are refusing radical restructuring, banks' bad
loan problems remain largely unresolved and the economy appears
likely to remain weak. Consequently, making money in Japan
for the foreseeable future will, on the whole, continue to
be about individual stock ideas, both good and bad.
To capitalise on this, in October 2002 Aberdeen Asset Management
launched the group's first long/short fund, the Aberdeen Japan
Absolute Return Fund. The fund's long position provides exposure
to leading global businesses such as Honda, Canon and Kao
Corporation, which are shareholder-friendly, and should continue
to enjoy strong profit growth. On the short side, we aim to
take advantage of ongoing structural changes. Specifically,
we are short stocks: a) that are under threat from increased
competition in China; b) that have been heavily exposed to
the bad loan problems in the banking sector; c) whose product
range is becoming obsolete; and d) whose share price simply
appears overvalued relative to the prospects for future profits
In addition, there are opportunities to arbitrage mis-pricings
between the underlying equity, CBs and ADRs. At present, the
range of the fund's net exposure is -20% to +50% and the gross
exposure 60% to 150%.
Operationally, the management of the portfolio has gone very
smoothly. A lot of time was spent prior to launch planning
the new procedures that would be required, and this has paid
off. In addition, the Japanese market is fairly accommodating
for long/short funds in that borrowing stock is relatively
easy and inexpensive, the market is diversified in terms of
industrial sectors and liquidity is not a major issue. The
performance of the fund has been respectable, a gain of 70
bps over the four months to the end of January, in a falling
market. This puts it in the middle of its peer group.
We visit over 200 companies a year, which provides a platform
for short stock ideas. One example is Aeon Credit, the financial
services business. When we last met its management we had
an open mind about future prospects, thinking the stock could
be a candidate for either the long or the short portfolio.
We soon concluded that its valuation was excessive given difficult
business conditions. Also, most of its operating profit comes
from cash advances, similar to consumer finance companies.
Yet while Aeon's customer base is of higher quality, it doesn't
seem to justify a 50% plus valuation premium to the consumer
finance sector. A short position was established at Y4000
and closed out a few weeks later when the stock price hit
our target of Y3200.
Our experience with Aeon is illustrative in another way.
Contrary to the widespread criticism that long-only managers
lack the skills to successfully gain alpha on the short side,
short selling has posed few problems for us. The bigger challenge
we have faced is in the constant need to generate new short
ideas. Many of the best ones are in the unfashionable and
structurally unattractive industries that as long only managers
we have had the luxury of ignoring for many years. For example,
we have included airlines, textiles, land transport and real
estate on our "radar screens" in order to develop
a proper understanding of the valuations and relative strengths
and weaknesses of stocks within each of these sectors. We
have made good progress in our coverage, but to be thorough
takes time. We will continue to develop this aspect of the