Alphex Investments Company Limited is the advisor to the Arlington Alphex Japan Fund, a non-benchmark, absolute return fund focused on Japanese public equities across all market capitalisations.

1. Can you discuss the Arlington Alphex Japan Fund and the background of the research team at Alphex Investments?

   The Arlington Alphex Japan Fund was launched on 4 April this year with just over US$7 million. The fund is advised by Alphex Investments in Tokyo and managed by Arlington Capital Management in Singapore.

   Alphex Investments is a five-person team headed by CIO Ichiro Takamatsu and myself as CEO and risk manager. We co-founded Alphex Investments in 2004, having previously worked together for seven years at CIGNA International Investment in Tokyo, where Takamatsu-san was head of equity investments and I was head of investments.

   We currently advise on a total of US$45 million in both long/short and absolute return Japanese equity funds.
   
   Takamatsu-san is supported by two research analysts, Sanae Saga and Koki Okahashi. Okahashi-san covers the automobile and raw material sectors. Saga-san looks after retail, food and services. Takamatsu-san covers electronics, financials and the remaining other sectors.

2. Can you discuss your investment process and how it gives you a competitive advantage in Japan's current market conditions?

   We take a bottom-up, fundamental approach in a search for both value and growth companies trading at compelling valuations. We believe the investment story today in Japan is one where there is sustainable economic improvement led by the domestic sector. But underneath this improvement, there is a growing divergence between successful and losing companies.

   In order to have an investment edge in this environment, one must have a deep and experienced investment team that spends its time meeting with companies, trying to find those successful ones that are trading at good valuations and where we also have an informational edge.

   And these successful companies may not be only the large caps that are extensively covered by the brokerage community. We believe that you have to cover all market capitalisations; and being Japanese nationals with local expertise gives us a competitive advantage, especially for the mid and small caps.

   Finally, Japanese equities can be extremely volatile at times; and one needs to be active in trimming positions or placing index hedges when portfolio holdings run past their fair value. We will aggressively move our net exposure depending on the market conditions; and believe our edge in this respect comes from Takamatsu-san's trading experience shown from his track record at CIGNA and Alphex Investments.

3. What is your firm's outlook on the Japanese economy and markets for the next 12 months?

   Generally, we are positive on the Japanese economy and markets. We are expecting market returns over the 12 months to be around 15%, consistent with the earnings improvements we are going to see from Japanese corporations.

   We think that the Japanese economy has already entered into a self-sustainable economic expansion, predominantly led by the recovery in domestic sectors.

   
   From market supply/demand factors, we would like to see more domestic investors shift their allocations to Japanese equities. This potential shift also supports our positive view on the markets. However, we don't believe the rise will be as sharp as what we saw last year.

4. Will that increase in allocations be coming from Japanese institutions?

   We believe in the coming months we're going to see Japanese financial institutions shifting from being net sellers to net buyers.

5. It appears that the re-flation story in Japan is well known with year-on-year CPI and real estate numbers both positive. Is there more room for the financial and real estate sectors to run?

   I think going forward it is not going to be a free play like it was, where every name in the real estate and financial sectors outperformed because they were beneficiaries of the re-flation story. We are going to see some mixed results in both sectors going forward. We will need to focus on individual companies' quality of earnings and expected rate of changes.

6. Will this environment favour the regional or city banks?

   The city banks have gone through a very difficult period of streamlining their businesses with large mergers and system integrations, as well as writing down their non-performing loans.

   Given this, we think the large city banks are in a position to capture any forward momentum we see in loan growth and improvement in interest rate margins.

7. Do you feel real estate prices this year will begin to rise outside of the three largest cities - Tokyo, Osaka and Nagoya?

   Nagoya in particular has seen property values in the commercial area rise, having benefited from the Toyota group. The areas outside these three cities are still lagging. I think we will see a gradual spillover improvement led by the prime properties supported by strong demand from both domestic and foreign real estate funds.

8. How is the fund playing the real estate sector?

   We were early enough last year to participate in the rise of the real estate and construction stocks; we still like the sector in general but are less excited than before which calls for more selective individual stock-picking going forward.

9. What effect will possible rate rises from the Bank of Japan (BoJ) later this year have on Japanese equities?

   The BoJ's intention is to step up on its first move towards normalisation in monetary policy. I think the next move will be to inch up short-term interest rates. Our belief is that they will do one rate hike around the third quarter this year. The forward curve on the money market futures is implying two rate increases, which we believe is too excessive.

   We expect that the Japanese fundamentals are in a sound position to absorb any negative impact from rising interest rates. In fact, expectations for rate hikes may spark front loading of capital and housing investments, contributing to GDP growth.

10. What effect will the transition to a new Prime Minister in September have on reforms?

    Our view is that we are not likely to see any significant changes in the speed of reforms whoever the successor is. I think Prime Minister Koizumi has pushed hard for structural, economic reforms which are well appraised by the markets but on the other hand have resulted in unintended divergence between winners and losers at the corporate and household level.

    However, if the successor does move backwards on reforms, then markets would take it as a sign of retreat and be disappointed.

Contact details
Hiroki Itoh
Alphex Investments Co Ltd
+81 3 5776 7281
hiroki.itoh@alphex.co.jp