The Jade Japan Fund was launched in June 2000 and is managed by Dominic McEwan, who joined Jade in May 2001. He has over 15 years' experience in the Japanese markets, most recently as a director of Bonfield Asset Management, where he was one of the inaugurators of its Japanese funds. Prior to Bonfield, Mr. McEwan was head of Japanese equities at Commerzbank and a senior vice president at Jefferies International.
The Jade Japan Fund is a long/short Japanese equities hedge fund. Security selection is based on both bottom-up and top-down fundamental analysis. The Fund was -1.1% for 2002 and estimated to be +0.5% for January 2003.
Interview with Dominic McEwan
- What are the current plans to raise the assets under management which are currently at US$10m?
Today we have officially launched a Yen class for the fund. This class will be subscribed for, redeemed in and priced in Yen. Subscriptions for this class begin at the end of January and have already attracted around $1.5 million dollars worth of new money. We believe that this class will be attractive to investors who are ultimately Asian domiciled. This is a geographic area which until now has remained largely untapped by us; recent published reports suggest that there is $5 trillion worth of assets held by Asian high-net-worth investors and this is likely to increase to around $7.5 trillion by 2006. In addition, it would appear that the Asians have an increasing appetite for hedge fund products, having become very jaundiced by continued stock market declines and almost zero interest rates (in Japan).
- Did the collapse of the $300m Eifuku Japan long/short hedge fund in early January have any effect on your portfolio?
No noticeable effect observed. Reading the news items associated with this collapse there are two main points concerned with the wind-up. Firstly it would appear that they were running a highly leveraged, position focused strategy which went wrong. We run a strategy which is diametrically opposite to this, that is an un-leveraged and diversified portfolio. Secondly, the names mentioned in which they were running big positions were: Sega, NTT and NTT DoCoMo. Jade Japan did not have positions in any of these names at the time of the collapse.
The Fund had its worst two months during September and October 2002 (combined -5.4%) since its launch in June 2000. What went wrong during those months and have you changed the Fund's risk controls because of the drawdown?
We took the September 19th announcement by the Bank of Japan (BoJ) to purchase shares from Japanese banks' portfolios as a positive step forward in the battle to combat the problems in the Japanese banking system. Many have argued in the past that it was the BoJ that caused the "bubble" economy and it was the BoJ that eventually burst the "bubble", and so now perhaps it would make sense for the BoJ to help solve the problem caused by the bursting of the bubble. Furthermore, when Mr. Yanagisawa, (who would have been opposed to such actions by the BoJ) was replaced by Mr. Takenaka as Minister for Financial Services, it further strengthened our belief that this was a positive move.
In years to come this may be seen as the "turning-point" but as is often the case these inflection points are at first misunderstood (or it may just be another false dawn). Worries about what this all meant, and the prevarication in making a coherent policy statement caused some US and European long only funds to throw in the towel, and they aggressively sold off their Japanese holdings. This kind of capitulation selling pays no attention to fundamental valuation, cheap stocks became cheaper. It was, not surprisingly then that our long positions caused the majority of the poor returns over this period; running slightly net longer overall positions (40% instead of 15 to 20%) also exacerbated the problem. At the same time stock prices were experiencing very quick reversion periods, as the fund tends to have a low turnover this also didn't help.
After the analysis of what had occurred was completed, it was decided that improved sentiment indicators were needed to better understand current market conditions. This now means that we are less likely to be fooled into false rallies and in determining the "quality" of the market means that one is more likely to get out of the way of "capitulation" selling. Furthermore in identifying, at the time, whether a market is better suited to a trader or a fundamental investor, we can adjust our levels of turnover to fit the prevailing conditions.
It is worth noting here, that the 6.6% annualized standard deviation for the fund since launch shows that the Jade Japan Fund has one of the lowest volatilities for a long/short fund in its peer group.
What investments went well in 2002?
The biggest winners were on the short side; gains here included short positions taken out in May on Nikon, Sanyo Electric and Sharp, all of these were closed in the last quarter of the year. Although it was harder to make money on the long side of the portfolio, we were pleased with good gains in UFJ in early February and again in early May and our handling of Fanuc where we were long from late January to early March capturing a 38% gain in the price, and then short from late April until early August capturing a 23% decline in the share price.
- As a manager who focuses on the most liquid names of the market, has there been a decrease of liquidity in Japan over the past 12 months? Has the change affected your investment style?
If one looks at the daily value of turnover, rather than share turnover, of the Tokyo exchange, over the last year, there was only a fall off from the late summer, and this has mainly reversed now. As stated in your question we concentrate on the more liquid names and because of this there was no easily recognizable impact felt on investment decisions. However, turnover is always important which is why hedge fund managers close their funds to new investment at significantly lower sizes than traditional long only managers; we feel that unless there was a marked increase in volumes then the fund could be run without any style change up to around $300 million.
What has market volatility been like over the past few weeks?
Up until the week beginning 27th January, the volatility has been reasonably normal since the start of the year. Large, unexplained movements in share prices with fast reversion periods, as observed in the last quarter of 2002, have not up until now been seen in such abundance. This makes position selection more fundamentally value based and thus Alpha should be easier to capture.
- Are you finding enough companies with strong balance sheets and free cash flow to keep you excited about Japan at the micro-economic level?
Corporate Japan is continuing to rationalize its businesses. Companies have been concentrating their efforts in growing their profits rather than their sales. This has meant that unprofitable, non-core businesses have been sold on or shut down and because of this free-cash-flow generation has become more rather than less evident. Free-cash-flow is important for highly indebted companies as it allows them to pay down debt, but also a significant number of Japanese companies have net cash rather than net debt on their balance sheets. This has allowed a vast number to embark upon share buy-back programs, adding value to companies where share prices have fallen too low. Opportunities appear when share prices get sold off or bought aggressively, but do not adequately reflect the valuations on a historic or peer group comparison.
- It appears that government-induced market rallies have become a yearly occurrence coming into the end of March (fiscal year-end for many Japanese companies). Do you think it will occur again this year; if so, in what form?
A certainty only ceases to be a certainty when it no longer occurs; this frequently is the case when the vast majority of participants believe it is a certainty. If there is to be a government-induced rally it will probably coincide with the announcement of the new Governor of the Bank of Japan.
- Ordinarily, hedge funds have bought back short-sales in Japan ahead of the 3rd week in March, which is the deadline for returning borrowed stock. This year it appears that hedge funds had already begun to actively close their short positions by mid January. Has this indeed occurred; if so, what are the reasons?
There is a classification of "callable" or "non-callable" on stock borrowing, only callable has to be returned prior to the year or half-year book closing points. The continued depression of the stock market may have something to do with the earlier closing of short positions. There has only been one time since the market opened post the Second World War when the Japanese market has been down four years in a row, which was from the end of 1960 to the end of 1964. The total decline during this period was just under 17%. The decline we have suffered in the last three years is around 51%, this compares to the decline seen in the three years after the peak of the bubble (years 1990, 1991 and 1992) of around 54.5%.
- Who do you see as replacing Mr. Hayami as the new Bank of Japan Governor; and will this person take an active approach in re-flating the economy?
The Japanese political system is as opaque as it has always been, therefore it is not prudent of me to forecast who will be appointed the next governor of the Bank of Japan. However if Moody's Credit Rating Agency is to be believed then an inflation-targeting governor may have "positive longer-term implications for the country's credit ratings" and therefore could only be perceived as a short-term positive.