Fund in focus: Baillie Gifford Shin Nippon looks to disruptive shares for big returns

Bottom-up research is the key to the Japan trust’s stellar returns. Manager Praveen Kumar explains why he focuses on entrepreneurial risk-takers.

Praveen Kumar likes investing in businesses run by young, dynamic, entrepreneurial risk-takers. He looks for fast-growing companies that are disrupting their industries.

Japan, you might think, is not an obvious hunting-ground for firms with these characteristics. The country has gained a reputation for poor corporate governance, decades of deflation, and notoriously cautious savers who are unwilling to put their money in the stock market. It is not known as a nation of risk-takers.

‘Those assumptions are just intellectual laziness,’ Kumar insists. ‘Japan is not the basket case that people make out: it is a country with a phenomenal standard of living, one of the highest life expectancies in the world, the most Michelin-starred restaurants, one of the world’s best transport systems, where the people are content. The armchair critics who say otherwise have probably never set foot in the country.’

 

Japan: the curveball option?

Certainly, performance figures seem to back up his view. At the start of every year, when fund pundits are making their forecasts, Japan is frequently touted as the curveball option for a region that might finally start to shine. Yet, if you look at the top-performing fund lists over recent years, they are littered with Japan funds. Baillie Gifford Shin Nippon itself has returned an incredible 225 per cent over the past five years.

Of course, Kumar has only been at the helm himself for three years. It’s a position which he admits ‘left big boots to fill’ with predecessors including John MacDougall and Sarah Whitley.

While he is a wholehearted subscriber to the Baillie Gifford mentality of focusing on the long term and ignoring macro problems, he is also putting his own stamp on the 33-year-old trust. Kumar has convinced the board to let him move further down the market cap spectrum from the smaller companies the trust has traditionally focused on, and to start introducing unlisted firms. He says: ‘I drove the idea to invest in unlisted companies. I saw evidence to suggest things were changing in Japan in that space, and I wanted to be ahead of that curve rather than wait for it to develop.’

Currently there is just one private company in the portfolio. Moneytree is an artificial intelligence platform, which creates a full financial profile of people to help banks and financial institutions determine which products they should recommend to customers. He invested in the firm 18 months ago and so far things are going well, with monthly sales growing by around 70 per cent. But it’s a tiny portion of assets, at just 0.2 per cent of the portfolio. Companies have to be run past the board for approval, but Kumar says it’s a new area and he ‘can understand their cautiousness’.

Entrepreneurialism is at the heart of Kumar’s ethos, and he wants Japan to recapture that spirit. ‘It was historically an entrepreneurial country. Hitachi, Sony: people forget that these businesses were founded by individuals.’ He believes a batch of recent successes has inspired a new generation of start-up businesses, chief among them e-commerce company Rakuten, a Japanese equivalent of Amazon whose market capitalisation has reached almost £8 billion.

But finding these stars of tomorrow requires a lot of legwork. Each member of the nine-strong Japan team at Baillie Gifford visits the country at least once a year. Kumar himself is heading there imminently (October) for an extended six-week trip, in which he will visit more than 60 companies as well as seeing ‘what’s happening on the ground’.

It’s no real surprise that the focus on dynamic, disruptive businesses tends to lead Kumar to tech companies, with a third of the trust’s assets invested in the sector. But it’s not their technological prowess which attracts him to these businesses, so much as their ability to solve a specific problem.

He explains: ‘I’m not sure many of these companies are actually tech firms. We invest in a business which is the Japanese equivalent of [fast food delivery app] Just Eat. Is that a tech company? Tech to me is Google; I think of these businesses more as service providers.’

Another example in the portfolio is an app that helps car garages compare the price of parts and track their delivery; while Start Today is an online fashion retailer, similar to the UK’s Asos. ‘These are companies that have found an inefficiency in the system and are using the internet to solve it,’ he adds.

Private companies are difficult to analyse – in Japan or anywhere else

Dealing with private companies can be difficult anywhere – unlisted companies don’t have any obligation to disclose information, and when they do they can be selective, which can make it difficult to get a full picture of the company and how it is developing. But Japan in particular has garnered something of a reputation as a difficult place in which to do business in this respect.

Kumar says going through the reports and accounts of unquoted firms in the country has its risks – primarily the danger of mistranslation (he doesn’t speak the language) – but insists doing business in the region is no different from anywhere else.

‘I think as long as you take a gentle approach, rather than aggressively taking over a meeting, it makes management feel more comfortable,’ he explains. ‘The most important thing is building a relationship so they feel that they can trust you. At that point, disclosure and engagement improves considerably.’ He also favours young, entrepreneurial management, often people who have studied or worked overseas. It means they are more willing to take risk, which has historically been frowned upon in Japan.

One aspect he did have to adjust to when he first started investing in the region was the lack of information. When you invest in huge, international businesses in the UK and US, details are available at the touch of a button. A small Japanese company, on the other hand, might not even have a website, let alone one with an English translation and a readily available archive of reports.

That means more conference calls and meetings are required to get a feel for businesses. But this, he says, is where the opportunity lies. ‘A lot of people are not willing to spend time on research – they want the information to come to them,’ Kumar explains. ‘But if you are patient and willing to go and meet a smaller company in Japan and do some genuine kicking of the tyres, the company appreciates it, and you can add phenomenal value as an investor.

Improved corporate governance

One of the more recent attractions of Japanese stocks is that improvements in corporate governance means more companies are rewarding shareholders with dividends. While that’s a positive trend generally, Kumar would prefer the companies he invests in not to pay out their profits: ‘We are backing fast-growing companies, so we would prefer they reinvest any money back into their business so they can grow.’

This focus on growth also means Kumar doesn’t have to consider macro issues beyond his control. While many investors might fret about the potential impact of trade tariffs or natural disasters on the region, he thinks any short-term share price falls are merely an opportunity to top up his holdings. One he has recently been adding to is Harmonic Drive, a company which makes a part that controls the precision with which a robot’s arm moves. It has almost a 50 per cent share of its market globally, but worries about a slowing of demand from China have pushed shares out of favour.

Kumar says: ‘People are too worried about the short term when this is undeniably a long-term theme. The pool of opportunities among Japanese smaller companies has definitely been growing over the past decade, and those who take the time to look will see the potential.’

Kumar in six

1) My best investment was… Bengo4. Com. It’s an online service that connects lawyers with people who need legal advice, which has historically been hard to find. I like that the founder is a lawyer himself and owns a big part of the company.

2) My worst investment and the lesson it taught me was… Oisix, which is a bit like ingredients delivery firm Hello Fresh. I sold it because the management drastically changed its strategy from digital-only and started opening stores. Since then shares are up three or four times. This has taught me to be more patient, as sometimes it can take a while for things to play out.

3) My alternative career would be… I’m quite an unusual hire for Baillie Gifford, which usually recruits people from university. Previously I was a management consultant and before that a software developer, so I would probably still be doing that.

4) In my spare time… I play cricket for a local club and spend time with my four-year-old son.

5) One thing I would like to change in financial services is… for there to be more humility. Investment success can easily go to your head and it is overconfidence and arrogance that leads to harmful events such as Lehman’s collapse.

6) Do you invest in the trust? Yes, both through my pension and via some of my other savings.

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