LEI: 213800JOFEGZJYS21P75

22 September 2022

Nippon Active Value Fund plc

HALF-YEARLY REPORT

FOR THE SIX MONTH PERIOD ENDED 30 JUNE 2022

 

CHAIR'S STATEMENT

Performance

I am pleased to present the third half-yearly report ("Half-yearly Report") for Nippon Active Value Fund plc ("NAVF" or the "Company"), covering the period from 1 January 2022 to 30 June 2022.

This was an exceptionally difficult period for all markets, which corrected in the face of increased geopolitical risk, the disruption to commodity supplies, largely related to the war in Ukraine, as well as a sharp rise in inflation forecasts.  The US dollar strengthened against most currencies and the yen was particularly weak, falling by 17.9% against the US dollar and 6.1% against sterling over the reporting period.

Between the end of 2021 and 30^th June 2022 the total return of the Company's net asset value in sterling terms was -10.9%, while the share price total return fell by 20.7%, reflecting a widening in the discount from 2.8% to 13.7%. For comparison, the MSCI Japan Small Cap Index in sterling terms fell by 8.7% over the same period. The Company's policy is not to hedge the currency; the rationale for this is discussed in detail in the Investment Adviser's report which follows.

Since the end of June 2022, the Company's NAV has risen by 8.9% (as of 20 September 2022) while the discount to share price has narrowed slightly to 11.9%.

Rising Sun Management, our Investment Adviser, benefits greatly from the resources of its colleagues and research affiliates who are based in Tokyo. In May, members of RSM based outside Japan were also able to visit Japan in person for the first time since the launch of the Company. The results of those and earlier 'virtual' meetings, as well as details of their activity in a very productive and active AGM season, are included in the Investment Adviser's report. That report also summarises the fundamentals of the portfolio, which confirms the exceptional value offered by their target universe.

Dividend

The Company's intention is to achieve its returns primarily through capital appreciation. As such, no specific dividend policy has been established and any distributions will be made entirely at the discretion of the Board, taking into consideration the requirement to ensure the Company's compliance with the rules relating to investment trusts. The Board has decided not to declare an interim dividend for the half year ended 30 June 2022.

Co-investments

In June, the Company announced that it had reached an agreement with RSM and Dalton Investments which enables both NAVF and Dalton to invest in securities already held in the other's portfolio subject to the ratification of the NAVF Board. This is in addition to agreements with two other investment vehicles advised by RSM. As a result, NAVF is able to include slightly larger companies in their universe, given the greater impact of the combined holdings. At the end of June there were 22 holdings in the NAVF portfolio that were jointly held with Dalton and/or the two Special Purpose Vehicles. 

Gearing

The Company has arranged a borrowing facility of £30 million to provide the Investment Adviser with flexibility to gear the portfolio when appropriate.  At the 30 June 2022, the portfolio held 6.8% in cash and as of 20 September 2022 is approximately 14.713% net cash.

Outlook

The Company's strategy is to invest in a small number of deeply undervalued companies where there is a strong potential for engagement with management to improve returns to shareholders through, for example, higher dividend pay-outs or share buy backs. Over time, we expect that performance to be less correlated to the broad Japanese stock market and economy than more traditional equity funds. We have been encouraged by the increase in corporate activity and shareholder engagement in the first half of the year, and in particular the greater participation of domestic investors. According to the Daiwa Institute of Research activists submitted proposals to a record number of company AGMs this year, and while the majority of proposals were from foreign investors, domestic institutions are increasingly supportive.

The RSM team continues to identify a number of potential investment opportunities and is encouraged by the responsiveness of many, if not all, of the companies they engage with.  Despite the disappointing start to the year, we remain confident of the prospects for the rest of the year and beyond.

Rosemary Morgan

Chair

21 September 2022

INVESTMENT ADVISER'S REPORT

For the half-year ended 30 June 2022

Performance of the Company for 2020, 2021 and Q1, Q2 and YTD 2022: 

Russia's war on Ukraine and its attendant effect on energy prices in Europe and food supplies around the world have exacerbated concerns over growing global inflation and caused dramatically weaker stock markets everywhere. The calendar year-end 2021 marked the highpoint of the multi-year bull market with share prices in all markets beginning this year in full-scale retreat, none more so than those listed on Japan's already ridiculously cheap exchanges. The last month and a half have witnessed the cautious start of a recovery, but this cannot be described as confident - as I write this (12^th August 2022), the jury is still out on the medium-term direction of investment flows.

Ascribing the relatively disappointing performance of NAVF in the first half of 2022 to jittery stock markets worldwide would be misleading - they were not even the most significant factor! NAVF is a sterling denominated fund that does not hedge the underlying currency of its yen investments. The pronounced decline in the Yen's value against the pound, itself weakening substantially against a dollar reinforced in its role as the world's reserve currency, cost the Company almost 15% of total return performance by the end of April. This has started to moderate slightly in the last two months. Measured in purely Yen terms, the cumulative return of the Company since inception was +50.5%. This had declined to 36.6% by the end of April 2022 but had recovered to 48.2% on 31^st July. In sterling terms, the equivalent performance of the Company's NAV, as reported daily to the London Stock Exchange, for the same dates was: 37.9%, 17.9% and 30.2%. As of the date of writing (12^th August 2022) this has improved further to 34.0%.

Several investors have asked whether we harbour any plans to introduce hedging now. The answer is no. NAVF was conceived as an unhedged vehicle, which is what the prospectus provides for. Our focus is on identifying undervalued companies whose managements are likely to respond to our arguments for improving returns to all shareholders. We are not foreign exchange specialists or better market timers than anyone else and do not want to increase our shareholders' risk through poorly timed macroeconomic decisions.  

Portfolio Composition

We have continued to divest from FEFTA Category 3 companies (the Foreign Exchange and Foreign Trade Act category which imposes the most restrictions on foreign shareholders). These included Soda Nikka, Teikoku Electric and Nihon Kagaku Sangyo, as well as selected other positions we felt would not contribute to overall returns. For example, the sale of Hirano Tecseed, and DKK Toa have been completed. At the same time, we have continued to add to our positions in Ihara Science, Meiko Transport and Meisei Industry.

This Golden Week AGM season, we sent shareholder proposals to eleven companies:

Predictably, all the recipients of our proposals (essentially the same: to grant meaningful allocations of restricted stock to management, not just directors, and to undertake a 10% buyback over the next year), rejected them formally. Nevertheless, six companies subsequently responded with actions of their own (as discussed below). As a result, and at their request, we were happy to withdraw our proposals before the AGMs. As noted below, our willingness to acknowledge the efforts they had made, allowed for noticeably more constructive meetings with senior management when we were finally able to meet them in person on our recent trip to Japan.

·      Mitsuboshi Belting

o  The company announced its intention to pay Y220 per share divided over two years, and a 100% dividend pay-out ratio, with a target to improve ROE to 8%

o  The shares were trading around Y2,000 per share at the time of the announcement, which equates to a 11% dividend yield, making it one of the highest dividend yields in the market

o  As a result of these initiatives, the shares have rallied more than 56% since the announcement to close at Y3,125 today

o  Given the shares are still relatively high yielding, we believe there may be further upside

o  As a gesture of goodwill and to congratulate the Company on its initiative, we were happy to withdraw our proposals and remain invested

·      Teikoku Electric

o  The company announced a 100% pay-out ratio (50% pay-out in dividends and 50% in share buybacks) starting next financial year

o  Although we were again happy to withdraw our proposals, we had already taken the decision to start selling down our holdings of this Category 3 company (see above)

o  Following their announcement, we suspended sales and, given we still own 3.3% of outstanding, we have enjoyed the roughly 17% bounce in the stock

·    Chiyoda Integre

o  The Company announced indifferent earnings but also pledged a 100% pay-out ratio and initiated a large buyback

o  We withdrew our proposals and took the opportunity to exit

·      Ihara Science

o  In early May the company announced a new restricted share compensation programme and a modest dividend increase. The proposed scheme is one-third the size of our proposal, but a large step in the right direction

o  In early August it followed these moves with a strong earnings announcement

o  We were happy to withdraw our proposals and have enjoyed the stock's recent 25% blip upwards

·      Bunka Shutter

o  The Company announced a 13.1% buyback - larger than our proposal

o  We were happy to withdraw our proposals. Since early May the stock has risen 17%, of which 5% was on the day of the buyback's announcement

·    Sankyo Seiko

o  The Company announced a large buyback which produced a spike in its shares.

As can be seen by our increasingly public interchange, our most fractious relationship with a portfolio company has been with Intage Holdings. They continue to reject out of hand our suggestion that the Company would benefit from a friendly Management Buyout (MBO) and we made little progress on this subject when we were finally able to sit down with their leadership team in Tokyo in late May.

Their AGM was a little later than the other portfolio companies we had written to, but, nevertheless, we decided to urge our favourite proposals at the meeting. We were surprised and gratified when, on 5^th August, Intage announced (i) that they will replace their current trust-type share incentives with restricted shares of the type we were advocating, (ii) a JPY 2 billion share buyback and (iii) a JPY 3 dividend increase.  Although the size of the restricted share incentives, share buyback and dividend increase were all smaller than our proposals, it was apparent that the Company had taken them seriously and had responded positively. On this occasion, we were delighted to formally remove our recommendations and this 'friendly' act has been met with approbation at the Company. The share price had been improving since June and this has continued following the Company's actions.

Tokyo May 2022

At the end of May, Jamie Rosenwald and I were finally able to travel to Tokyo for the first time since NAVF was launched back in February 2020. Going there is still not easy and there are multiple hoops to jump through and much time and patience needed to gain entry. However, it was worth the effort. During the week we were there, we had meetings, in both Tokyo and Osaka/Kobe, with the CEOs and senior management of the following NAVF portfolio companies:

Ebara Jitsugyo

Ihara Science

Intage Holdings

Chino Corporation

Mitsuboshi Belting

Ishihara Chemical

Meisei Industrial

In addition, we saw a host of other potential investments, including several companies where Dalton Investments (see below) is already one of the largest shareholders and which may well be suitable targets for acquisition under our new Memorandum Of Understanding (see 'a new strategic alliance' below). We also met companies that are themselves the managers of a portfolio of companies they control, in which we have shared interests, such as Hikari Tsushin and Ai Holdings.

Our meetings with successive professional services providers revealed an unexpected potential sea-change in local attitudes. We met a number of Private Equity houses, both locally and American-owned, and they showed as much enthusiasm for their prospects as we have come to expect. Nevertheless, putting poorly run companies 'in play' and into the arms of our PE contacts, forever keen to be seen as white knights against RSM's 'black hat,' has proven more difficult than we would like. Maybe, though, things are beginning to change.

The real surprise was the banks. The three big money-centre banks who list most of corporate Japan amongst their clients and for whom they function as principal banker, and often as adviser (as we saw in the case of Sakai Ovex) have not changed. However, we saw representatives of two regional second-tier operators and the local branch of an European behemoth. With varying degrees of commitment (and fees!), they all said something similar: That a tender offer launched for less than a majority of a company's outstanding equity, say up to 48% (as in the case for SBI's offer for Shinsei Bank, surprisingly and happily waved through by the regulators), could now be deemed to be in a 'grey area'. Clearly, there are varying shades of grey, but all three were willing, in principle, to finance and front what they termed an 'unsolicited,' rather than 'hostile,' offer. We have initiated detailed discussions with all these banks under the protection of NDAs, including providing our initial wish-list of companies with which we would like to engage, to see if we can come to terms. This process will not be straightforward, and potential funders are still very concerned about their reputations, but access to this type of funding and the credibility it would provide to the regulators, is worth almost any effort to procure. Time will tell.

A new strategic alliance

NAVF investors know that the Company was set-up because the principals of Dalton Investments, who had grown a thriving business predicated on friendly co-investment in owner or entrepreneur-operated Japanese companies, wanted a separate vehicle to pursue the far sleepier and much larger (roughly 85% of all listed companies) 'salaryman'-run segment of the market. The prevailing logic was that companies run by owners would benefit from shared aspirations and economic alignment with external shareholders. Thus, their actions would be typified by the efficient use of capital and designed to help the business and shareholder returns grow.

By contrast, the corporate governance reforms and stock exchange restructuring brought about by then Prime Minister Abe and his successors would finally give investors the tools and leverage they needed to 'buck-up' the managements of the vast bulk of companies who hugged traditional norms and inertia to their bosoms, while they slept soundly at night on enormous mounds of surplus cash.

Though simplistic, this description of a divided market has largely been accurate, but now several themes are emerging that might lead to a fusion of both styles of investment and, perhaps, change.

Dalton's management has recognised two new drivers in the owner-operated portion of the world. First, many founder entrepreneurs are retiring (or dying) and handing on the reins - and not always to managers of the same quality, imagination, and commitment. Sometimes, even to the dreaded 'salarymen.' Second, and as a logical consequence of the first, and of time passing generally, the principals at Dalton are becoming increasingly frustrated with slow progress, while eyeing jealously their experience with NAVF and its greater ability to influence recalcitrant or just plain lazy managements.

With the test cases of change forced at Toshiba and the surprisingly successful takeover of Shinsei Bank by SBI Holdings Inc.'s chief executive officer, Yoshitaka Kitao, it is obvious that the ever-increasing activism going on at all levels in corporate Japan is only going to expand and is gaining traction. The combination of Rising Sun's tool kit, used on NAVF's behalf, with the added firepower of Dalton's investment capacity in individual and carefully chosen counters, should result in greatly enhanced leverage when managements are engaged. As has been seen, scale is important in this process, and while NAVF continues to grow slowly, operating with Dalton in specific instances will supercharge its efficacy and, hopefully, returns. To this end, NAVF, Dalton Investments and Rising Sun Management have executed a comprehensive Memorandum of Understanding (MOU) on 2^nd June 2022 allowing, under clearly defined conditions, overlapping investments in both directions. This will deliver an order of flexibility NAVF has never enjoyed before.

Early examples of this new co-operation include T&K Toka, where Dalton already owned over 20%, and Stella Chemifa, a company poised to benefit greatly from the current energy squeeze and the potential recommissioning of Japan's dormant nuclear power generators, a policy being promoted by the Kishida government.

Outlook

For some while, RSM has wished that NAVF had more firepower to intervene in particular situations. By combining with Earle 1927, Michael 1925 (both of which it already advises) and now, crucially, Dalton, it will. If you couple this luxury to take bigger positions and become the largest or one of the largest holders of each target company, with the ability to satisfy the Kanto Finance Bureau (or Japanese equivalent of the UK's Takeover Panel) that financing is available in an acceptable form, activism moves to the next level. We met a senior corporate lawyer in Tokyo, who likened the direction of travel for the Japanese activist industry as towards the LBO funds of the US in the nineties. This may be an exaggeration, and is certainly premature, but one thing is clear: greater financial firepower and facility with the regulators will change public perceptions over time and put recalcitrant managements under ever greater pressure. We are already beginning to see this with the recent successes of some of the more notorious activist operators. The patient wait of Japanese Private Equity is almost over, their warrant is about to become over-arching. NAVF and its co-investors will, with other activists, provide the bridge to reach this promised land. It will be important to NAVF and its investors to be in the vanguard of this change - we will make sure we are.

Rising Sun Management Limited

Investment Adviser

21 September 2022

PORTFOLIO SECTORS BREAKDOWN

As at 30 June 2022

Sector breakdown

INTERIM MANAGEMENT REPORT

The Directors are required to provide an Interim Management Report in accordance with the Financial Conduct Authority ("FCA") Disclosure Guidance and Transparency Rules ("DTR") and consider the Chair's Statement and the Investment Adviser's Report in this half-yearly report to provide details of the important events which have occurred during the period and their impact on the financial statements. The following statements on related party transactions, going concern and the Directors' Responsibility Statement below, together constitute the Interim Management Report for the Company for the period ended 30 June 2022. The outlook for the Company for the remaining six months of the year ending 31 December 2022 is discussed in the Chair's Statement and the Investment Adviser's Report.

RISKS AND UNCERTAINTIES

The principal and emerging risks and uncertainties facing the Company are detailed in the Company's most recent Annual Report for the year ended 31 December 2021. These remain unchanged during the period under review.

The principal and emerging risks, together with a summary of the processes and internal controls used to manage and mitigate risks where possible are outlined in the Annual Report for the year ended 31 December 2021.

The Board is responsible for the management of risks and uncertainties faced by the Company. The Board relies on the Investment Adviser, who will seek to mitigate these risks through active asset management initiatives and carrying out due diligence work on potential targets before entering into any investments. The principal and emerging risks and uncertainties of the Company are continuously monitored by the Board, with input from the Investment Adviser.

The Board are of the opinion that these principal and emerging risks and uncertainties remain and are very much applicable to the remaining six months of the Company's financial year.

RELATED PARTY TRANSACTIONS

The Company's Investment Adviser is Rising Sun Management Limited and is considered a related party under the Listing Rules. The Investment Adviser is entitled to receive annual advisory fee calculated as 0.85 per cent. of the Company's net assets (exclusive of VAT). Investment advisory fees paid during the period to 30 June 2022 is £634,000 (30 June 2021: £506,000). There is no performance fee payable to the Investment Adviser.

GOING CONCERN

The Board has a reasonable expectation that the Company has adequate resources to continue in operational existence for at least the following twelve-month period from the date of this report. In reaching this conclusion, the Directors have considered the liquidity of the Company's portfolio of investments as well as its cash position, income, and expense flows. The Company's net assets as at 30 June 2022 were £136.8 million (31 December 2021: £155.9 million). As at 30 June 2022, the Company held £127.2 million (31 December 2021: £138.6 million) in quoted investments and had cash and cash equivalents of £8.7 million (31 December 2021: £15.8 million). The total expenses (excluding finance costs and taxation) for the period ended 30 June 2022 is £0.8 million (30 June 2021: £0.9 million).

The Directors have considered the impact of the secondary effects of the COVID-19 pandemic and the Russian invasion of Ukraine on the Company's portfolio of investments and that any future prolonged and deep market decline would likely lead to falling values in the Company's investments or interruptions to cashflow. However, the Company currently has more than sufficient liquidity available to meet any future obligations. In addition, the Board believes that the Company and its key third party service providers have in place appropriate business continuity plans to continue to maintain service levels throughout future pandemics.

DIRECTORS' STATEMENT OF RESPONSIBILITY FOR THE HALF-YEARLY REPORT

The Directors confirm to the best of their knowledge that:

• The condensed set of financial statements contained within the half-yearly report has been prepared in accordance with International Accounting Standard 34, "Interim Financial Reporting" as required by DTR 4.2.4R.

• The Interim Management Report includes a fair review of the information required by 4.2.7R and 4.2.8R of the FCA's Disclosure Guidance and Transparency Rules.

Rosemary Morgan

Chair

For and on behalf of the Board of Directors

21 September 2022

CONDENSED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)

CONDENSED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)

*Audited

The Company's distributable reserves consist of the capital reserve attributable to realised capital profits and revenue reserve.

The accompanying notes form part of these interim financial statements.

CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED)

* Audited

The accompanying notes form part of these interim financial statements.

NOTES TO THE INTERIM FINANCIAL STATEMENTS

Rights attaching to the Ordinary Shares

Dividend rights: All Ordinary Shares are entitled to a distribution of dividends, in the event that the Directors resolve to make such a distribution to Shareholders,  in the same proportions as capital is attributable to them.

Rights as respect to capital: On a winding-up or a return of capital, in the event that the Directors resolve to make such a distribution to Shareholders, all Ordinary Shares are entitled to a distribution of capital in the same proportions as capital is attributable to them.

Voting rights: Every Shareholder shall have one vote for each Ordinary Share held.

ALTERNATIVE PERFORMANCE MEASURES ("APM")

 

For further information contact:

 Secretary and registered office:

Sanne Fund Services (UK) Limited

6th Floor, 125 London Wall, London, EC2Y 5AS

Tel: 020 3327 9720