Aberdeen Japan Growth

Muna Abu-Habsa, fund analyst at Morningstar: As with all Aberdeen funds, this one uses a team-oriented process. Peter Hames, who co-founded Aberdeen's Singapore office over 20 years ago with long-serving Hugh Young, heads all other Asian equities teams. This fund, however, depends largely on Aberdeen's Tokyo-based team of three Japan specialists. This group has been headed by Pascal Masse since the departure of Graeme Sinclair in early 2007, but given the consistency of the process and Masse's experience, we aren't overly concerned by the change.

Over its life the fund has registered competitive returns relative to its peers in the Morningstar Japan Large-Cap Equity category, returning 3.2% per year on an annualised basis versus a 1.9% return for the category average. The team has built that record using a disciplined, bottom-up driven investment process. They run two screens on all stocks in the TOPIX. The first is a quality screen which examines the growth prospects of a company, whether its balance sheet can support such growth and if it offers good stewardship for shareholders. The second is a value screen which filters for stocks trading at attractive prices relative to valuations of similar companies. This focus on valuation implies the team will not pay too much for growth and can invest in out-of-favour stocks or sectors. The team invests with a long term mindset as the typical holding period is 3-5 years, and they will hold a stock for longer if it continues to perform as expected. Canon Inc exemplifies this well. The stock has been in the portfolio for over eight years as the team has confidence in its product range, business model and favourable corporate culture.

Given this value orientation, the fund can at times look out of step with its broader competition. It lags in momentum-driven markets and the team is not afraid to deviate from the herd. The fund is also benchmark-agnostic and highly concentrated (29 holdings as of October 2008). Investors should thus note that while the fund's performance over its lifespan is encouraging and it has resided in its category's top quartile during a number of calendar years, it can also experience periods of high relative underperformance, such as in 2005 and more recently in 2007.

In 2007, the fund's underperformance was partly attributable to the relative underweight in arguably expensive commodities issues, as well as exposure to small caps. Its heavy tilt towards value stocks backfired at a time when larger, growth oriented issues rallied. Conversely, many of those same factors helped the fund in 2008. The fund's value bias has worked in its favour and the team has been adding to industrial materials which had been dumped indiscriminately in the recent sell-off such as Amada and Ricoh, and also some financials issues. To the team's credit, the fund's volatility over the last 3, 5 and 10 years compares favourably with its category peers'.

In general, we prefer broader Asia Pacific funds where the manager has discretion to allocate assets to those countries in which he finds value, but for those seeking dedicated Japan exposure, this fund's well resourced team and consistent investment process make it a solid enough choice.

Strategy

The team invests on the premise that share prices over the long term reflect underlying business fundamentals. Consequently, this bottom-up, unconstrained fund invests only in stocks that successfully pass through its quality screen and meet its stringent valuation criterion. The team assesses a company on the clarity of its business strategy and execution of this resting in the hands of experienced top management. The team also looks for strength of balance sheet, transparency of earnings and a commitment to shareholders. A company is attractively valued if it is trading cheaply relative to the valuations of similar stocks based on ratios such as price to earnings and price to cash flows. This focus on quality and valuation renders the team unwilling to pay too much for growth or chase momentum and also means they are willing to go against the grain and buy into sectors or companies that are out of favour. The fund is thus likely to experience pockets of benchmark relative underperformance. The average holding period for the portfolio is 3-5 years and annual turnover is extremely low at just 15%-25%, helping to reduce dealing costs.

Management

Hugh Young has managed Aberdeen's Asian assets since 1985. Based in Singapore, he set up the local office in 1992 and developed the investment process that is now applied across Aberdeen's equity range. Young is Global Head of Equities at Aberdeen, while Peter Hames heads up the Asian Equities team. Hames has 20 years of experience and co-founded the Asian head office with Young. His team comprises 13 investment managers and analysts located in Singapore and three Japanese specialists in Tokyo who are involved in the day-to-day management of this fund: Pascal Masse, Shota Iijima and Keita Kubota. Masse had been at Aberdeen since 2000 and was appointed head of the Japanese team in February 2007 to replace Graeme Sinclair, who stepped down as a result of the team's relocation from Singapore. Analysts are typically hired early in their career arcs and trained comprehensively in the group's approach. This helps in applying the group's investment process consistently, across all levels. In general, each member of the team spends at least half their working day on proprietary stock research, with senior members increasingly tilting their workload away from security research and toward portfolio construction.