A rarely available wide discount: Baillie Gifford Shin Nippon

 
Baillie Gifford Shin Nippon (BGS) is managed by Praveen Kumar, who aims to identify Japanese small caps which have exceptional growth potential, ideally buying them early and holding for years if not decades. BGS has an excellent track record over the longer run, as we discuss in Performance. This has been driven by exceptional returns in individual stocks which have typically been held for a long period – almost a third of the portfolio by weighting has been held for over a decade and in total 60% for over five years.

Praveen focuses exclusively on identifying exceptional companies rather than making calls on market or sector direction. Aided by a deep team of Japanese specialists (see Management), the portfolio he has constructed at present is heavy in niche manufacturers, often with specialised technology, and in digital disruptors. The portfolio displays a sensitivity to the growth factor and tends to be volatile.

Last year saw a significant sell-off in growth stocks as markets reacted to rising interest rate expectations. BGS was not immune, and had a tough year of performance. However, Praveen says the long-term growth outlook for his companies has not deteriorated, but in some cases has actually improved. He views the cheaper portfolio and market as a major opportunity, and the board arranged an extra Gearing facility in March 2023 in order to allow him to take advantage.

BGS has traded on a premium during periods when growth has been in favour and in periods when recent performance has been good, but the shares have fallen to a 10.4% discount to NAV at the time of writing.

BGS has an unabashedly high-risk, high-return strategy. Managed without reference to a benchmark or market cycles, it is focused on maximising long-term growth by finding companies with exceptional growth opportunities.

This has led to excellent returns over the long run but has worked against it over the past 18 months as macro factors have dominated market returns and growth stocks have de-rated. We think there is an argument that markets have already overshot, with the portfolio now trading on a reduced premium versus the market. This, plus the wide discount, means there is potentially an exciting opportunity to invest for the long term.

The Portfolio contains many interesting companies with the potential to dominate international markets, particularly in the technology industries. It also contains multiple companies benefitting from secular changes in Japan, dominating in niches and/or developing new markets.

The Japanese economic situation looks interesting at this point in time, with modest inflation, wage growth, and the belated lifting of COVID restrictions all encouraging domestic economic activity. This could be a further boost for BGS’ portfolio in the near future. On the other hand, if global interest rates remain higher for longer, then this will likely weigh on the portfolio’s valuations.

BGS runs with significant gearing, and the highly active approach means there are sector and style biases which bring volatility. But for investors who can stomach that volatility, we think it offers the potential for excellent long-term returns.