Recent Portfolio Changes and Ukraine

Investment Views
3 March 2022Print article
James SalterFund Manager
David MitchinsonFund Manager

We have been horrified by recent developments in Ukraine and our thoughts go out to everyone involved. In the light of the tectonic plates shifting again we thought it worth updating our shareholders with what we have done to navigate further volatility.


In January we published our outlook for Japan. We were worried about more structural inflationary forces, globally. We concluded that although the pricing pressures were largely reflecting higher energy costs and persistent industry and transportation bottlenecks, there was evidence to suggest that these could continue for some while longer. The economist in David has continued to be concerned that we may well witness a sharp pick up in wage growth.  The employment market in the west remains extremely tight. Up until the invasion of Ukraine we were predicting above potential growth rates in the US and western Europe as there is limited slack in these key economies right now. The US/China trade disputes in 2019 and now the geopolitical shock of war in Europe will only accentuate the de-globalisation theme. This and war are both inflationary.

The conflict in Ukraine will certainly have profound economic implications. Whilst Russia only accounts for 2% of GDP, it is the hold it has on key commodities that will exert further upward pressures on inflation and further highlight a growing cost of living crisis. Talk of stagflation is too early, but the threat remains very real. Japan’s economy has been slowly opening up and after a weak Q1 as a result of Omicron, we had expected a sharp upturn in the economy in Q2 2022. That said, events in Ukraine have cast somewhat of a shadow. Russia represents just 1% of exports and 2% of imports. Thus, a major impact on trade to GDP is limited. However, Russia accounts for 4% of Japan’s oil imports and 9% of its liquified natural gas imports. Japan has so far banned transactions in Russian sovereign debt and denied access by most Russian banks to the SWIFT system. There is no indication that Japan is prohibiting imports of crude oil and liquified natural gas. Energy costs as a percent of GDP have risen very sharply. This is a tax on the rest of the economy (all economies) and disposable income and profit margins will be impacted if this persists.

The cabinet office has calculated that a 20% increase in crude oil depresses real GDP by 0.18%. Also, if Brent was to stay at $120 Japan’s Core CPI will reach 2%. The worry is that the vast majority of imports are settled in dollars and the yen has been very weak touching Y116/$1 at the time of writing.


Playing commodities has always been difficult in Japan. We have introduced a hedge into the portfolio in the form of a trading company, Mitsui and Co. Its largest areas are energy and metals. Half of EBITDA is upstream development and trading in oil and gas. Its second largest business, or 25% of EBITDA comes from iron ore and steel. Whilst the opacity of trading companies balance sheets is always a risk, we believe that some form of hedging oil and metal price inflation is warranted. We have a 4.2% position in the company. Like BP and Shell there is exposure to Russia (from the Sakhalin project) but any write offs should be dwarfed by the rise in the oil price and raw material prices.  We raised money for the purchase by reducing our weighting in both MUFG and Bank of Kyoto. Both banks had done well from a steepening US yield curve. Whilst interest rate hikes are still very much on the cards the pace of rises is now under review by both the Fed and the BoE.

The Fund also has a deep value commodity play called Nittetsu Mining. Our weighting here is 3%. It has both limestone operations and significant upstream copper assets. It has a 60% mining right at Atacama, in Chile. We are confident that with a much higher copper price and shortage of supply issues in Russia and more stringent royalty taxes in Chile that the company will see profits rise even further from here. They are developing a new mine at Arqueros, in Chile. With the market cap ex-treasury of Y54bn comes Y26bn in cash and Y12bn of miscellaneous short term and long-term assets. There is Y20bn of debt and Y17bn of unrealised gains on land. Essentially, we are only buying the company for Y19bn compared to EBITDA this year forecast to be Y19bn.

We have also taken a position in JGC. JGC is one of the world’s top liquified natural gas contractors. It trades below its net cash and below book and offers an excellent way to play liquified natural gas which we believe will be a reliable and lower emission energy source partner to renewable energy and a back up in the event of intermittent supply. We expect to see a substantial liquified natural gas supply deficit.

These three stocks now account for 9.5% of the portfolio.

Our largest position at the moment is the specialty retailer, Pan Pacific. This should also act as a defensive hedge. Business there has been improving and a higher private brand mix has led to better-than-expected recent numbers. Elsewhere in the portfolio, we had a phone call with Sun Corporation and Cellebrite and they confirmed that they have no dealings with Russia as from last year. Sun Corp has close to its' entire market cap in net cash and then a further 150% of its' market cap in the encryption software company Cellebrite (CLBT US). We also spoke to Orix, the diversified financial company and there is little exposure directly to Russia. The biggest indirect exposure is via AVOLON, where they own 30%. The Dublin based aircraft lessor has 14 aircraft out of a fleet of 592 which represents 1.65% of book value. On a group basis we think the hit would be less than 1% of book value.

Our regional banks have virtually no exposure to Russia, but the Japanese City banks do. These total about $9bn, which is small. However, we may have to expect some provisions, depending on how the situation unfolds. To put this in context, the Japanese banks lend $2 trillion to the US and $230bn to the United Kingdom.

In terms of the negative drag from raw material costs, AGC, a large holding for the fund will see a negative drag from its glass business which is oil and energy intensive. Current PVC spreads though are holding up well and we also have a good structural story on CDMO growth and EUV mask blanks.

Overall, the fund yields 2.3%. The forecast PER is 10.2X and the portfolio trades at 0.79X book. These are some of the lowest valuations we have seen.