SOURCE: Japan Equity Fund

Japan Equity Fund

March 06, 2012 11:03 ET

The Japan Equity Fund Announces First Quarter Earnings

JERSEY CITY, NJ--(Marketwire - Mar 6, 2012) - The Japan Equity Fund, Inc. (NYSE: JEQ), a closed-end management investment company, today announced its performance results for the three months ended January 31, 2012, the first quarter of its 2012 fiscal year.

For the quarter ended January 31, 2012, the Fund incurred a net investment loss of approximately U.S. $239,000 (equivalent to a loss of U.S. $0.02 per share). In addition, net realized and unrealized gains from investment activities and foreign currency transactions during that same three-month period were approximately U.S. $832,000 (equivalent to a gain of U.S. $0.06 per share).

In comparison, for the quarter ended January 31, 2011, the Fund incurred a net investment loss of approximately U.S. $232,000 (equivalent to a loss of U.S. $0.02 per share). In addition, net realized and unrealized gains from investment activities and foreign currency transactions during that same three-month period were approximately U.S. $9,226,000 (equivalent to a gain of U.S. $0.64 per share).

On January 31, 2012, the total net assets of the Fund were approximately U.S. $86.9 million. The net asset value ("NAV") per share on that date was U.S. $6.00, based on 14,481,811 shares outstanding. In comparison, total net assets on January 31, 2011 were approximately U.S. $99.2 million, equivalent to a NAV of U.S. $6.86 per share, based on 14,456,819 shares outstanding. Assuming the reinvestment of the U.S. $0.052 per share dividend paid on December 28, 2011, the Fund generated an investment return of 0.88% for the three months ended January 31, 2012, when measured against the NAV per share of U.S. $6.01 on October 31, 2011, based on 14,456,819 shares outstanding at that time. During the same period, the Fund's benchmark, the TSE Tokyo Price Index (the "TOPIX"), increased by 0.79% in U.S. dollar ("USD") terms.

As of January 31, 2012, the Fund had 99.23% of its net assets invested in Japanese common stocks. The remaining net assets were represented by a short-term USD-denominated time deposit (0.20%) and other assets less liabilities (0.57%).

As of March 5, 2012, the Fund's NAV per share was U.S. $6.24, based on net assets of U.S. $90.3 million. On the same date, the market price of the Fund's shares on the New York Stock Exchange closed at U.S. $5.61, representing a trading discount to net asset value per share of 10.10%.

Market Review and Outlook

The Japanese stock market struggled amid a lack of investor interest during the period, particularly in November and December, as we saw little progress in the sovereign debt problems of the eurozone. Trading volume on the Tokyo market declined through November and December, despite expanded trading hours. Meanwhile, macroeconomic conditions remained soft in Japan, due in part to a decline in exports resulting from the flooding in Thailand. However, the overseas markets, and particularly that of the U.S., bottomed out in mid-December, as robust trade activity continued despite mounting concerns over Europe's debt woes. The Japanese market appears to have started a catch-up rally that began in January, as the domestic economy has started to return to growth and because most stocks have already been beaten into oversold territory. Throughout the three months ended January 2012, the benchmark TOPIX declined slightly, falling 1.2% (in Japanese yen terms).

Looking forward, global economic prospects such as progress made on the European debt issue, the U.S. and Chinese economies and domestic government policies will continue to be major driving forces behind the future performance of the Japanese equity market, and we currently remain cautiously optimistic on these issues. For the month of February, we have decided to focus our attention on Japan's corporate earnings situation as well as on items that may potentially influence the movement of the Tokyo market, including investor buying trends and the country's enormous budget deficit.

  • Corporate Earnings
    The Tokyo market is currently in the middle of the earnings announcement season for the October to December 2011 period. As of February 2nd, 55% of Tokyo Stock Exchange-listed companies by market capitalization, or 42% of companies by number, had announced their third quarter FY2011 earnings. For the nine-month period from April to December 2011, excluding financials and utilities, sales increased by 1% YoY, while recurring profits declined by 17% YoY. Corporate guidance for FY2011 sales was revised down by 1%, while recurring profits were revised down by 7%. Specifically, we have observed downward earnings revisions among export-oriented manufacturers amid the yen's appreciation, weak global demand and the effects of the flooding in Thailand. Negative announcements were especially striking among consumer electronics firms such as Sony, Panasonic, and Sharp, which had been symbols of Japan's strong manufacturing sector. In the aggregate, these three companies announced net losses of 1.29 trillion yen (around 16.8 billion U.S. dollars), including Panasonic's net loss of 780 billion yen, Sony's loss of 220 billion yen and Sharp's 290 billion yen net loss, with these declines mainly attributed not only to the yen's appreciation but also to the companies' lack of innovative products and competitiveness against foreign rivals. Industrial electronics firms such as Hitachi, Toshiba and Mitsubishi Electric have transformed their business models by divesting unprofitable business lines as well as by strengthening their mainstay businesses through acquisition; however, these companies are still not yet ideal by any means. In our view, industry consolidation and/or business reshufflings must occur in the near future, and we believe that such developments will positively contribute to the long-term future of Japanese corporations, despite the fact it may be painful in the short run.
  • Investor buying trends
    The movement of the Tokyo market is highly correlated to the net purchasing of foreign investors. From the fourth week of December 2011 to the fourth week of January 2012, foreign investors net purchased 546 billion yen worth of Japanese equities, a fifth consecutive week of net purchases, reflecting a shift by global investors to increase their risk profiles. During this same five-week period, individual investors net sold Japanese equities by 461 billion yen, while trust banks, which tend to represent the activities of domestic institutional investors, net purchased a total of 29 billion yen. Looking forward, domestic institutions will seek to purchase Japanese equities when the market declines, as they rebalance their asset allocations to more neutral positions. However, it is difficult to expect domestic institutional investors to continue with their large net purchases as the country's pension accounts gradually mature, which will lead them to take on lower risk tolerances and, thus, cause these investors to reduce the home-country bias in their equity allocations. On the other hand, there is a relatively good chance that individual investors, who have historically been reluctant to invest in the Japanese equity market, will buy Japanese stocks in the long term. With interest rates extremely low and expected to continue, Japan's individual investors have been starved of income. They have also flooded into high-income foreign bond funds, including several denominated in Brazilian reals, Australian dollars and South African rands. However, the financial crises of 2008 and 2011 have taught us that high-income foreign bonds inevitably bring with them huge currency fluctuation risks. Now, with Japanese stocks providing an average dividend yield of 2.5% and several blue-chip names with sound business structures offering yields of 4% or more, individual investors can now begin to directly purchase these blue-chip companies, while financial institutions are busy preparing to bring high-yield Japanese equity mutual funds to market.
  • Japan's Budget Deficit
    As everyone is aware, heavy government debt has become a huge problem for several European nations. Japan also has a huge budget deficit. Specifically, Japan's fiscal deficit is -9.2% relative to GDP for 2010, while those of Greece and Italy are -10.4% and -4.5%, respectively. Some analysts have pointed out that the problems now facing European countries could eventually spread to Japan. However, we do not believe that this outcome will play out in the foreseeable future for two fundamental reasons. First, Japan's current account surplus profile differs greatly from those of European nations. Japan's current account surplus is +3.6% relative to its 2010 GDP while those of Greece and Italy, for example, are -10.5% and -3.3%, respectively. More importantly, the current account surplus trend is expected to continue with an income surplus. Second, unlike many European nations, Japan's budget deficit is supported almost exclusively by domestic investors who are unlikely to sell their holdings, as evidenced by the foreign holding ratio for Japanese government bonds, which currently stands at only 7.1%. Although we do not foresee a budget crisis to hit Japan for these reasons, it nevertheless remains necessary for Japan to take drastic measures, including the implementation of not only tax and social security reforms but also a powerful economic growth strategy.

Regarding sector strategy, our portfolio remains overweight in cyclical names, including industrials, information technology and materials, and underweight in defensives such as utilities and consumer staples, as we maintain our main scenario that the global economy will gradually recover this year and because valuations have become highly attractive in cyclical sectors. We have increased our exposure to commodities-related names by shifting out of energy stocks and into materials and industrials. We have also acquired a new position in the financial sector. In terms of stock selection, we will continue to search for companies with specific earnings drivers, including firms that can supply superior products for energy saving purposes as well as those that can meet the growing demand of emerging nations. Finally, we will continue to focus on value, namely stocks with high-dividend yields and low price-to-book ratios.

The ten largest industry classifications of the Fund's Japanese equity investments held as of January 31, 2012 were:

Percentage of
Industry Net Assets
1. Electric Appliances 11.68 %
2. Transportation Equipment 10.81
3. Banks 10.48
4. Chemicals 6.12
5. Wholesale Trade 5.97
6. Pharmaceutical 5.46
7. Land Transportation 5.20
8. Non-Ferrous Metals 4.66
9. Machinery 4.49
10. Communication 4.34

The Fund's ten largest individual common stock holdings at the same date were:

Percentage of
Issue Net Assets
1. Mitsubishi UFJ Financial Group, Inc. 4.89 %
2. Mizuho Financial Group, Inc. 3.98
3. Honda Motor Co., Ltd. 3.77
4. East Japan Railway Co. 3.15
5. Marubeni Corp. 2.65
6. Mitsubishi Corp. 2.54
7. Toyota Motor Corp. 2.50
8. Hitachi Ltd. 2.16
9. NTT Corp. 2.16
10. Mitsui Fudosan Co., Ltd. 2.08
QUARTERLY RESULTS OF OPERATIONS
Net Realized and Net Increase
Unrealized Gains (Losses) on (Decrease) in Net Assets
Net Investment Investments and Resulting From
Income (Loss) Currency Transactions Operations
Total Per Total Per Total Per
QUARTER ENDED (000) Share (000) Share (000) Share
January 31, 2012 $ (239 ) $ (0.02 ) $ 832 $ 0.06 $ 593 $ 0.04
January 31, 2011 $ (232 ) $ (0.02 ) $ 9,226 $ 0.64 $ 8,994 $ 0.62
April 30, 2011 539 0.04 (5,428 ) (0.38 ) (4,889 ) (0.34 )
July 31, 2011 (167 ) (0.01 ) 4,062 0.28 3,895 0.27
October 31, 2011 526 0.03 (11,810 ) (0.81 ) (11,284 ) (0.78 )
For the Year Ended October 31, 2011 $ 666 $ 0.04 $ (3,950 ) $ (0.27 ) $ (3,284 ) $ (0.23 )
PER SHARE SELECTED QUARTERLY FINANCIAL DATA
QUARTER ENDED Net Asset Market Share
Value Price* Volume*
High Low High Low (000)
January 31, 2012 $ 6.00 $ 5.54 $ 5.45 $ 4.89 739
January 31, 2011 $ 7.06 $ 6.23 $ 6.35 $ 5.40 1,710
April 30, 2011 7.26 5.79 6.66 5.35 1,899
July 31, 2011 6.96 6.26 6.38 5.75 712
October 31, 2011 6.93 5.75 6.29 5.11 997

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*As reported on the New York Stock Exchange.

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