Annual Financial Report

RNS Number : 9405S

SchroderJapan Growth Fund PLC

06 October 2017

 

6 October 2017

ANNUAL REPORT AND ACCOUNTS

Schroder Japan Growth Fund plc (the "Company") hereby submits its Annual Report for the year ended 31 July 2017 as required by the UK Listing Authority's Disclosure Guidance and Transparency Rule 4.1. 

The Company's Annual Report and Accounts for the year ended 31 July 2017 are also being published in hard copy format and an electronic copy will shortly be available to download from the Company's website http://www.schroders.co.uk/japangrowth.  Please click on the following link to view the document:

http://www.rns-pdf.londonstockexchange.com/rns/9405S_-2017-10-6.pdf

The Company has submitted its Annual Report and Accounts to the National Storage Mechanism and it will shortly be available for inspection at www.morningstar.co.uk/uk/NSM.

Enquiries:

Ria Vavakis

Schroder Investment Management Limited                    

Tel: [phone]

Chairman's Statement

The year to 31 July 2017 has been an excellent one for shareholders, with the Company's net asset value ("NAV") and share price reaching the highest levels in the Company's history. The Company's NAV outperformed the TSE First Section Total Return Index, producing a total return of 20.4%, compared with 16.8% produced by the Index. This performance was largely due to a buoyant local market (which rose 25.1% in local currency terms, albeit partially offset by the weak yen which affected sterling returns) and outperformance of the market by our Manager. The share price also performed strongly, producing a total return of 22.4% over the period, as the discount narrowed from 10.7% to 9.5%.

Further comment on performance and investment policy may be found in the Manager's Review.

Revenue and dividend

I am pleased to report that revenue return per share has continued to grow, increasing by 16.0% to 3.62p. Taking this into consideration, the Directors have declared a final dividend for the year ended 31 July 2017 of 3.50p per share, representing an increase of 25.0% over the final dividend paid in respect of 2016. This dividend will be paid on 6 November 2017 to shareholders on the Register on 13 October 2017, subject to approval by shareholders at the Annual General Meeting on 2 November 2017.

Gearing

The Company has in place a yen 6 billion three year term loan (expiring in January 2019) and also has access to a revolving credit facility of yen 1 billion, the latter of which was extended during the year for a further 12 months. The gearing level decreased slightly, beginning and ending the year at 12.1% and 11.2% respectively. The Company's gearing continues to operate within pre-agreed limits so that it does not represent more than 25% of shareholders' funds.

Purchase of shares for cancellation

The Directors did not use the authority given to them to purchase shares for cancellation during the financial year ended 31 July 2017, as the discount narrowed and the shares traded within a relatively small band. Nevertheless, as the ability to buy back shares is one of a number of tools that may be used to enhance shareholder value and to reduce the discount volatility, the Board will be seeking to renew the share buy back authority granted at the Company's Annual General Meeting in November 2016 to purchase up to 14.99% of the Company's issued share capital for cancellation.

Board refreshment

The Board continues to consider the balance of its skills, experience and diversity and, in accordance with its refreshment and succession plans, has commenced a search for a new Director. An external search agency has been engaged to assist in this process, and it is anticipated that a new Director appointment will be made in the new year.  It is intended that one of the longer-serving Directors will retire during 2018.

Outlook

As mentioned above, the Company's share price set a new all-time high this year, while the NAV's outperformance of the benchmark adds to the longer term record. I am also pleased to see the continuing rise in the Company's revenue. This is not a priority for us in itself, but it is an indicator of the improved financial strength of the companies in the portfolio. The Company's revenue per share has more than trebled in the last five years. While exaggerated by sterling's weakness and the Manager concentrating the portfolio in companies capable of improving their profitability and dividends, it emphasises that parts of Japan really have improved. The much-discussed changes to the economy from 'Abenomics' are still a work in progress, but at least shareholders can see higher dividends.

As the Manager's Review mentions, Japan has now had six consecutive quarters of positive GDP growth, for the first time in more than 12 years. Economic growth is rarely enough to create stronger markets, and we rely on our Manager to find the companies that will turn this more stable domestic position into new highs for the Company's shares.

Annual General Meeting

The Annual General Meeting will be held at 2.30 p.m. on Thursday, 2 November 2017, and I hope as many of you as possible will be able to come along to participate. The meeting, as in previous years, will include a presentation by the portfolio manager on prospects for the Japanese market and the Company's investment strategy.

Jonathan Taylor

Chairman

5 October 2017

Manager's Review

Market background

The Company's NAV total return for the year of 20.4% outperformed the benchmark total return of 16.8%.

The start of the Company's year coincided with the low point for the stock market, which was still in the process of absorbing the implications of the Brexit vote and the knock-on effect which that vote had imparted to the yen. The pattern of the year was, therefore, the opposite of the previous year with strong market returns, partly offset by moderate weakness in the yen relative to sterling. The bulk of the action in terms of market strength and yen weakness occurred during the first half of the year. The ostensible triggers were macro and geopolitical in nature, namely a Bank of Japan policy change in September and the US Presidential election result, to which the stock market's initial response was positive. At the same time company profitability hit a short term trough around the autumn and subsequent upward revisions have been supportive of sentiment.

Broad sector and style trends diverged between the first and second half of the year. Initially cyclicals - stocks that tend to do well in an economic upswing - and financials performed strongly, which was in turn reflected in "value" stocks - shares on lower ratings - outperforming. That reversed in the second half of the year with defensive stable growth sectors - companies that tend to do relatively well in most economic environments - outperforming. The net picture for the 12 months was that the upper echelons of sector performance were populated by cyclical or cyclical growth areas such as technology, steel and chemicals whilst the other end of the scale was more represented by defensive areas such as pharmaceuticals, food and transport.

Portfolio performance

Net gearing was generally 10-12% and this contributed positively given the strong market. Sector and stock selection were also beneficial. The largest stock contributors were in technology (e.g. Disco and Fujitsu) and financials (e.g. life insurer T&D Holdings). Detractors included holdings in more defensive areas such as Santen Pharmaceutical and telecommunications company KDDI.

Activity

One of the strongest areas of the market has been semiconductor equipment manufacturing. We sold out of two positions in this area, Screen Holdings and Hitachi Hi-tec. A long-standing position in Nitto Denko, which makes polarising film for flat panel displays, was also sold as the shares had become expensive. We also took profits in global cyclicals such as Mitsui OSK (shipping line) and Sumitomo Heavy Industries (a diversified machinery manufacturer). Some of the proceeds were reinvested in domestic cyclicals such as a new holding in Iida (affordable home builder). We also added to factory automation companies, including a new holding in SMC (pneumatic equipment manufacturer).

Smaller companies were strong as an asset class over the 12 months which facilitated some profit-taking, e.g. Sakata Inx. We also initiated some new small cap positions, such as Ship Healthcare (hospital consultancy) and Enplas (manufacturer of engineering plastics). Amongst more defensive parts of the market we started a new holding in Japan Tobacco, whose shares had been sold off due to a slow ramp-up in production of its new product, T-Vapor cigarettes (inhalable vapour tobacco cigarettes).  We expect the company to catch up in 2018 and view the valuations as attractive.

Outlook

Market fundamentals remain broadly favourable. For the first time in more than 12 years the economy has recorded six consecutive quarters of positive GDP growth. A supportive global backdrop is a precondition of this relatively positive performance continuing, but domestic indicators have also improved. Inflation targets remain elusive, but the chances of a pick-up here are better than they have been for many years due to the extremely tight labour market. Bank of Japan policy is likely to remain accommodating until more concrete progress is visible in generation of inflationary expectations.

One area of domestic macro concern had been a fall in Prime Minister Abe's opinion poll ratings. However, the perceived threat to national security from North Korea is the type of event which usually favours an incumbent. This has been the case in Japan, such that the Prime Minister has called a snap election. Current polling suggests the Liberal Democratic Party (LDP) should win this handsomely but it does introduce short term risk. Were there to be a change of leadership, this would most likely undermine short term sentiment but ultimately it would be unlikely to lead to a change in policy, as the LDP is likely to remain the dominant party.

Previous reviews have mentioned the stronger incentives for companies to improve corporate governance. This remains the case and is being reflected in improved shareholder returns. Companies have just announced better than forecast first quarter profits. It seems likely that estimates for this year are in aggregate still too conservative. On this basis valuations look relatively attractive and this should contribute to more positive flows from international investors than has been the case so far in 2017.

Whilst the last six months have seen a reversion to outperformance by domestic/steady growth sectors, valuation premiums attached to these areas have not reached the extremes of mid-2016. Reflecting this we have added to positions in retail, food and transport. Nevertheless, we are still finding more opportunities in cyclicals such as autos, machinery and trading companies. Amongst domestic cyclicals we have been adding to real estate, a sector which has underperformed since the early days of Abenomics. The Company is still overweight financials, especially insurance. Valuations are attractive although it will probably take a more positive macro backdrop in the form of higher interest rate expectations for the sector to rise.

Schroder Investment Management Limited

5 October 2017

Securities shown are for illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Principal risks and uncertainties

The Board is responsible for the Company's system of risk management and internal control and for reviewing its effectiveness. The Board has adopted a detailed matrix of principal risks affecting the Company's business as an investment trust and has established associated policies and processes designed to manage and, where possible, mitigate those risks, which are monitored by the Audit Committee on an ongoing basis. This system assists the Board in determining the nature and extent of the risks it is willing to take in achieving its strategic objectives. Both the principal risks and the monitoring system are also subject to robust review at least annually. The last review took place in September 2017.

Although the Board believes that it has a robust framework of internal control in place this can provide only reasonable, and not absolute, assurance against material financial misstatement or loss and is designed to manage, not eliminate, risk.

The principal risks and uncertainties faced by the Company have remained unchanged throughout the year under review, except in respect of cyber risk relating to the Company's service providers, which has now been extended beyond the custodian. Cyber risk relating to all of the Company's key service providers is considered an increased threat in light of the rising propensity and impact of cyber attacks on businesses and institutions. To address the risk, the Board is seeking enhanced reporting on cyber risk mitigation and management from its key service providers to ensure that it is managed and mitigated appropriately.

Actions taken by the Board and, where appropriate, its Committees, to manage and mitigate the Company's principal risks and uncertainties are set out in the table below.

Risk	Mitigation and management
Strategic
The Company's investment objectives may become out of line with the requirements of investors, resulting in a wide discount of the share price to underlying net asset value.	Appropriateness of the Company's investment remit periodically reviewed and success of the Company in meeting its stated objectives is monitored. Share price relative to net asset value monitored. Marketing and distribution activity is actively reviewed.
Investment management
The Manager's investment strategy, if inappropriate, may result in the Company underperforming the market and/or peer group companies, leading to the Company and its objectives becoming unattractive to investors.	Review of the Manager's compliance with the agreed investment restrictions, investment performance and risk against investment objectives and strategy; relative performance; the portfolio's risk profile; and appropriate strategies employed to mitigate any negative impact of substantial changes in markets. Annual review of the ongoing suitability of the Manager.
Financial and currency
The Company is exposed to the effect of market fluctuations due to the nature of its business. A significant fall in Japanese equity markets could have an adverse impact on the market value of the Company's underlying investments and, as the Company invests predominantly in underlying assets which are denominated in yen, its exposure to changes in the exchange rate between sterling and yen has the potential to have a significant impact on returns.	Risk profile of the portfolio considered and appropriate strategies to mitigate any negative impact of substantial changes in markets discussed with the Manager. Board considers overall hedging policy on a regular basis.
The Company's cost base could become uncompetitive, particularly in light of open-ended alternatives.	Ongoing competitiveness of all service provider fees subject to periodic benchmarking against competitors. Annual consideration of management fee levels.
Custody
Safe custody of the Company's assets may be compromised through control failures by the Depositary, including cyber hacking.	Depositary reports on safe custody of the Company's assets, including cash, and portfolio holdings are independently reconciled with the Manager's records. Review of audited internal controls reports covering custodial arrangements. Annual report from the Depositary on its activities, including matters arising from custody operations.
Gearing and leverage
The Company utilises credit facilities. These arrangements increase the funds available for investment through borrowing. While this has the potential to enhance investment returns in rising markets, in falling markets the impact could be detrimental to performance.	Gearing is monitored and strict restrictions on borrowings imposed: gearing continues to operate within pre-agreed limits so as not to exceed 25% of shareholders' funds.
Accounting, legal and regulatory
In order to continue to qualify as an investment trust, the Company must comply with the requirements of Section 1158 of the Corporation Tax Act 2010. Breaches of the UK Listing Rules, the Companies Act or other regulations with which the Company is required to comply, could lead to a number of detrimental outcomes.	Confirmation of compliance with relevant laws and regulations by key service providers. Shareholder documents and announcements, including the Company's published Annual Report, are subject to stringent review processes. Procedures have been established to safeguard against disclosure of inside information.
Service provider
The Company has no employees and has delegated certain functions to a number of service providers, principally the Manager, Depositary and Registrar. Failure of controls, including as a result of cyber hacking, and poor performance of any service provider could lead to disruption, reputational damage or loss.	Service providers appointed subject to due diligence processes and with clearly-documented contractual arrangements detailing service expectations. Regular reporting by key service providers and monitoring of the quality of services provided. Review of annual audited internal controls reports from key service providers, including confirmation of business continuity arrangements and IT controls.

Risk assessment and internal controls

Risk assessment includes consideration of the scope and quality of the systems of internal control operating within key service providers, and ensures regular communication of the results of monitoring by such providers to the Audit Committee, including the incidence of significant control failings or weaknesses that have been identified at any time and the extent to which they have resulted in unforeseen outcomes or contingencies that may have a material impact on the Company's performance or condition. No significant control failings or weaknesses were identified from the Audit Committee's ongoing risk assessment which has been in place throughout the financial year and up to the date of this Report.

A full analysis of the financial risks facing the Company is set out in note 20 on pages 39 to 44 of the 2017 Annual Report.

Going concern

Having assessed the principal risks and the other matters discussed in connection with the viability statement set out above, and the "Guidance on Risk Management, Internal Control and Related Financial and Business Reporting" published by the FRC in 2014, the Directors consider it appropriate to adopt the going concern basis in preparing the accounts.

Statement of Directors' responsibilities in respect of the Annual Report and Accounts

The Directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulation.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the financial statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards, comprising FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland", and applicable law). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing the financial statements, the Directors are required to:

-        select suitable accounting policies and then apply them consistently;

-        state whether applicable United Kingdom Accounting Standards, comprising FRS 102, have been followed, subject to any material departures disclosed and explained in the financial statements;

-        make judgements and accounting estimates that are reasonable and prudent; and

-        prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements and the Directors' Remuneration Report comply with the Companies Act 2006.

The Directors are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Manager is responsible for the maintenance and integrity of the Company's webpage. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

The Directors consider that the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's performance, business model and strategy.

Each of the Directors, whose names and functions are listed in the Board of Directors on pages 14 and 15 of the Annual Report 2017 confirm that, to the best of their knowledge:

-        the Company financial statements, which have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards, comprising FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland", and applicable law), give a true and fair view of the assets, liabilities, financial position and profit of the Company; and

-        the Strategic Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces.

Income Statement for the year ended 31 July 2017

		2017			2016
		Revenue £'000	Capital £'000	Total £'000	Revenue £'000	Capital £'000	Total £'000
Gains on investments held at fair value through profit or loss		-	41,386	41,386	-	25,692	25,692
Net foreign currency gains/(losses)		-	1,910	1,910	-	(11,102)	(11,102)
Income from investments		6,391	-	6,391	5,588	-	5,588
Other interest receivable and similar income		-	-	-	1	-	1
Gross return		6,391	43,296	49,687	5,589	14,590	20,179
Investment management fee		(621)	(1,450)	(2,071)	(514)	(1,198)	(1,712)
Administrative expenses		(501)	-	(501)	(531)	-	(531)
Net return before finance costs and taxation		5,269	41,846	47,115	4,544	13,392	17,936
Finance costs		(108)	(252)	(360)	(87)	(203)	(290)
Net return on ordinary activities before taxation		5,161	41,594	46,755	4,457	13,189	17,646
Taxation on ordinary activities		(639)	-	(639)	(559)	-	(559)
Net return on ordinary activities after taxation		4,522	41,594	46,116	3,898	13,189	17,087
Return per share		3.62p	33.27p	36.89p	3.12p	10.55p	13.67p

The "Total" column of this statement is the profit and loss account of the Company. The "Revenue" and "Capital" columns represent supplementary information prepared under guidance issued by The Association of Investment Companies. The Company has no other items of other comprehensive income and therefore the net return on ordinary activities after taxation is also the total comprehensive income for the year.

All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued in the year.

Statement of Changes in Equity for the year ended 31 July 2017

	Called-up share capital £'000	Share premium £'000	Warrant exercise reserve £'000	Share purchase reserve £'000	Capital reserves £'000	Revenue reserve £'000	Total £'000
At 31 July 2015	12,501	7	3	97,205	99,692	2,693	212,101
Net return on ordinary activities	-	-	-	-	13,189	3,898	17,087
Dividend paid in the year	-	-	-	-	-	(2,500)	(2,500)
At 31 July 2016	12,501	7	3	97,205	112,881	4,091	226,688
Net return on ordinary activities	-	-	-	-	41,594	4,522	46,116
Dividend paid in the year	-	-	-	-	-	(3,500)	(3,500)
At 31 July 2017	12,501	7	3	97,205	154,475	5,113	269,304

Statement of Financial Position at 31 July 2017

		2017	2016
		£'000	£'000
Fixed assets
Investments held at fair value through profit or loss		300,497	254,114
Current assets
Debtors		949	1,077
Cash at bank and in hand		11,026	16,565
		11,975	17,642
Current liabilities
Creditors: amounts falling due within one year		(1,979)	(973)
Net current assets		9,996	16,669
Total assets less current liabilities		310,493	270,783
Creditors: amounts falling due after more than one year		(41,189)	(44,095)
Net assets		269,304	226,688
Capital and reserves
Called-up share capital		12,501	12,501
Share premium		7	7
Warrant exercise reserve		3	3
Share purchase reserve		97,205	97,205
Capital reserves		154,475	112,881
Revenue reserve		5,113	4,091
Total equity shareholders' funds		269,304	226,688
Net asset value per share		215.43p	181.34p

Notes to the Accounts

1.       Accounting policies

The accounts are prepared in accordance with the Companies Act 2006, United Kingdom Generally Accepted Accounting Practice ("UK GAAP"), in particular in accordance with Financial Reporting Standard (FRS) 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland", and with the Statement of Recommended Practice "Financial Statements of Investment Trust Companies and Venture Capital Trusts" (the "SORP") issued by the Association of Investment Companies in November 2014 and updated in January 2017. All of the Company's operations are of a continuing nature.

2.       Dividends

Dividends paid and proposed

	2017	2016
	£'000	£'000
2016 final dividend of 2.80p (2015: 2.00p) paid out of revenue profits	3,500	2,500
	2017	2016
	£'000	£'000
2017 final dividend proposed of 3.50p (2016: 2.80p) to be paid out of revenue profits	4,375	3,500

The proposed dividend amounting to £4,375,000 (2016: £3,500,000) is the amount used for the basis of determining whether the Company has satisfied the distribution requirements of Section 1158 of the Corporation Tax Act 2010. The revenue available for distribution by way of dividend for the year is £4,522,000 (2016: £3,898,000).

3.       Return per share

	2017	2016
Revenue return (£'000)	4,522	3,898
Capital return (£'000)	41,594	13,189
Total return (£'000)	46,116	17,087
Weighted average number of ordinary shares in issue during the year	125,008,200	125,008,200
Revenue return per share	3.62p	3.12p
Capital return per share	33.27p	10.55p
Total return per share	36.89p	13.67p

4.       Creditors: amounts falling due after more one year

	2017	2016
	£'000	£'000
Bank loan	41,189	44,095

The bank loan is a yen 6.0 billion three year term loan with Scotiabank, expiring on 18 January 2019, and carrying a fixed interest rate of 0.82% per annum. The loan is unsecured but is subject to certain undertakings and restrictions, all of which have been complied with by the Company.

The Directors consider that the carrying amount of the bank loan approximates to its fair value.

5.       Called-up share capital

	2017	2016
	£'000	£'000
Ordinary shares allotted, called-up and fully paid: 125,008,200 ordinary shares of 10p each	12,501	12,501

6.       Net asset value per share

	2017	2016
Net assets attributable to shareholders (£'000)	269,304	226,688
Shares in issue at the year end	125,008,200	125,008,200
Net asset value per share	215.43p	181.34p

7.         Disclosures regarding financial instruments measured at fair value

The Company's financial instruments within the scope of FRS 102 that are held at fair value comprise its investment portfolio. The Company currently holds no derivative financial instruments.

FRS 102 requires financial instruments to be categorised into a hierarchy consisting of the three levels below. Note that the criteria used to categorise investments include an amendment to paragraph 34.22 of FRS 102, issued by the Financial Reporting Council in March 2016, and which the Company has early adopted.

Level 1 - valued using unadjusted quoted prices in active markets for identical assets.

Level 2 - valued using observable inputs other than quoted prices included within Level 1.

Level 3 - valued using inputs that are unobservable.

Details of the valuation techniques used by the Company are given in note 1(b) on page 32 of the 2017 Annual Report.

At 31 July 2017, all investments in the Company's portfolio are categorised as Level 1 (2016: same).

8.       Status of announcement

2016 Financial Information

The figures and financial information for 2016 are extracted from the published Annual Report and Accounts for the year ended 31 July 2016 and do not constitute the statutory accounts for that year. The 2016 Annual Report and Accounts have been delivered to the Registrar of Companies and included the Report of the Independent Auditors which was unqualified and did not contain a statement under either section 498(2) or section 498(3) of the Companies Act 2006.

2017 Financial Information

The figures and financial information for 2017 are extracted from the Annual Report and Accounts for the year ended 31 July 2017 and do not constitute the statutory accounts for the year. The 2017 Annual Report and Accounts include the Report of the Independent Auditors which is unqualified and does not contain a statement under either section 498(2) or section 498(3) of the Companies Act 2006. The 2017 Annual Report and Accounts will be delivered to the Registrar of Companies in due course.

Neither the contents of the Company's webpage nor the contents of any website accessible from hyperlinks on the Company's webpage (or any other website) is incorporated into, or forms part of, this announcement.

 

END

 

 

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