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Timing is all for Dejima’s Japan Synthetic Warrant Fund

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Rowan Chaplin, a portfolio manager for the Japan Synthetic Warrant Fund from Dejima Asset Management describes the past 30 years of the Japanese market as a “litany of disasters for many fund managers”.

“For 30 years, since 1989, people have struggled to play Japan effectively in their portfolios,” Chaplin (pictured) says. “One of the clarion calls you hear is ‘if I go long Japan, it just doesn’t come off’.”

Chaplin, Matt Lonergan and Trevor Sliwerski co-manage the Japan Synthetic Warrant Fund, a fund that does things very differently from other Japanese equity funds. It offers, Chaplin says, a unique strategy that enables investors to gain geared exposure to Japanese equities in a low-cost way.

The fund invests in long dated Japanese equity options via Asset Swapped Convertible Option Transactions (ASCOTs). 

The strategy creates longer term, geared exposure to

Japanese equities via the option contained in the selected convertible issue. The strategy enables the fund to have access to that geared equity exposure at low cost, and to deliver a multiple of the positive return of the underlying Japanese equity market. 

The warrant created by asset swapping a convertible bond (usually on a fixed vs. floating rate basis) is constructed by selling the fixed income value of the convertible bond subject to a repurchase agreement, in effect creating a synthetic ‘short’ of the Japanese fixed income market. 

The managers aim to return three to five times the underlying equity market with the multiple they get on the upside, currently calculated at about seven times, while the multiple on the downside is about three times. 

Performance is volatile but over the long term enjoys significant outperformance. Over the last five years the fund is up 89.08 per cent compared to 14.73 per cent for Topix, the Japanese stock market, and over 10 years it’s up 401.11 per cent compared to 73.89 per cent for the market. It has outperformed the market by 6.05 times over five years and 5.43 times of 10 years. 

Nevertheless, performance is subject to short-term volatility. 2018 was a difficult year which reflected a poor year for the Japanese stock market. 

However, the last time the firm’s strategy was in this position was in 2005 when within six months, the firm had gained USD100 million in assets and was enjoying a six fold increase in performance.

The original Dejima fund was launched by Trevor Sliwerski in 1998. Sliwerski has more than 35 years of experience in Japanese markets with Nomura, Flemings, Barings and Investec, and continues to manage the fund. The fund originally had monthly dealing but the current version, in action since 2005, allows investors to deal weekly, giving them greater liquidity. The investor base is largely funds of funds, family offices and sophisticated investors, drawn from the UK, Hong Kong, Singapore and Switzerland.

Lonergan says: “We think that the December performance for equities globally was odd and that Japan had a blip because of the earthquake and hurricanes that hit the country. We believe that now is a good opportunity to be investing in the space.”

Chaplin says: “When you look at Japan, people often go through the cycle of redemptions and no one wants to put money in at the bottom, but the implied volatility has come off and the supply and demand situation is now favourable.”

Chaplin observes that the changes in the Japanese equity markets are set to improve as return metrics are being adhered to much more closely by Japanese management than in the past. “Sentiment has been so very much worse than the data that has come out,” he says.

Lonergan explains that this fund’s strategy is unique, offering a strategy that big hedge funds and proprietary trading desks might use but with the fund achieving it through gearing, using options, as opposed to direct borrowing through leverage.

This means that while the assets are worth less when the fund has a difficult run, the managers are not having to use remedial action to recover assets.

The fund’s investment arena of choice is Japan because of its combination of low interest rates, low credit spreads and a wide range of diversified convertible bonds. 

“One could go to an investment bank and ask for an OTC option but the importance of what we do is that we buy the convertible bond from the market place and sell it back to the market place to exit it,” Lonergan explains. “We are trading with the market and so are not beholden to an investment bank’s trader for pricing.”

There are currently 110 convertible bond investment issues in Japan and the fund’s current portfolio has 20. The universe is growing again, as well, because post Abenomics, the market is trading above book value, enough that companies are more willing and able to issue convertible bonds.

 

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