Unlocking Japan’s next chapter of growth

As with any investment, your capital is at risk. Past performance is not a guide to future returns.

Sarah Clark (SC): Good morning, everyone, and thank you very much for joining this webinar on the Baillie Gifford Japanese Fund. My name is Sarah Clark, and I'm an investment specialist for the Japan team. I'm joined today by investment managers Matthew Brett and Jared Anderson, who are the co-managers of the Japanese Fund. Welcome, both.

Matthew Brett (MB) & Jared Anderson (JA): Hi Sarah.

SC: As a reminder, this fund aims to invest in Japan's best growth companies. We do this by taking a flexible approach and constructing a portfolio of 45 to 65 companies across the market cap range. Our plan for today is to have a 30-minute discussion on Japan's next stage of growth, the structural opportunities that we are backing, and how the fund is positioned to capitalise on this. 

We'll then move on to answer questions from the audience, so please do submit questions as we go through using the Q&A function at the bottom of the screen, and we'll answer as many of them as we can today. Let's start with you, Matt. I wanted to start with a bit of scene setting. A lot has happened since the start of the year in global markets, especially with tariffs. How are you thinking about Japan in this context?

MB: I think it's pretty obvious that the global macro backdrop has been getting more challenging in recent times. It's the really obvious things - the tariffs and the wars, and in some countries, maybe even internal conflicts going on. This clearly is presenting globally a more challenging backdrop for investing. 

Under the surface, within the idea of macro, there's also continuing technology progress happening, which I think sometimes people don't see as clearly. It's not as newsworthy, but we can see under the surface that AI is continuing to make some pretty big strides forward, both theoretically and practically. We can see the Chinese are continuing to do really well in some areas, most dramatically, for example, in cars recently. I think the overall backdrop is getting tougher. That being said, when we look at Japan specifically, I think domestic Japan has actually been doing very well.

Japan ended the years of deflation some time ago and had a period without much inflation or deflation. Recently, it's clearly had inflation across a whole variety of different areas, whether you look at things like land prices, food prices - a whole load of things have been on a more inflationary trend. One of the questions I've often been asked is, well, this is all very good, but this is just increasing people's costs. It doesn't really matter until we get that backed up by wage rises. I think that's what's been so encouraging in recent times - that we've seen the wages starting to rise, both for small and big companies, and those wages have been rising at the kind of level which hasn't been seen since the late 1980s in Japan. I think that's a very encouraging backdrop for Japan specifically. It's allowed the Bank of Japan to move away from QQE, which is encouraging and to start the process of interest rate rises.

As we look at the domestic economy in Japan, it looks a lot more normal than it did a few years ago. I think that great dragon of deflation is very much in the past now. That being said, going back to the start in terms of the more global challenges that are happening, there is the risk here of importing difficulties from elsewhere. The reality is that Japan's biggest trading partner is the US, and its second biggest trading partner is China. Those two countries are engaged in a trade war with each other, and in the case of the US, with other people as well. The risk is that the total pie shrinks and that that's challenging for Japan, but overall, my perspective on the macro situation is, yes, there's a lot going on and yes, it's more challenging than before, but actually, Japan is a relative haven within what we're seeing, and I think it's relatively quite well positioned.

SC: Thanks, Matt, that's clear. It sounds like there's some positive developments happening there. Coming to you now, Jared. One question that I am often asked by clients is about corporate governance reforms. Is this a value story or is it good for growth?

JA: Thanks, Sarah, and good morning to everyone. I think at a high level, some of the changes, some of the movements that we've seen to date, obviously these things are good for corporate Japan in general. You have a corporate sector that is more agile, more dynamic, more shareholder-friendly, that should drive up returns, attract flows of capital, both domestic and foreign, more so as the world outside of Japan looks increasingly shaky, as Matt just mentioned. 

However, I would caveat that with the following - I think we're maybe just at halftime here. If you look at the Japanese index via the US index, for example, and take something like return on equity, Japan's roughly 10 per cent. US is roughly 20 per cent. There's a long way to go for here. There's a long runway still in play.

I think the first half has very much been about companies going after low-hanging fruit, so selling off non-core assets, doing buybacks, thinking harder about board independence, that kind of thing. Return on equity maybe going from 5 per cent to 10 per cent. That's not really where we play. 

I think what's interesting for us is how the second half plays out here. This could be much more beneficial for the types of companies that we invest in when you combine that more shareholder-friendly mindset with, for example, more assertive pricing, with structural growth drivers, gaming, automation, healthcare - take your pick. That then brings return on equity of 15, 20 per cent into play, and that's where we want to be. We want to own high-quality companies for long periods of time, not mediocre ones that have suddenly come to terms with some of these concepts like shareholder value. 

What we're really excited about at this juncture is really squeezing more value from already strong franchises with great brands, with distribution muscle and marketing dexterity, and really elevating returns to where global peers are. To give some concrete examples, companies like CAL in cosmetics, working some of its leading brands like Molten Brown harder or Asahi, the beer company, pushing its premium products into Europe. Or Daikin, who make air conditioners and have number one market share globally, building out more of a presence in North America. This is about more ambition, more of an outward looking agenda from a standing start. That's that too here, and that should suit the types of companies that we're backing.

SC: Thanks, Jared. Some good examples there of companies in the portfolio and what they've been doing. Coming back to you, Matt, so we're halfway through the year. How has the macro backdrop that you were describing translated into fund performance so far?

MB: It's obviously a very short period of time, the first half of the year, but in general, it's been a good start to the year for the fund, and I think this isn't particularly surprising. 

We're quality growth investors. So overall, our portfolios are a bit less cyclical than the wider market. We don't have any car companies, for example. We don't own any megabanks, for example. Also, because we don't own any car companies at the moment, we're also a bit more domestically focused right now, which is where less of the challenges have been. We do have a lot in internet and service-related businesses, and also quite a lot in a variety of quality growth names. 

If you look back over the longer time period, in general, tougher times haven't been a particular problem for us as a strategy in relative terms. In fact, the problem we've had in recent years has more been the other way around, that we've had a difficult time coming out of COVID, as a very strong global economic recovery combined with a very weak yen resulted in some pretty high returns for some of the most cyclical areas in Japan. 

However, I think that that momentum is fading now, and particularly, for example, in the car area, it's pretty clear that technologically, the Japanese have unfortunately fallen quite a long way behind the leaders, both in the US but also in China. I think that's going to present continuing challenges for those areas. Basically, what has been in many ways a bit of a headwind to us in recent years of this rising tide lifting all the boats, I think the tougher times are probably upon us again. Consequently, we would have a good degree of conviction in this portfolio continuing to be able to demonstrate growth, and that growth probably being more valued by the market than in the very buoyant times we've had in recent years.

SC: Thanks, Matt. Coming back to you now, Jared. One area that I know you've been looking at quite a lot is gaming companies, and we've obviously recently added Square Enix to the fund. What's the broader opportunity here?

JA: Yeah, thanks. Look, I don't think it will be a surprise to the audience to call out gaming as a pocket of Japan that can stand its own ground on a global stage. You have well-known companies like Sony, for example - 70 per cent global market share in high-end consoles. You've got the new Nintendo Switch doing record-breaking sales - more than 3.5 million units, in just a few days. That's more than the original console managed in a month, and of course the original switch was hugely hugely successful in its own right - one of the most popular consoles of all time. But, there's a number of trends here that are worth flagging. Most obviously, more and more people, young and old, are playing games, engaging with content and engaging in different ways. Japanese content is increasingly relevant outside of Japan - you only have to look at genres like animation here, one of the fastest growing genres in places like North America and places like Europe, and the number of mediums through which this content can be pushed is multiplying.

This is no longer just about mobile, console, PC… this is about film, this is about TV, this is about animation, this is about theme parks, and so on. The distribution side here is becoming much more fragmented, and the demand side is becoming much more broad based, and so that plays into the hands of the content owners. 

The cost structure in this industry is changing too. Over the last decade or so, you've had this pivot away from physical retail to digital, which has been a big tailwind. But what comes next here? What does AI do when 70-80 per cent of development time here is not doing creative work, but it's things like testing, it’s things like quality assurance. Can you strip out some of these costs? Can you streamline some of these workflows? What does that do to the economics? Of course, as gamers get older and richer, the back catalogs become much more valuable in a similar manner to what we see in music, in TV and film. Remember, this is still a relatively young industry, the other media forms. 

Finally, as you alluded to in the question, Sarah, there's real depth here beyond familiar names like Sony, like Nintendo. Square Enix, a recent purchase, is a really good example of a company that makes these brilliantly crafted games, like Final Fantasy and Dragon Quest, that have a large and loyal following. Really, these games are second to none when it comes to game making heritage, and when you mold that with some of the mentioned trends, there's a lot to be optimistic about here. Matt mentioned some of the car companies - I think there's a case to be made that content is fast replacing the car as Japan's prized export, and we're nicely placed for that.

SC: Thank you. I've no doubt that you rushed out last week to buy Nintendo's new Switch 2 console. Coming back to you now, Matt. We're seeing a lot of the companies in the portfolio making good progress. What would you highlight?

MB: I think one of the really interesting features of our portfolio for the past few years is that although the sales growth has been faster than the market, actually the earnings growth has been a bit slower, and a lot of that has been to do with some of the big names in the portfolio investing heavily in new areas. What is exciting me is we're starting to see that investment starting to come to realisation. 

For example, CyberAgent is invested very heavily in growing a business called AbimaTV, which is a bit like a cross between a Netflix and a YouTube type of business, and that business is basically at break-even now. So, as we push forward, we're starting to get the benefits coming through in terms of earnings coming from that one. Similarly, Rakuten invested very heavily in a mobile business, and again, that has now hit breakeven. Both of these businesses are businesses with high fixed costs, so once you get past the breakeven point, the incremental returns become extremely positive, and that's really encouraging in terms of progress. 

We've also seen progress from the likes of SBI, one of the major online financial companies in the portfolio. It's just agreed to sell its stake in SBI Sumishin Net Bank at a very good priced NTT and form a broader relationship with that group. It looks on track to be able to list its acquisition of Shinsei Bank, which would be a further step forward. The underlying progress across a variety of these internet names has been continuing under the surface, and I think over the next few years, we're going to see it really come through quite strongly in terms of earnings growth. 

Another name just to highlight briefly is Eisai, which has a very innovative Alzheimer's drug. This drug essentially tries to deal with the root cause of Alzheimer's by cleaning up the plaques that form in the brain that are probably one of the underlying causes of the condition. They're making really good progress with getting approvals, but also getting approval to be able to give the drug, not just through an intravenous type of injection, which is quite difficult when you need to do it in a healthcare setting, but through a simple injection into the muscle, which would make it massively easier for people to take it and benefit from it.

I think putting these things together, there's a number of companies in the portfolio where the growth might have been depressed by investment over the past few years. But now looking forward, they're going to realise the benefit of that investment, and that's why on a forward-looking basis, the analyst estimates for the portfolio are much higher than those of the market.

SC: Thanks Matt, some good progress there. Now, we are getting a few questions from the audience, so I'm keen to move on to those soon, but please do continue to submit questions if you have any. One final question for you, Jared. I'd love to hear your thoughts, given your experience of investing in other markets, something that you share with our clients. But what do you think makes Japan stand out as an exciting opportunity?

JA: Yeah, thanks, I’ll maybe just try and pull some of these things that we've talked about together. I think if we just take a step back here and look at the Japanese index, the TOPIX, say, versus the US index, the S&P - earnings per share growth over the last decade or so has pretty much been identical. What's not been identical is how these earnings have been appraised by the market. Japan, roughly speaking, has derated from, say, 20 times P.E. to 15. The US has rerated from about 20 times PE to 25 times, and that's even more pronounced if you layer on style factors like growth fee value.

Obviously, the former has really powered the US. Think about tech companies, think about software companies, but it's the latter that's powered Japan. Think about the auto companies, think about the banks. Matt was getting at this point earlier, but I think there's a question here about the sustainability of some of these earnings and the extent to which you want to make a cyclical adjustment of sorts. 

If you take the currency as an example - if you've got the yen dollar going from 100 to 150, and you've got a big chunk of your sales overseas, and those sales are disproportionately profitable, then you can quite easily end up in a position where your profits in the whole have doubled on the basis of currency moves alone. So, you need to be careful about distilling between structural growth and cyclical growth, and that's really why we're upbeat at this juncture. We're investing in companies that are faster growing, more profitable, less indebted via the index as a whole, and yet the valuation wedge after adjusting for different capital structures is very narrow. 

Now, is that right if our portfolio is forecast to grow earnings significantly faster than the index over the next few years? This is a question for the audience to answer, obviously. But look, our message here is quite a simple one, and it is that Japan has these world-leading companies with endearing traits, craftsmanship, precision engineering, durability. You don't see the egregious pay structures that are rampant in other markets, and they're going after these long-lasting secular growth themes, and they're on a big discount. So, you're potentially getting a three-pronged attack here. It's faster earnings growth, it's better and improving returns on capital, and it's higher valuations. In our mind, now is the time to own Japan's most exciting growth companies, and that's what this ticket is getting you.

SC: Thanks, Jared. I think that sums up very well, and it's an encouraging note to finish our questions on. I'm conscious of time and we do have quite a few audience questions that have come in, which is great, so let's move on to those. The first one is for you, Matt, and the question is on ESG. What role does ESG play in the manager's personal investment philosophy?

MB: The first thing to say is that we're growth investors and that naturally leads us to staying out of trouble when it comes to some ESG related things. When we look at where the growth is, we think there probably isn't going to be a great deal of growth in fossil fuels, and so currently we don't have any direct exposure in that area, for example. Similarly, tobacco is not an area where we see growth opportunities, so we don't have any exposure there. Overall, the weighted average carbon intensity of the portfolio drops out as being around half that of the wider market, which I think is unsurprising given our orientation towards some of the internet and the service-related businesses. 

That being said, we don't have an explicit label on the fund in terms of ESG. We're not seeking to be that type of fund. But certainly, it is something that we think about in the investment process. It's certainly something that at a high level, with my background is as a scientist, I think factually the world seems to be warming up and it would be unwise not to pay attention to that from a stock picking point of view.

Overall, there's certainly elements to which this is important to us, but there's also elements to which we don't let it constrain our universe.

SC: Okay. Second question for you, Jared, and this is around market cap range. Obviously this is an all-cap fund, but how do you select small and medium caps? Do those ideas feed in from our Shin Nippon Investment Trust, and roughly what percentage of the fund is in that small, medium cap?

JA: Thanks, Sarah. Obviously, I think a big strength of the team at Baillie Gifford is we have these different component parts to the Japanese team, one being the small cap team, which I myself am involved in, and I think we're looking for the most exciting growth companies in Japan. Obviously, that's a natural place to fish going down the market cap spectrum. 

Over the last few years, if we look at what's been in favour and what's been out of favour in Japan, small cap has been at the extreme end of that spectrum and not for good reasons. So certainly, in a historical context, if we look at the overlap in the all cap funds versus some of the small cap funds that we manage, it is probably around about 5-10 per cent, whereas historically, that number would be a lot higher. 

But it's certainly an area that we're zoned in on and I think that's both from a direct standpoint looking for new ideas to get into the fund but also an indirect standpoint when we're thinking about some of the more established businesses we own. The small cap universe is also a bit of a check on those names in terms of companies emerging, developing new products and services, pushing new technology, so that's something that won't change. As Matt mentioned, given the philosophy of the fund, going down that market cap spectrum is perfectly natural.

SC: Okay, thank you. We've received a question here that is about activists. This one is for you, Matt. Activists are leading to big improvements in ROE at many companies. The question is, is this a factor that you look at when selecting companies?

MB: It's an interesting question. The question, I think, is asking, activists are leading to improvements in ROE. I mean, certainly there's a correlation. There are certainly activists in Japan, and there's certainly improving ROEs in Japan. Whether the improving ROEs are always as much down to the activists as they would have people believe, I think, is unclear. 

There's been a long-standing drive within Japan with the governance code, the stewardship code, with actions of Japan Exchange to encourage companies to think about improving their return on capital and their return on equity. I think that's been a big driver of the improvements in returns in this area, even without the presence of activists. 

Secondly, a number of companies in Japan have improved their profits in recent years, and consequently, they are showing a higher ROE than the past. But the big question is the sustainability of those ROE improvements.

In some cases, we have very cyclical businesses that have been operating with the dual tailwinds of good demand post-COVID, and, in addition to that, a very weak yen. Now even before we talk about any kind of structural ROE improvement, if you have those conditions, then the earnings will improve and therefore the ROE will improve. The big question though is how sustainable that ROE improvement is, and I think in a number of cases that's questionable. 

That being said, of course we're always interested in companies that can go on a journey of having sustained high return on equity. One of the ways in which that can be done is by sometimes stopping doing things which are poorly returning. So yes, it does form a part of our process, but I just would slightly question the narrative that the main driver of ROE improvement in Japan has been activists. I think there's multiple drivers and a few complexities in there as well.

SC: Okay. We've received one question that's stock specific. This is on Calbee. The question is just focusing on how does it stack up against other snack companies? For example, like Pepsi in the US and Lotus Bakeries in Europe. Sorry, I never said I'm going to give this question to you, Jared. Apologies.

JA: For those that don't know, Calbee makes potato snacks and cereals. As is pointed out in the question, it's similar to something like Pepsi in the US. This is actually a good one to talk about because this is a business that has a really strong domestic franchise in Japan. And indeed, Pepsi uses Calbee to distribute in Japan. Pepsi's got a 20 per cent stake in Calbee, so the market position in Japan is very, very strong. You're talking 60, 70 per cent market share in snacks, in cereals. It's a very well-known company. The brand is very strong and has a real history of innovation in coming up with all these sorts of crazy flavors that you probably see in the news and in pictures - pizza flavored crisps, chocolate flavored crisps, that kind of thing. The domestic business here is really strong.

I think what's exciting about Calbee is, whether or not it can push that strength further afield, it's increasingly moving into markets like North America, China, the UK and other parts of Europe. The investment case here is really a bit about taking those attractive traits that we see in Japan and parachuting them into other geographies. 

This really comes back to some of the points that we were talking about earlier. If you were to look at the return on equity on something like Calbee, it's probably roughly 10, 15 per cent. If you were to look at a company like Pepsi in the US, easily 40, 50 per cent in a good year, so that's your blue-sky upside. Obviously, there's lots of differences between these companies in terms of size and scale. But a lot of the companies that we own in the portfolio, be it Calbee, be it Asahi, these kinds of names, consumer branded goods - we're starting to see a much more active, ambitious mindset from management teams and talk more openly about who their global peers are and who they're benchmarking themselves against. I think that's encouraging that the mindset is changing. Obviously, you have to then go and execute, but I think we're definitely moving in the right direction with these types of companies.

SC: Thanks, Jared. We've got a few more audience questions to go through, but there is still time to answer more, so please do submit if you have any. Coming back to you, Matt, the question we've received is on demographics. Is this a headwind to finding growth companies in Japan?

MB: I mean, I think demographics is undoubtedly not Japan's strongest suite, and the birth rate is very low, and the population is aging. That being said, it's not that dissimilar to large parts of the developed world in terms of having those trends. But, I think we need to distinguish here between the situation for the Japanese economy as a whole, and the situation for our portfolio. When it comes to our thinking about the Japanese economy, our view is that it's in a much healthier place than it was a number of years ago. 

We talked about that a bit at the start, but at the same time, Japan is a wealthy place already. Clearly, the demographics are a bit of a headwind, so we don't expect there to be a very large amount of growth in the domestic economy as a whole. Therefore, when we are trying to find growth businesses, what's really important to us is that they are able to take share domestically. So essentially, we've got this big stable pie available to us to invest in domestically, but what we're looking for are businesses that can structurally take more of that pie over time. That's led us over the years to a few biases. 

One of them is looking for things that are internet related things. For example, online retail or online financial services both play big parts in the portfolio, but also looking for things that make things structurally more efficient in Japan. For example, we have things like Bengoshi, which offers online legal advice, or Infomark, which allows restaurants to order more efficiently than the old-fashioned paper-based systems. What that means is within that portfolio, we talked a little bit about the exposure to smaller companies within the portfolio, but it's fair to say that domestically in particular, we skew smaller than the market. That is because we're looking for these newer emerging businesses that are going to have a long growth runway ahead of them by taking share from some of those big traditional companies operating in the domestic space.

SC: Thanks, Matt. Coming back to you now, Jared. This question is asking, are Japanese businesses run for shareholders in the same way that the US and European businesses are?

JA: Yeah. That's a good one. I think the first thing to say here is that Japanese shareholders are definitely moving up the pecking order in Japan. When I first went to Japan five, six years ago, you would pitch up to some of these companies and it was almost an affront to them that you were seeing them. They could be quite defensive, quite wary of the views of shareholders - I generalise, obviously, but that's completely turned on its head. The mindset, the mood here has changed. Even the function of investor relations is now a key cog in the machine. ‘Return on capital’, ‘return on equity’ - these terms are now firmly entrenched in the corporate vocabulary.

This point about balancing stakeholder needs and interest, if I was being provocative here, I might even suggest that shareholders increasingly rank higher in Japan versus the US versus Europe. If you take something like executive pay, and you look at median CEO pay in Japan for the bigger companies, it's probably one to two million US dollars. Go to the US, you can add a zero on there happily, and Europe is probably somewhere in the middle, albeit probably closer to Japan. It's not just the quantum of these pay packets; it's the composition too. The US is obviously much more heavily skewed to equity-based packages, and that's a simple transfer of value from shareholders to management. That sort of thing is just much less prevalent in Japan.

Obviously, there's some pluses and minuses that go along with that, but I think all these things are things to think about and things to consider. It's certainly no longer the case that shareholders in Japan are at the back of the queue, and indeed, I would be arguing on the contrary.

SC: Thanks, Jared. Matt, coming back to you. This question is on semiconductors. It's asking, does the fund have any semi-exposure, and what is Japan's global edge advantage in semis?

MB: To take the second part of that first, I think Japan has some clear advantage when it comes to very complicated, very difficult manufacturing processes. They've proven that over the years in a whole variety of different industries, and there are some maybe where that edge has been eroded over time with catch up elsewhere. The most obvious one right now would be cars coming out of China, where the Chinese have gone from being an importer to an exporter of cars quite quickly. 

But when it comes to semiconductors, the reality is that a lot of these things are very, very difficult to make, to the point where in some cases you have only one or two suppliers globally who are able to make that, and Japan does have a number of these companies. Now, in terms of our exposure to that area, right now it's fairly modest. We have some look-through exposure if you like through SoftBank's large investment in ARM which, although not a manufacturer of semiconductors, provides the design that's used in almost every smartphone globally and is increasingly exposed to other uses as well.

We also have things like SMC in the portfolio, which the pneumatic valves are also used in semiconductor production equipment, and we've certainly held names like this in the past. For example, we've had things like Disco and ADVANTEST in the portfolio in recent years, but don't currently hold them. I suppose the question is, why don't we currently hold them? There are two main reasons here. 

One is that we think this is part of a bigger mega trend of the adoption of technology and AI. In many cases, we find that to offer a better risk reward to invest in some of the internet businesses and Jared talked about some of the gaming businesses, for example, that are going to be the beneficiaries of the improved technology and the improved AI. We don't necessarily have to invest directly in the toolmaker. We can invest in the beneficiaries of those things. 

The second reason is that there's a lot of cyclicality in this industry, and it's been an incredibly booming industry in recent years. Some of that is undoubtedly real demand, but some of it may have been inflated. I was talking to Tokyo Electron a couple of weeks back when I was in Japan, and they make a variety of semiconductor production equipment and they've been selling a great deal to China in recent years. It's now half of their sales, basically, and of what they've been selling to China, it's not all even necessarily leading-edge equipment. Some of it is older equipment.

The Chinese companies have been paying very high prices for some of this equipment, but what is interesting is that the telemetrics allow them to see the utilisation of that equipment. In many cases, some of the machines that have been bought appear to be still sitting in a warehouse somewhere. It may well be that for geopolitical reasons, some of the demand that the Japanese semiconductor companies have experienced in recent years may well be China, to some extent, stockpiling equipment out of fear of being cut off from access in the future. 

There are multiple reasons why analysing these companies is quite tricky. Yes, these are good companies, and yes, we'll absolutely invest more in them again at some point. But we also want to think quite carefully about what is already embedded in the share prices, and we don't necessarily want to have a large exposure to an area that we think might have been over-earning in recent years.

That's the current position, but over the long run I would certainly expect to be coming into these companies again at some point in the future, given their very deep competitive edge.

SC: Thanks, Matt. We've got a couple of minutes left and two final questions, so I'm going to fire through these. Jared, this is on the Megabank. Someone's commenting that we don't have any exposure to these companies, but surely they will continue to benefit if interest rates continue to increase?

JA: The answer here is going to be similar to Matt's previous remarks. I think one point to make here is, first of all, these companies have done very well in share price terms. It was absolutely a mistake not to own them over the more recent past. The profits in MUFG, SMBC and Mizuho (the really big banks in Japan) are up 2x over the last three, four years and the share prices have been following suit. I would make a few points about rates going up, just to add a bit of nuance. On one hand, that argument sounds perfectly sensible - higher rates, higher profits, fine. I would stress the kind of size and complexity of the banking system in Japan.

I'd be a little hesitant just to make these kind of linear arguments. You've had a period of 30 years where rates have been next to nothing, so what we're seeing now is quite a big shock to the system. To make that a little less abstract, when rates were very, very low in Japan, you didn't really have competition for deposits, for example. It wasn't economic to win more deposits. They weren't doing anything for you. More recently, we've seen the emergence of challenger banks like Rakuten doing very well, so there's a competitive angle there. 

The second thing is, and again, this gets to the point of all these different linkages here, if we just take rates in and off themselves, fine higher rates - good for banks. But if we think about the exposure some of these mega banks have to business outside of Japan, non-yen revenue line, that's a significant bit of the megabank's business. It's maybe 50 per cent of profits, so if you're in a situation where rates are going up and the currency is going up, there's offsetting factors there, so it's certainly an area that we're looking at. Some of these big legacy sectors are worth keeping an eye on, and certainly, when we think about themes like AI and what that maybe does to the cost base, I think there's possible attractions in these companies. But I would be slightly hesitant in making the argument that higher rates just pile into these things, given what the share prices have done, given where expectations are, and given the exposure that these businesses have to the currency.

SC: Thank you. Final question for you, Matt, and it is on the yen. What are your expectations there? And what implications do you think it'll have for companies in the portfolio?

MB: The yen is one of those really, really hard questions, and as a result of that, we're basically stock pickers. At the end of the day, what we've generally done is run the portfolio with a pretty similar to the index mix of exporters and domestic companies. But I think sometimes things get so extreme that you have to pay attention to them. I think the yen is one of those at the moment, where it's just become really, really strikingly cheap. You can go to Japan now, and you can literally have double the number of hamburgers in Japan than the US. Or you can go for a meal in the central business district of Tokyo, and have a beer with your meal, and you can get change from ten pounds. That just feels totally wrong. You can get on the metro in Japan, and it costs about one pound.

A couple of weeks ago, I picked up some metal kitchen tongs. Not the world's most exciting thing, but some metal kitchen tongs. They were three pounds. I saw similar tongs in Marks and Spencer at the weekend, seventeen pounds for two. You can do the maths, but it's still a multiple more expensive in the UK than Japan. Right now, the yen does seem just strikingly cheap, and partly as a result of that, partly as a result of being really, really worried about the competitive position of some of the car companies, we've ended up somewhat overweight the yen. I'm perfectly happy with that. Overall, this portfolio would benefit a bit from a strengthening of the yen, and it would be quite helpful for the portfolio as an additional tailwind.

SC: Thanks, Matt. That is us now out of time. We've come to the end of today's webinar. Thank you both Matt and Jared for your time. Thank you to everyone who joined and for your questions. We hope you find that a really useful discussion on why we're excited about Japan's next chapter. If you do have any further questions, please do get in touch. Thank you.

Baillie Gifford Japanese Fund  Annual past performance to 31 March each year (net%)

Source: FE, Revolution, Japan Exchange Group. Total return net of charges, in sterling.
Share class returns calculated using 10am prices, while the Index is calculated close-to-close.
*TOPIX (in sterling)
**TOPIX (in sterling) plus at least 1.5% per annum over rolling five-year periods
***IA Japan Sector

Past performance is not a guide to future returns

The manager believes this is an appropriate target given the investment policy of the Fund and the approach taken by the manager when investing. In addition, the manager believes an appropriate performance comparison for this Fund is the Investment Association Japan Sector.

There is no guarantee that this objective will be achieved over any time period and actual investment returns may differ from this objective, particularly over shorter time periods.

Important information and risk factors

This communication was produced and approved in June 2025 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA).

Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority. Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.

Investment markets can go down as well as up and market conditions can change rapidly. The value of an investment in the Fund, and any income from it, can fall as well as rise and investors may not get back the amount invested.

The specific risks associated with the Fund include:

• Custody of assets involves a risk of loss if a custodian becomes insolvent or breaches duties of care.
• The Fund's exposure to a single market and currency may increase share price movements.
• The Fund has exposure to a foreign currency and changes in the rate of exchange will cause the value of any investment, and income from it, to fall as well as rise and you may not get back the amount invested.
• The Fund’s share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced.

Further details of the risks associated with investing in the Fund can be found in the Key Investor Information Document or the Prospectus, copies of which are available at bailliegifford.com.