RNS Number:4707B
Prospect Japan Fund Ld
12 April 2006
THE PROSPECT JAPAN FUND LIMITED
PRELIMINARY PROFIT ANNOUNCEMENT
This is not the Company's statutory financial statements.
All figures are based on the audited financial statements.
Change of accounting policies: adoption of new UK Financial Reporting Standards
("FRSs"):
In the current year, the Company has adopted new UK FRSs, applicable for listed
entities for accounting periods beginning on or after 1st January, 2005.
Under these revised standards, investments are valued at bid price, and
transaction costs and commissions are charged to the Statement of Total Return.
This is in accordance with the requirements of FRS 25 and FRS 26.
CHAIRMAN'S REPORT
For the year ended 31 December, 2005
Performance - Japanese small cap equities enjoyed another year of positive
returns during 2005, with TOPIX SMALL up 39.35% for the year. During this
review period, the net asset value ("NAV") per share of the Company returned
39.41% (on a mid market basis). The shares ended the year trading at a discount
of 5.7% to the underlying NAV per share.
Dividend - As with previous years and in line with expectation, the Company has
not earned sufficient income to pay a dividend to shareholders.
Directorate - Mr Rupert Evans is subject to annual re-election under the
Combined Code due to his position as a Director of the Manager and, being
eligible, has offered himself for re-election. All of the other Directors are
totally independent and this provides an appropriate balance.
Due to the length of my tenure on the Board I am now subject to annual
re-election and I offer myself for such re-election. My fellow Directors have
met in my absence for the purpose of considering my eligibility for re-election.
They considered that my experience, my independence of mind and the manner in
which I have filled the role of Chairman over the last 12 years has been
beneficial to the Company. They confirmed that they wish me to continue as
Chairman and they are recommending that I be re-elected as a Director at the
forthcoming Annual General Meeting.
The Board has considered the proposal for the re-election of each of the
above-named Directors and recommends to shareholders that they vote in favour of
the proposals.
Continuation Vote - In accordance with the Articles of Association of the
Company, a Special Resolution that the Company be wound up was considered at the
2005 Annual General Meeting. Shareholders voted against the Special Resolution
in line with the recommendations of the Board. A further continuation vote will
be held at the Annual General Meeting in 2008.
Association of Investment Trust Companies - The Company's application for
membership of the AITC was accepted on 2 December 2005. I believe that
membership will be helpful in raising the Company's profile among UK investors.
Directors' remuneration - The Board has reviewed the level of remuneration
received and agreed that Directors' fees for 2006 remain at the same level as
2005, being #15,000 per annum for the Chairman, #12,000 per annum for the
Chairman of the Audit Committee and #10,000 per annum for Directors.
Annual General Meeting - The Annual General Meeting of the Company is due to
take place on 31 May 2006 at 10.00am at the Company's registered office at
Trafalgar Court, St Peter Port, Guernsey. Full details of the meeting are given
in the Company's Annual Report and I look forward to meeting you then.
David Fitzwilliam-Lay
Chairman
INVESTMENT ADVISER'S REPORT
For the year ended 31 December, 2005
Fund and Market Performance (%), US$ NAV
1 Year 3 Year 5 Year
(Annualized) (Annualized)
PROSPECT JAPAN FUND* 39.41 38.87 22.33
Topix Small 39.35 39.46 17.06
TSE2 50.34 53.74 22.70
* Based on mid price.
Prospect Japan Fund inception date is 20 December 1994. Topix Small is a
capitalization-weighted index designed to measure the stocks not included in the
Topix 500 Index that are listed on the First Section of the Tokyo Stock
Exchange. TSE2 is the capitalization-weighted index of all companies listed on
the Second Section of the Tokyo Stock Exchange. As of August 2003, the benchmark
of the Prospect Japan Fund changed from TSE2 to Topix Small since its
characteristics with respect to average market capitalization more closely
resemble the investment strategy pursued by the portfolio. Above performance is
net of fees and expenses and includes reinvestment of dividends and capital
gains. Prospect Japan Fund performance from Prospect Asset Management. Index
performance from SEI Investments.
The Prospect Japan Fund had outstanding performance in 2005, up 39.41%. In
particular, the second half of the year showed excellent gains in the real
estate and retail sectors, where the Fund is heavily concentrated. Amidst the
sharp rise in the market, however, we remain cautious on the outlook going
forward. Much of the market has now risen to valuations we cannot reconcile with
medium-term earnings growth potential at the individual company level. We remain
broadly unsympathetic to the argument "this time is different" because that is
not the message we are getting from our company visits. The most recent survey
of corporate profits forecasts second-half profit growth of 3.9% to March 2006.
Our positions in retail and real estate continue to prove rewarding, and we
remain positive in this area, as well as in 2005's laggard sector, J-REITs. We
remain optimistic on smaller, high RoE specialty retailers. One theme in this
sector is retailers which consistently alter their merchandise mix to meet the
shifting demands in trends in women's fashion. By contrast we find the business
models of many of the traditional big city department stores to be outmoded,
particularly with the gradual phasing out of traditional Japanese corporate
practices such as year-end gift giving.
Our positions in Property & Construction continue to deliver encouraging
results. Our readings show the J-REITs to be the most attractively valued set of
opportunities in the broadly defined real estate sector (Figure 1). We are
especially bullish on the group now that they are so far behind the real estate
stocks themselves as we cannot see why only the real estate which is owned by
companies has gone up in price, while that owned by J-REITs has not.
Figure 1: J-REITs plunge relative to the market - the most overlooked sector?
(see attached)
Reflecting on a year of mixed fortunes
We at Prospect failed to make the psychological adjustment required by this bull
phase and we remained puzzled by the market's logic. The mood seems redolent of
1986-88. Those of us active in the market then remember with humility how
difficult it was fully to enter into the spirit of the party. It's difficult to
do again in one's forties. We believe some measure of caution is warranted by
the fundamental outlook for stocks.
The factor which sparked the Quarter 3 bull run was not a fundamental one. It
was politics - and here we entirely failed to see what was so exciting. Our view
has been and remains that Prime Minister Koizumi is of little relevance to
stocks. This led us to underestimate the effect positive press coverage of
"reform" would have on non-resident investors. For us nothing changed - nothing
that was impossible before the election has suddenly become possible. Indeed the
laws that would have been passed in the absence of an election have in fact been
passed in unchanged form. Neither we nor the management of the companies in
which we invest spend time wondering about the future of the Post Office. We
remain puzzled that so many people do.
We do not base the positioning of the Fund on a macro view, but we do test our
micro presumptions against the macro data. In particular, the last ten years in
Japan has taught us to be wary of a stock market rally unless it is accompanied
by a major fall in bond prices. While the 10-year benchmark JGB yield briefly
touched 1.63% in mid-November, it came back to 1.48% as of the year end. Bonds
have, in our view singularly failed to embrace the view of the world now
expressed in stock prices. This, our experience suggests, ought to worry us.
The puzzle we have failed to resolve is whether trusting the bond markets -
which we have tended to do - is sensible when commodities, and now the action of
individual stocks, is sending the opposite message. On reflection, perhaps we
should have noted more carefully the second half of 1999, when stocks rose and
bond prices too. In the end bonds were right, but managers who did not
participate in the rally in stocks that peaked in February 2000 experienced a
difficult six months prior to the peak.
The macro dilemma can be summarized as follows: Is the current situation
obviously a case of excess supply, returning deflation, and markets forecasting
very low real returns in future - in which case the message from long bonds
needs to be taken seriously by stocks? Or is it in fact a case of excess debt,
excess liquidity growth, and a real danger of resurgent inflation against a
backdrop of a spreading energy shortage - in which case commodities are telling
the story of importance to stocks in Japan.
We tend to suspect that in the near term it is the former, and in the longer
term the latter, which is closer to a correct classification. What has
wrong-footed us in the later part of this year is the speed with which Japanese
stocks have moved like commodities. This sort of step change in the way the
market views itself comes infrequently, and we are chastened that we largely
missed this one.
Our views have remained prosaic. Evidence is clearly there that labour market
conditions are improving. This observation underpins our positioning in
consumption-related stocks. But we remain aware that the pace of improvement is
slow and its scope patchy. We have also been encouraged by the firming of
property prices - with which we remain closely in touch via our affiliated
company Prospect Residential Advisors, which manages a listed J-REIT. Yet these
have presented themselves to us as rather small scale, single stock stories, and
not as the sort of "Japan jumps free of recession" argument the market appears
to have had in mind.
A discussion of labour market conditions highlights how mixed the data is when
examined closely. A November survey by the Ministry of Health, Labor and Welfare
suggested that companies faced the most acute shortage of appropriate workers
since August 1992. Clearly this is a "good thing". Perhaps partly as a result,
the Nihon Keizai Shimbun's preliminary compilation of major companies' winter
bonuses showed a 5.35% increase over a year - a new all-time high. This
represents the first time in 15 years that the rate of increase will exceed 5%.
The only year stronger than 2005 was the Bubble era peak of 1990 (with a rise of
6.4%). So far so good.
But the most interesting features of this report are two important disparities
that have opened up. The first is between companies using "performance-based"
remuneration systems and those that do not (that is to say, those that continue
to operate pure, or relatively pure, seniority based systems). Those that do use
performance-based systems will see bonuses rise an average of 13%, while firms
that do not will see an increase of only 2.3%.
The second important divergence has opened up between manufacturers and
non-manufacturers. Manufacturers will raise bonuses by 7.25%, an acceleration of
2.7 percentage points compared with the prior year and the second highest rate
of increase ever (after the 8.46% of 1989). Only two of 16 industries will see
bonuses fall (shipbuilding and precision machinery) while materials and
energy-related companies will see a whopping 44% rise in bonuses. Yet for
non-manufacturing firms bonuses will grow a mere 0.23%. Bonuses will actually
decline in four of nine industries, leaving a bare majority in positive
territory.
According to Government data (the Labor Force Survey of the Ministry of Internal
Affairs and Communications) only 20% of the employed workforce works in
manufacturing. Though firm data is elusive, we suspect less than 10% of the
workforce is the beneficiary of any sort of performance-related pay. So the
Nikkei's headline about bonuses actually told us much less than it might appear.
Perhaps dichotomy is why new car sales in November slumped to the lowest level
in 30 years. It is still not the case that all parts of consumption can trend
higher, in our view. One area has to be weak in order for another to be strong,
it would appear to us.
This underscores our perspective that, while many encouraging signs exist, the
current recovery is still rather patchy and uneven.
Figure 2: Headline and Median CPI - No genuine resumption of inflation? (see
attached)
A further area in which our perception differs from that of the consensus is
with regards to inflation. Despite much commentary deflation has not given way
to genuine inflation. In fact, the median CPI (a useful measure calculated by
Takehiro Sato at Morgan Stanley) shows no sign of breaking decisively above
zero. The Government's new Core CPI measure on the same basis is used in the US,
and this too fails to confirm the onset of inflation. We see the median CPI as a
leading indicator and would suggest that no further good news is likely to be
delivered in terms of a resumption of measured inflation for the time being.
Figure 3: Japanese Core CPI & Japan's Core CPI restated on the same basis as the
US Core CPI measure - persistent deflation? (see attached)
But this is where it gets difficult. While our company visits tell us that
companies are in the main still struggling for pricing power, optimists
interpret the absence of inflationary pressures as indicating that monetary
policy will remain looser for longer. We just don't know - and we don't invest
on the basis of calls on what policy makers are going to do or not going to do.
What we do think is that the outline of policy is far from clear, while what we
hear from companies is "real world" "real time" information. The environment is
better, certainly, but transformed? Probably not, in our view.
Of course we are encouraged when talk of delaying the worst aspects of fiscal
tightening (a rise in the consumption tax) appears in the press; we are
heartened when the Bank of Japan ("BoJ") appears to retreat from monetary
tightening. But we are disturbed when a Nihon Keizai Shimbun front page article
advertises a BoJ effort to rein in the growth of real estate lending; and we
wonder whether delaying obvious tax increases but accelerating "stealth" tax
increases (for instance, health charges) really improves the outlook for the
sorts of companies in which we invest.
So where could we be wrong? So far we have underestimated investors' animal
spirits - and perhaps animal spirits alone can carry us further. Arguably too we
have not been adequately encouraged by the depreciation of the Yen against major
currencies. This alone can be seen to carry the potential to become a massive
reflationary influence. Maybe "reform" does matter after all. Put simply,
perhaps our mistake is to remain locked in a 1995-2005 mindset at a time when
events and the market have moved on.
But reviewing Japan at year end we still cannot find the true "positive feedback
loop" story that drives really big bull markets. Nothing appears remarkable in
the economic data, and companies seem to us to be facing many of the same
problems that they have confronted over the past few years. Our team makes 800
company visits a year, and while broadly encouraged by what we hear, we still
face problems in reconciling the mid-term outlook for profit growth with the
recent rise in the market.
The most recent survey of corporate profits (the BoJ's December Tankan)
forecasts 2H profit growth of 3.9% yoy to March 2006. This compares with Topix's
gain of 43.5% in 2005, which can be read as a proxy for the entire market.
Prospect Asset Management, Inc.
8 February, 2006
The Prospect Japan Fund is a closed-end investment company incorporated in
Guernsey, and listed on the London Stock Exchange. The Company's investment
objective is to achieve long-term capital growth from a portfolio of securities
primarily of smaller Japanese companies Listed or traded on Japanese Stock
Markets. Past performance is no indication of future results.
Topix is a capitalization-weighted index of all companies listed on the First
Section of the Tokyo Stock Exchange.
STATEMENT OF TOTAL RETURN
for the year ended 31 December 2005
Revenue Capital Total Revenue Capital Total
2005 2005 2005 2004 2004 2004
In US In US In US In US In US In US
Dollars Dollars Dollars Dollars Dollars Dollars
Gains on
investments - 74,794,486 74,794,486 - 42,620,360 42,620,360
Other
(losses)/gains - (1,659,304) (1,659,304) - 190,780 190,780
Investment
income:
Dividends 1,976,420 - 1,976,420 1,975,903 - 1,975,903
Interest 15,236 - 15,236 64,455 - 64,455
-------- --------- --------- -------- --------- ---------
1,991,656 73,135,182 75,126,838 2,040,358 42,811,140 44,851,498
Management fee (2,974,534) - (2,974,534) (2,682,660) - (2,682,660)
Other expenses (1,671,577) - (1,671,577) (924,273) - (924,273)
--------- --------- --------- --------- --------- ---------
(Deficit) / return on
ordinary
activities
before tax (2,654,455) 73,135,182 70,480,727 (1,566,575) 42,811,140 41,244,565
--------- --------- --------- --------- --------- ---------
Withholding
tax (138,349) - (138,349) (127,999) - (127,999)
--------- --------- --------- --------- --------- ---------
(Deficit) / return on
ordinary
activities for
the year (2,792,804) 73,135,182 70,342,378 (1,694,574) 42,811,140 41,116,566
========= ========= ========= ========= ========= =========
(Deficit) / return per Ordinary Share -
Basic &
Diluted (0.027) 0.693 0.666 (0.016) 0.397 0.381
========= ========= ========= ========= ========= =========
The above results relate to continuing operations of the Company.
BALANCE SHEET
as at 31 December 2005
2005 2004
In U.S. Dollars In U.S. Dollars
Investments 222,256,720 172,510,268
Current assets
Debtors 10,642,397 829,238
Bank deposits 17,062,149 9,824,151
---------- ----------
27,704,546 10,653,389
Liabilities falling due within one year
Creditors 1,176,550 1,016,712
---------- ----------
Net current assets 26,527,996 9,636,677
========== ==========
248,784,716 182,146,945
========== ==========
Represented by:
SHARE CAPITAL AND RESERVES
Share capital 105,354 107,063
Redemption reserve 102,139,113 104,906,086
Capital redemption reserve 310,155 308,446
Other reserves 146,230,094 76,825,350
---------- ----------
Shareholders' funds attributable to
equity interests 248,784,716 182,146,945
========== ==========
Ordinary Shares in issue 105,354,520 107,063,020
========== ==========
Net Asset Value per Ordinary Share -
Basic & Diluted 2.36 1.70
========== ==========
This preliminary profit announcement was approved by the Board of Directors on
12 April 2006.
CASH FLOW STATEMENT
for the year ended 31 December 2005
2005 2004
In U.S. Dollars In U.S. Dollars
Operating activities
Net cash outflow from operating
activities (2,634,431) (1,845,018)
--------- ----------
Financial investment
Purchase of investments (126,739,575) (69,800,699)
Sale of investments 141,038,281 74,659,317
---------- ----------
Net cash inflow from financial
investment 14,298,706 4,858,618
---------- ----------
Net cash inflow before financing 11,664,275 3,013,600
Financing
Repurchase of shares (2,766,973) (2,699,592)
---------- ----------
Net cash outflow from financing (2,766,973) (2,699,592)
---------- ----------
Increase in cash 8,897,302 314,008
========== ==========
Reconciliation of net cash inflow to movement
in net funds
Net cash inflow 8,897,302 314,008
Effects of foreign exchange rate
changes (1,659,304) 190,780
Net funds at beginning of year 9,824,151 9,319,363
---------- ----------
Net funds at end of year 17,062,149 9,824,151
========== ==========
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