As I was preparing for the monthly, I was surprised to see that the major indices were actually up this month. It definitely felt like a down month. But it turns out that it was just the large caps that were down and, notably, the exporter-heavy Nikkei 225 whose total return was -3.3% (I would note that March was a large ex-div month which added +1% or so to returns). The broader Topix index was up +0.2% of which the top 100 names were down -0.3%, mid 400 names were up +1.1%, and small caps were up +1.9% (all total returns). Similar to February, value outperformed growth, both within the Topix universe as well as MSCI. I should point out that, despite our “Quality-Value” mantra, we mean “undervalued” when we say “value” and not your traditional Fama-French definition of value. As such, because almost all of our names trade well above average PBRs within their sectors or market caps, our names are largely bucketed under Growth. Just as a side note, MSCI properly uses EPS growth rates as their factor assessment while Topix just sorts the relevant constituents by PBR and places the high ones in Growth and the low ones in Value. However, the MSCI and Topix style indices have relatively high correlation between each other which basically goes to show that style indices are probably useless (unless you think high EPS growth and high PBRs are correlated, which I suppose has some truth but shouldn’t necessarily be the case). In either case, our correlations to either factor is comparatively low but that with Quality is definitely higher.

 

Anyway, using my often-quoted statistic of MSCI Large Growth vs MSCI Small Value returns, this spread widened by another -3.9% in March, making the year-to-date spread -9.9% of which, I’d say about 2/3rd comes from the style spread and 1/3rd from the mega-cap vs rest-of-market. This is a major shift from 2024. After the strong run from early 2023 to the first quarter of 2024, the Japanese markets have been largely flat during the rest of 2024 without much strong bias between market cap or style (large caps still outperformed slightly but style shifted from growth to value). However, both large caps and growth clearly began to underperform this year (while the meaning is equivalent, I hesitate to say that small-caps or value were outperforming). If we could truly isolate all factors, I’d guess that it is just momentum reversal.

 

Not that any of it matters to our strategy. I look at these figures because of my background in quants trading and derivatives but, in all honesty, is irrelevant to the TriVista strategy. [...]

 

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“Certainty is the great enemy of unity. Certainty is the deadly enemy of tolerance. … Our faith is a living thing precisely because it walks hand in hand with doubt. If there were only certainty and no doubt, there would be no mystery and therefore no need for faith.” – Cardinal Lawrence, played by Ralph Fiennes, in Conclave.

 

Last month, we were back on the road to see existing and prospective investors. We generally made it a point to go twice a year but that changed with the pandemic, and we reduced our pace to once a year or less. Besides, these global tours had become much more exhausting with age. However, I have to admit that it was good to see potential partners in person again. Just as I dislike Zoom meetings with our companies, I much prefer investor meetings face-to-face as well. So much more color can be expressed (and received) through body language; one doesn’t have to be Japanese to know that these subtle signs are a major tell for both sides of the table. Besides, it’s simply more fun and enjoyable. And we get to eat some foods that are simply not available in Japan, at least not at the quality we remember, New York bagels being one. As such, we will restart our twice-a-year trip (and not just for the bagels).

 

As it’s been a while since we were on our last trip, like a first-time traveler in business class, I was unable to settle in and had to play with all of the buttons on the new high-privacy A350 seats. Furthermore, the movie library was incredibly long so I spent at least 20~30 minutes watching several previews. I had to jot down the list of about 20 movies I wanted to watch later (I inevitably lost that list). On the flight, though, I ended up watching only one or two. Conclave was one of them.

 

When I flick through new movie lists, whether it be on the plane or Netflix, there isn’t any pattern that makes me pause and want to watch the preview. Some are easy like prequels/sequels of existing series. Some have a name that piques my interest or maybe it’s the poster. But most often, it’s who the lead is. Ralph Fiennes is most famous in, of course, the Harry Potter series playing Voldemort. I can’t say that I was a fan of the series, and I’ve never read her books (I’m much more of a Lord of the Rings person; I’ve read almost every Tolkien or LOTR-related book published). But I’m guessing Voldemort was portrayed well. He’s also been in several other notable movies with great performances as the antagonist in Red Dragon (the Hannibal Lecter series), the Greek God Hades in the Titans series (Clash of the Titans and Wrath of the Titans), “M” in a few Daniel Craig 007s (of course, I wouldn’t miss those!), and was the lead in a star-studded cast in The Grand Budapest Hotel, as well as, more recently, The Menu which, I must say, left a very strong impression.

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Because of these great experiences, I selected Conclave as the first movie to watch. And it did not disappoint. It was very thoughtful and intriguing to watch and reminded me, a little, of 12 Angry Men, though the ending was not quite what I expected. And I’d say Cardinal Lawrence’s quote does explain well the significance of religion.

 

I would say that the quote is also suitable for investing. The many variables that ultimately culminates into a number representing value, whether it be the price of Toyota, oil, gold, or bitcoin, is based on an uncertain future, as well as unclear and imperfect past and present information, with a vast number of views that change by the second, producing a market of buyers and sellers. It is this uncertainty that creates opportunity. It is doubt that makes one person sell at the same price that another buys. It is mystery that draws us to the market. And it is faith that creates conviction within the uncertainty and doubt.

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Arguably, we are living in a time when uncertainty is growing. Yes, the last 5 years had seen some unprecedented events. But someday, we were sure to escape COVID. While it was a major disruption to the world economic order (with some possibly permanent ramifications), it was still just a temporary disturbance in time, albeit longer than expected. The war in Ukraine, similarly, will eventually end. But some changes will have lasting consequences. I suspect AI is one such evolution, though I am hardly an expert. I had my doubts at first but now, I am a believer. I have posited that sustained inflation, wage increases, and rising interest rates in Japan are another. Both are events that we all seemed certain never to envision (at least in our investing lifetime). Just a few years ago, I suspect very few people would have thought AI would revolutionize the world this quickly. And even while we first suggested back in early 2022 that we may finally see a period of positive real interest rates here in Japan, I still thought it be far-fetched myself.

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Now, we may be in the midst of seeing yet another impossibility happen, the unraveling of the Western alliance. Recent news articles seem to suggest that possibility. A recent New York Times article read, “Now Europe Knows What Trump’s Team Calls It Behind Its Back: ‘Pathetic’”. Prime Minister Mark Carney says “old relationship with US ‘is over’”. Reuters reported that “South Korea, China, Japan agree to promote regional trade as Trump tariffs loom”. Who would have thought, in their wildest dreams, that the transatlantic partnership might be in jeopardy, that the US’s closest ally would question their relationship, and that the 3 historically hostile Asian powers might unite.

 

These alliances were all based on faith in the US, one that we were absolutely convinced without a shred of doubt or uncertainty that it could ever be questioned. And yet, now, we are questioning.

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What does this mean? For now, we appear to be witnessing a trend away from dollar-denominated assets. Could the faith of the US government falter? With 30% of US DHBP held by foreigners (of which a quarter is held by Japan and China), this might be significant. Might the US dollar no longer become the world’s reserve currency? Perhaps the yen does actually strengthen back to 100 yen per dollar, something which still feels like an impossibility but who knows? What implications does that have to Japan, our portfolio, and future investments? I’m not certain. What I do know is, like our thesis on Japan, the answer won’t be to buy “the market”. We do not think “buy Japan” is the way to take advantage of the changing dynamics here and one needs to be selective regarding what to own. Similarly, I’m guessing this will be true about most equity markets and the huge shift toward passive investing during the last several decades will reverse. Active management will, in my view, become increasingly important, particularly if growth slows in a higher risk-free rate environment. It will no longer make sense to simply buy-and-hold equities if one wants to maintain their current rate of return. In early March, I read in the FT that Norway’s sovereign wealth fund made its first allocation to a long/short strategy and is exploring additional mandates in Europe and the US. This makes sense to me. I would argue similarly in other markets if it weren’t for the fact that, at least in Japan, the shorts will have to contend with the rise in activism which runs the risk of random short squeezes, primarily in companies that most likely would invite shorts, i.e. low-quality enterprises. But, in either case, diversification will finally start to make sense and that with managers running actively managed portfolios, whether it be long-only or long/short (of course, I think those portfolios should be highly concentrated, but I’m biased by the endowment model of investing [not to mention being self-serving]).

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In either case, what was certain is now uncertain. So, we must have faith to survive. Rising uncertainty means rising opportunity. We should embrace this new environment with faith. Let me end on a lighter note with a quote from Men in Black:
 

“1,500 years ago, everybody knew the Earth was the center of the universe. 500 years ago, everybody knew the Earth was flat, and 15 minutes ago, you knew that humans were alone on this planet. Imagine what you’ll know tomorrow.” – Agent Kay, played by Tommy Lee Jones, from Men in Black.

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