November was yet another strong beta month, though I continue to be perplexed as to why. Black Friday sales were softer than I think we had hoped (in volume terms), the yield curve has inverted even further, and China was still in full zero-COVID mode (at the time). A recession is a near certainty (although the depth and length is uncertain) and corporate visibility is probably worse than before. And yet, we are now above the levels prior to the deep summer sell-off in Aug~Sep. TOPIX even closed the month almost flat YoY (-0.3% price return YTD to be precise and +2.2% total return YTD). Of course, in USD terms, it still looks pretty bad (TOPIX in USD terms -17.4% and -15.3% respectively compared to -14.4% and -13.1% for the S&P 500 respectively) but it’s significantly better, both in JPY and USD terms compared to September end. The only reason that appears to be discussed during these past 2 months is a hope for weaker US economic output to cause the Fed to slow and, later, reverse their tightening faster than previously expected (which seems counter-intuitive). I’m hoping it’s not quite that simplistic and that global stock markets aren’t trading based on this single factor, i.e. forward US interest rate expectations. But it certainly feels that way. As of Sep end, fed funds futures implied a peak 4.5% rate after the Feb 1 meeting and would end 2023 at 4.3%. As of Nov end, the figure had changed to a peak of 4.9% after the May 3 meeting and falling to 4.4% by the end of 2023. I don’t quite understand why that would justify a +14% rally in the S&P 500 (and +8% for Topix) but that’s the talk. It wasn’t as if earnings were particularly strong. Topix consensus estimates for this fiscal year have fallen about -0.7% in the last 3 months and I suspect next fiscal year’s figures will have to fall further given that current estimates see +3.3% EPS growth next year; S&P expectations are running at +6.9% according to Bloomberg, which feels rather optimistic.

But one thing that comforts me a little is that the rally was not driven by the usual growth stocks but by value stocks. In fact, the boring DJI outperformed the S&P by 6 points and S&P Value index outperformed the Growth index by 8 points. Small caps had acted very similarly in the US. Unfortunately, in Japan, it was growth that still outperformed value and large caps that outperformed small caps quarter to date, but the difference was minimal.

 

The other movement that was rather surprising was the sudden yen strengthening. Now, I had been arguing that the yen would likely strengthen and we had begun adjusting our portfolio to expect as such; but I’m surprised at how quickly it came about (I thought it’d start from next year). But, I suppose if the talk is about a relaxation of interest rate hikes, the yen movements would match that view. Of course, any reversal of that interest rate expectation (like we’re starting to see during early Dec) should, in theory, reverse the yen strengthening too, at least for the time being.

​

But, like I always say (despite all of this commentary), we are not economists. And therefore, we continue to do very little to our portfolio. It’s still defensively positioned (i.e. less cyclical, less currency sensitive, more idiosyncratic) with a few macro-sensitive positions but only those that are trading at deep discounts, the same as it has been for the last several months. We are trying to raise a little cash using some of the more resilient stocks in order to be in a position to add new, less-defensive-but-still-cheap (or cheaper) names if and when the markets adjust. Now that the looming recession is largely consensus, I’m not entirely sure what could trigger a strong market downturn, except maybe that the Fed does go too far or for too long because the datapoints are lagging indicators causing the economy to slow more significantly and painfully. I’m certainly not betting on an Armageddon event that has yet to unfold triggered by the fastest rate hike cycle since the early 1980s fight against the “Great Inflation”; but if such event were to occur, I do believe we are comparatively insulated, at least as well as one can with a long-only, fully invested portfolio. In reality, I suspect it’ll just be a very slow recovery and as companies adjust to the new norm, we will be able to reposition based on not only quality and value but future growth potential too.

​

Someone recently suggested to me that we run a GARP-like portfolio, or Growth at a Reasonable Price. I would disagree. I’d say we run a “Q-VRG”, Quality-Value with Reasonable Growth. I suspect this acronym won’t catch on … but I do believe it’ll be a tailwind in a low-growth market.

​

Masaki Gotoh

​

===

​

“On the road from the City of Skepticism, I had to pass through the Valley of Ambiguity.” – Adam Smith, Scottish economist and the Father of Capitalism.

​

Later this month, our Chief Compliance Officer is doing a short presentation for FinCity.Tokyo, a quasi-public organization that has been sanctioned by the Tokyo Metropolitan Government to expand the presence of Tokyo in the global financial markets. One of their mandates is to promote emerging investment managers and we, as one such firm, are occasionally asked to provide up-and-coming managers with insight from our experiences. In this session, our CCO will be providing some thoughts on the regulatory hurdles one will face when registering as an investment manager (or as the FSA confusingly calls it, a Financial Instruments Business Operator in Investment Management Business, Article 28(4) of the Financial Instruments and Exchange Act or FIEA). But, more importantly, it is also a forum to explain to hungry, prospective CIOs the importance of compliance and what it ultimately stands for. If it were up to me, I’d ask for an hour to go over our “Code of Ethics and Standards of Professional Conduct” that each and every one of us at TriVista sincerely take to heart. But, alas, they will only give us 15 minutes which is hardly enough to express our ideology as well as we’d like to.

But as we discussed her upcoming talk, I was reminded of the rather cumbersome registration process. I had the privilege (?) to go through this intricate, lengthy process twice (four times if you include the upgrade process), twice at my previous shop and twice again at TriVista. While the process may have changed since we registered 3 years ago, it’s still complicated as per from those going through it now. The reason for the complexity was that there was no single form or website to reference. One must first navigate a very complex web of, well, websites. One of them, if you can find it, does have a Word document that needs to be completed with the basic parameters (and thanks to the efforts of the Tokyo Metropolitan Government and FinCity.Tokyo, it can now be completed in English which wasn’t the case 3 years ago). Additionally, there are over a dozen appendices and several dozen supporting documents that must be included and, 3 years ago, there were very few examples to reference. And so, one must ask around by finding others who’ve done it (and are kind enough to assist you) or take a wild stab at it yourself or hire someone to do this all for you (which is not at a trivial cost). 

 
Because it is a registration and not a license, anyone can register (unlike, say, a securities broker who must be licensed). But the registration must be “complete” to be accepted. So, one must go to the local finance bureau of the FSA multiple times (or have your lawyer do it for you) and receive consultation to make sure the forms and additional materials are “complete”. This process takes about 4 months while they look through your draft and get back to you after a month to tell you what you got wrong. While unwritten, it was well-known amongst the new managers that we’d have to go through 4 drafts regardless, before they’d finally accept the forms. In the interim, questions are bound to come up but they will be “answered” via an extremely vague response. I don’t think I’ve ever heard them ever say, “you must answer it this way” or “no, you can’t do it that way”. It’s more like “if you read through Article X of the ‘FIEA’ or chapter Y of the ‘Order for Enforcement of the FIEA’ or section Z of the ‘Cabinet Office Order on Financial Instruments Business, Etc.’, you’ll find the answer”. Thankfully, these are all available online (in both English and Japanese). But if you read that particular article/chapter/section, it inevitably references several other articles/chapters/sections and you’d have to maze through several levels and absorb all of this until you either solve this MENSA puzzle, give up and pay a lawyer to answer for you, or your brain explodes. And that’s when they’re being helpful. More often than not, they’ll say “follow the directions on the FSA website” (without actually directing you to where in their website; you’re expected to comb through it). If you are lucky enough to find the exact webpage that answers your question (or several webpages that reference each other), it’ll be full of vague directions on what, conceptually, needs to be in the appendix for which there is no example. And some of the questions are circular. For example, there is (was) a question that would ask how much capital you will raise with potential clients, but since we can’t market until we are registered (and, by the way, you actually can’t market anyway but need to find someone with a Type I Financial Instruments Business registration to do it for you, most of whom don’t want to deal with an emerging manager), one shouldn’t be able to answer unless they happened to have $10 mln in the bank already (and most of us, including myself, don’t). From start to finish, it’ll take about 6 months (although I’ve heard of some unfortunate managers have taken longer). We submitted our first draft in Apr 2019, about a month after our first contact with the regulators, and the final draft was accepted in September 2019 after the standard 4 back and forth exchanges. We were finally registered on the last day in October 2019. The final document was nearly 200 pages in total. We then had to do it all over again several months later when we upgraded our registration status, taking an additional 5 months to complete.
 
Now I understand that it’s gotten quite a lot better. There are more concrete examples available. The websites and examples are available in both English and Japanese. And the Tokyo Metropolitan Government has set up support services, again in both English and Japanese, to handhold you through the process, without having to pay those hefty legal fees. Furthermore, the government also provides consultation to establish a business in Japan (which is a separate process … you need a place of business first before you can apply for the FSA registration; this is similarly rather convoluted although, unlike the FSA registration, there are plenty of resources to help one set up a company). Once you complete your registration, there are plenty of subsidies and services offered by Tokyo. And all of this can be found via FinCity.Tokyo.
 
But getting there can be daunting. During my first run of this process (when it was even more difficult), we just plowed through the process. It was like walking through a forest without a map but just a compass and a smartphone whose panel is broken but Siri works occasionally when reception is good. You’d ask Siri questions and she’d give you partial answers. You’d beg her, coax her, and flatter her to help you. Once the reception is broken, you’d be bitter and infuriated with her. And this is because she’s never clear in her answers. It’s always very ambiguous, even cryptic at times. You simply cannot understand why this question needs to be answered or why they ask so much about a business unit that has little relevance to the strategy you are planning. But you accept it, brush it away by saying “they are just being annoyingly bureaucratic” and endure it. But the question always lingered, “why so vague?”. Why not just have a form to fill out with instructions and examples?
 
I’m guessing one reason might be that, because it is a registration process and not a licensing process, there is no training session or prep work for your Series 7 (or equivalent) examination. You are forced to read the Act and its related regulations. Maybe they’re hoping it’ll sink in. But after spending much more serious thought on our Code of Ethics here at TriVista, I came to understand what I believe to be the actual reason for the ambiguity. While some of it is bureaucracy, I believe it is because there is no cookie-cutter template on how to provide a safe environment to manage other people’s finances. Many of the laws and regulations were probably developed over time as errors were made along the way that had or could have harmed investors, whether maliciously or accidentally. But if you cut through all of the manuals and procedures and guidelines and processes and regulations and laws, the ultimate question that the entire organization must guarantee, whether it be at the direction of the FSA and other regulatory bodies, your shareholders, your board, your CEO, or your compliance officer, is, “are you, fairly and equitably, protecting your clients?” And even this question is vague. What does one mean by “protect”? Who is your “client”? What does “fair and equitable” mean and is it different depending on context? Because of this, the Japanese regulatory bodies probably prefer it to be unclear. If they defined them explicitly, there would be ways to maneuver around them. The fact that there is no clear direction puts the onus on the manager to apply common sense and logic. There are no absolutes except, perhaps, “Thou shalt not steal” and “Thou shall not bear false witness against thy neighbor”. Anything more specific and it becomes subjective. Sure, there are a few obvious ones like do you have a Compliance Program and who is responsible for it. But after a point, even your own bylaws start to get a little vague. So you should have the ethical background to make the right choices (and create policies and procedures to ensure your organization adheres to them). If it didn’t occur to you that commingling your money with customer money doesn’t feel right, you probably shouldn’t be running other people’s money. You shouldn’t need regulators to tell you. If you think trading 50% of the volume for multiple days causing the stock to rise and creating a buzz on the Street isn’t kosher, you shouldn’t run your own money either (and, if you levered to do it, then you shouldn’t trade stocks … period). The ultimate backstop is common sense based on your Code of Ethics.

​

While the Rule of Law does exist in Japan, it is rather subjective and is so on purpose, I believe; that sounds contradictory, I know, but that’s Japan. There is purpose in the ambiguity. And it is precisely this reason that, when we started up TriVista, we chose to do so in Japan and stomach the high personal/corporate taxes and the regulatory red tape. It is because this ambiguity exists when doing fundamental research too. Japanese corporate management is just as opaque as the regulators. Call it a Japanese cultural thing. But we find beauty in being indirect. No means yes and yes means no except when it doesn’t.  Straightforwardness is barbaric, at least when in Japanese. We accept the candidness of the English language, even envy it at times. But not in Japanese. And so, it is hard to read the subtle nuances that management is speaking of from a conference call or even a Zoom video. Our body language purposely speaks more volumes than just listening to our voice. It’s true of any charismatic spokesman globally but our culture is particularly partial to it in our day-to-day. And that body language as well as the subtle tone of voice that is often lost in translation provides much insight. And, most importantly, it helps create a bond and mutual respect that we cherish. It goes beyond the shareholder-company relationship and becomes more personal. Of course, there is no informational advantage; but it helps increase (or decrease) conviction, a vital component for a long-term investment strategy like ours.

​

Now that we can physically visit all of our prospective companies, I believe that our investment universe can grow more efficiently, and the conviction process shorten so that we can finally take full advantage of our local presence for our investors. 

​​

​