s t o c k m a r k e t sr e P o r t I N G

I N v e s t m e N t c a s e sa r t I c l e

a m a G a z I N e P u b l I s h e d b Y v a l u e I N v e s t a s s e t m a N a G e m e N t s . a .

2012

l u x e m b o u r g

3INTRODUCTIONTO ANNUALREPORTING 2011Several years of expe-rience has shown that company research and consistency pays off...

10REPORTING:VALUEINVEST LUX JAPANIn 9 calendar years the portfolio has accumu-lated a positive return of 39.5%.

12CASESLet's take a closer look at the softwaregiant Microsoft and the clothes brand Next from the UK.

4STOCK MARKETSShattered hopes of revenue growth influenced the stock markets.

16JAPAN - fROM GREATNESS TO DECLINE?What does stagnation mean for investments in Japanese stocks?

A magazine by

ValueInvest Asset

Management S.A.

Publisher

ValueInvest Asset

Management S.A.

36, rue Marie-Adelaïde

L-2128 Luxembourg

Tel: +352 315 155

fax: +352 315 155 31

info@valueinvest.lu

www.valueinvest.lu

Editors

Helen Cope

Jacob Vendelbo

Layout and production

PRinfoHobro A/S

Thurøvej 7

DK-9500 Hobro

Tel: +45 98 520 199

fax: +45 98 525 501

www.prinfohobro.dk

Disclaimer. ValueInvest Asset Management S.A. shall not be liable for the information contained in this magazine regardless whether contrary to expectation any such information should be incorrect. ValueInvest Asset Management S.A. shall therefore not be held liable for any damages or losses, directly or indirectly incurred on the basis of information contained in this magazine. The content of this magazine is intended as general information and can in no way be equated with advice. Investment may involve risk of loss, and historical returns are no guarantee of future returns. This material may contain information on historical returns and allocations, simulated earnings and forecasts that can not be seen as a guarantee of future returns or allocations. Returns may be reduced or increased as a result of currency fluctuations and changes in equity markets. It is therefore recommended always to seek professional investment advice and also advice on related individual tax systems, which could be affected by the current investment. Reservations are made for typographical errors, product changes, errors in prices, rates and the like. For further information, including prospectus, see www.valueinvest.lu

Caution anD DisCipline.long term Capital proteCtion.

Printet on environmentally certified paper

6REPORTING: VALUEINVEST LUX GLObALValueInvest LUX Glo bal accumulated a return of 41.4% over a ten year period.

9DEfINITIONS fOR VALUEINVEST LUXExplanations of terms used in the magazine.

perfor-mancevaluestability

541 371Tryksag

VA Lu E I n V E S T 1 : 2 0 1 22

Drastic downturn in the f¡nancial market in 2011Introduction to the annual reporting for 2011

Dear Investor

The current financial crisis has caused a dras-

tic downturn in the financial market in 2011

and has hit several industries hard, amongst

others the financial sector especially. The

funds have, in line with previous years, a high

weighting of earnings stable companies,

traded significantly below their fair value. As

in previous years, the SICAV in 2011 has not

had any exposure to the financial sector. Lux

Global delivered a negative return of 6.1%

whilst Lux Japan delivered a positive return

of 5.0%. In comparison, the Morgan Stanley

World Index and Japan Index delivered nega-

tive returns of 2.5% and 11.5% respectively.

We are not satisfied with the return in the

Global fund, as the investors in the fund

could have expected a slightly better return

in the light of tailwind in our sector alloca-

tion. We consider the return in the Japanese

fund to be »thin« in absolute terms but quite

satisfactory in relative terms.

In light of the latest 13 years the cautious

investment strategy of ValueInvest AM has

secured an investor in our Global product a

yearly return of 7.3% after costs. If an inves-

tor had decided to »save« these costs and

invested in e.g. the »cost free« Morgan Stan-

ley World Index in the same 13 year period,

he or she would have received a yearly

return of 1.1%. Thus receiving a return of plus

6.2%-point from the Global portfolio during

this period.

Naturally, after a number of years with low

returns (seen over several years) from the

overall markets, there is a focus on costs

linked to investing in a mutual fund. At the

moment we see heavy marketing from ETFs

(exchange-traded funds). ETFs offer a rela-

tively cheap access to investments in various

markets, but it does not change the underly-

ing risk related to the overall markets, which

offer a variety of cheap and expensively

priced companies of both low and high qual-

ity. It is exactly this combination that result-

ed in the previously mentioned return of 1.1%

from Morgan Stanley World Index, seen over

the last 13 calendar years.

ValueInvest remains true to its investment

strategy, which is focused on identifying

quality companies which are valued signifi-

cantly lower than their fair value and selling

them once they have reached their fair value.

Several years of experience has shown that

thorough and meticulous company research

combined with consistency pays off in the

long run. We welcome our new investors and

thank you, as well as our existing clients,

for the confidence and trust that you have

shown in our SICAV in 2011.

With kind regards,

ValueInvest Asset Management S.A.

In light of the latest 13 years the

cautious investment strategy of

Value Invest AM has secured an

investor in our Global product a

yearly return of 7.3% after costs.

VA lu e I n V e s t 1 : 2 0 1 2 3

Stock marketsReporting > Stock marketsShattered hopes of revenue growth influenced the stock markets

Sat ned i 65% - filter ARC lower + ARC upper 20% samt gradient fil

Global afdelingen inkl. -0,6% forventet vækstAktiemarkedet inkl. 38% forventet vækst

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

3,7% 4,0% 4,2% 4,5% 4,7% 5,0% 5,2% 5,5% 5,7% 6,0% 6,2% 6,5% 6,7% 7,0% 7,2% 7,5%

Kurs

stig

ning

spot

entia

le

Telecomm

unication Services

Information

Technology

Consumer

Discretionary

-2.5%

-17.2% -15.8%

-5.2%

-1.6% -0.1%

0.7% 3.4% 4.1%

12.1% 13.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

MSCI W

orld

Materials

Financials

Industrials

Utilities

Energy

Consumer Staples

Health Care

Consumer

Discretionary

Information

Technology

Telecomm

unication Services

-11.5%

-38.9%

-20.1% -20.0% -16.3%

-13.1% -8.6%

-2.9% -0.8%

4.9% 9.8%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

MSCI Japan

Utilities

Financials

Materials

Industrials

Health Care

Energy

Consumer Staples

Figure 1 MSCI World in EUR including reinvested dividends 2011

In our previous issue of our maga-

zine we expressed our doubts

whether the companies globally

could live up to the high expecta-

tions of revenue growth implied by

the stock market.

During spring 2011 we saw high expectations

of revenue growth for the year with an aver-

age up to 30% for more than 6.700 global

companies. Across the summer and autumn

there was less optimism in regards to the

earnings growth, due to several companies

having delivered their yearly reports (stag-

gered reporting) or periodic reports leading

to a market consensus (Bloomberg consen-

sus market expectations) for a lower average

earnings growth for 2011 of 16%.

Morgan Stanley World Index showed a fall

in stock prices of 2.5% at ultimo mid-year.

Concurrent with the partly shattered hopes

of earnings expectations, the stock market

dropped a further 9.9% in Q3, however recu-

perated in Q4. As a whole the year finished

with a negative yield for Morgan Stanley

World Index of 2.5%. The 10 main sectors in

MSCI World developed considerably different-

ly during the year. As can be seen from fig-

ure 1 the worst returns were delivered by the

sectors Materials and Financials with nega-

tive returns of 17.2% and 15.8% respectively.

In the other end of the scale we find the

more income stable companies from the sec-

tors Health Care and Consumer Staples with

positive returns of 13.0% and 12.1% respec-

tively. The reason for the poor results from

Materials in 2011 can partly be explained

by the very high expectations to operat-

ing profits for the sector as a whole, set at

the beginning of the year. In line with the

downgrading of the expectations to world

economic growth by the IMF, amongst oth-

ers, the great expectations to the companies

within the Materials sector are adjusted.

ValueInvest has not had any investments in

Materials in 2011 and has thereby escaped

from the subsequently negative impact. Fur-

thermore, we continue to avoid the sector

Financials and we have thereby been pro-

tected towards any negative returns within

this sector. ValueInvest remain confident in

our conviction that the true value for our cli-

ents lie in the high weighting of income sta-

ble companies valued below their fair value.

From financial crises to sovereign

debt crises

Leading up to the so-called financial crises

in 2008 many European countries and USA

experienced an overheating of the economy

and fast rising prices on the property market.

The combination of low interest rates as well

as the possibility of choosing non-amortis-

able loans in many countries led to a price

bubble, which later on led to economic reces-

sion and a severe crisis in the financial sector.

The central banks delivered large amounts

Va lu e I n V e s t 1 : 2 0 1 24

Stock markets

Figure 3 Fair Value including market consensus, MSCI World and MSCI Japan 31.12.2011

Sat ned i 65% - filter ARC lower + ARC upper 20% samt gradient fil

Global afdelingen inkl. -0,6% forventet vækstAktiemarkedet inkl. 38% forventet vækst

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

3,7% 4,0% 4,2% 4,5% 4,7% 5,0% 5,2% 5,5% 5,7% 6,0% 6,2% 6,5% 6,7% 7,0% 7,2% 7,5%

Kurs

stig

ning

spot

entia

le

Telecomm

unication Services

Information

Technology

Consumer

Discretionary

-2.5%

-17.2% -15.8%

-5.2%

-1.6% -0.1%

0.7% 3.4% 4.1%

12.1% 13.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

MSCI W

orld

Materials

Financials

Industrials

Utilities

Energy

Consumer Staples

Health Care

Consumer

Discretionary

Information

Technology

Telecomm

unication Services

-11.5%

-38.9%

-20.1% -20.0% -16.3%

-13.1% -8.6%

-2.9% -0.8%

4.9% 9.8%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

MSCI Japan

Utilities

Financials

Materials

Industrials

Health Care

Energy

Consumer Staples

Figure 2 MSCI Japan in EUR including reinvested dividends 2011

of cheap liquidity to the markets to avoid a

long-term recession.

Today, shortly after the start of the financial

crises, we are now faced with a sovereign

debt crisis and not a pure market crisis, as

was the case in 2008. USA and several coun-

tries in Europe have too much debt which

resulted in a EURO-crisis in 2011. The eco-

nomically weak countries in the Euro-zone

are threatening the common currency, for

which the stronger countries like Germany

and France, by providing bail-out packages,

have worked intensively during the year in

order to reinstate the trust in the Euro and

the European Community. Greece is at the

forefront of the firing line and now has to

establish tough economic cutbacks in order

to receive lifesaving economical help from

World Japan World Japan Price/Fair Value 52.6% 61.6% Risk Weighting Fair Value Weighting Fair Value Potential return 90.2% 62.5% catagories Consensus expectations growth 15.7% -8.1% Weighted risk premium 74.9% 79.6% A 11.9% 41.2% 8.5% 39.5%Earnings yield 9.8% 8.3% B 21.8% 49.9% 20.1% 91.2%Dividend yield 2.7% 2.2% C 34.6% 46.4% 30.4% 44.7%Net debt/operating profit 1.6 2.3 D 24.9% 61.7% 33.8% 68.1%Number of companies in screening 6.835 1.395 E 6.8% 82.5% 7.3% 127.3%

Included companies in screening > EUR 100 Mio. Included saectors in screening All except Financials

the EU and furthermore undergo actual debt

relief with the help of the private sector.

Other European countries within the Euro-

pean community are equally working hard to

maintain the trust of the markets. The finan-

cial sector is suffering economically from big

losses in investments in several European

government bonds and will as a consequence

face further demands to strengthen their

capital base.

Many companies are doing well

In these challenging times for many compa-

nies, especially small and medium sized com-

panies who do not have large exposure to

the developing markets, we are happy to con-

firm that many of the companies within our

funds are doing well.

Microsoft and Next are two young compa-

nies, established in 1975 and 1982 respec-

tively, and hence have only experienced few

larger crises such as the burst of the IT Bub-

ble after 2000, the financial crises, and the

current sovereign debt crises. These two

companies, which are considered atypical of

the ValueInvest selection, are featured in

detail in this issue. The majority of companies

in our funds have roots going back to before

1900 and some companies can even trace

back their history to before the French revo-

lution in 1789.

Fewer than ten companies are so young that

they have not experienced World War II and

if one opens the history books of the compa-

nies one will find that they have experienced

far worse crises than the one we are facing

today. It is not just the companies, but also

their products that have shown strength

throughout many decades. As an exam-

ple we can mention Nestlé’s Nescafé which

has existed from the early 1930ties. It took

Nestlé eight years to develop and refine the

Nescafé product which became one of the

field rations for the American soldiers dur-

ing WWII. Today the product is still sold and is

one of many true »world brands«. Regardless

of whether we are speaking of coffee from

Nestlé, ketchup from Heinz or cornflakes

from General Mills, ValueInvest has invested

in companies that sell products with a solid

resistance to the ups and downs of the world

economy, hence delivering a stabile income

even in an economically challenged climate.

Expectations to 2012

We do not expect to see an end to the eco-

nomic stimulus in 2012. The world economy

is expected to remain weakened economi-

cally and there will be much focus on the

economy of southern Europe and their plans

for economic restoration. The various eco-

nomic initiatives will in 2012 have the stock

markets jump between optimism and pessi-

mism creating fluctuations in the stock mar-

kets. This should create opportunities ena-

bling ValueInvest to buy sound companies

valued considerably below their Fair Value

and thereby maintain good return potential in

the funds.

...we are now faced with a

sovereign debt crisis and

not a pure market crisis as

was the case in 2008.

the majority of companies in

our funds have roots going

back to before year 1900...

Va lu E I n V E s t 1 : 2 0 1 2 5

GlobalReporting > ValueInvest LUX Global- delivered a negative return of 6.1% in 2011

ValueInvest Global Japan

ValueInvest LUX Global AMSCI World

RUNDE ENDER: ARC LOWER VERTICAL 20

MSCI JapanValueInvest LUX Japan A

-15.3%

14.9% 9.6%

14.0%

-5.3%

-22.2%

30.8%

10.4%

41.4%

-32.4%

11.7% 5.4%

16.5%

26.3%

7.5%

-1.6%

-38.1%

-6.1% -2.5%

26.8% 19.6%

-2.7%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Acc. wholeperiod

2010 2011 Acc. wholeperiod

4.4%

15.8% 21.5%

-4.0%

-21.7%

-0.2%

0.8%

19.6%

39.5%

14.0% 6.4%

44.7%

-4.8% -13.6%

5.0%

-11.5%

-26.1%

3.6%

23.6% 21.0%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

2003 2004 2005 2006 2007 2008 2009

1.8%

2.0%

34.6%

19.9%

10.0%

8.8%

7.3%

4.7%

4.2%

2.7%

2.4%

1.6%

0% 10% 20% 30%

Cash

Other Countries

USA

Japan

United Kingdom

Switzerland

France

Netherlands

Belgium

Ireland

Austria

Canada

Figure 1 Historical returns 31.12.2001-31.12.2011

property by losing much less than the market

in general. This is one of the major reasons

why the fund is able to produce a reasonable

positive return over time.

Historical returns

Figure 2 shows the historical results at 5,

7 and 10 years. All periods delivered better

returns compared to the MSCI World Index, in

combination with a lower risk, measured by

the annual standard deviation. The portfolio

is characterized by a low beta in all periods as

well as a high tracking error, which indicates

large differences in portfolio composition

relative to the MSCI World Index. Despite the

high tracking error, strong risk adjusted per-

formance has been delivered as measured by

the information ratio.

Decomposition of return - countries

It appears from Figure 3 that the majority of

the positive return delivered by ValueInvest

LUX Global in 2011 originates from exposure

to US and Swiss companies. The JPY, the

Swiss Franc and the US Dollar appreciated

against the Euro, which all contributed posi-

tively to fund performance. The aggregate

performance from UK companies was nega-

tively influenced by the English travel com-

pany Thomas Cook which shares fell through-

out 2011.

ValueInvest LUX Global delivered a nega-

tive return of 6.1% in 2011 against a nega-

tive return of 2.5% from the MSCI World

Index. ValueInvest LUX Global accumulated a

positive return of 41.4% against a negative

return of 2.7% for the MCSI World Index over

a ten year period.

Figure 2 Historical returns incl. key figures

ValueInvest LUX Global 31.12.2001-31.12.2011 31.12.2004-31.12.2011 31.12.2006-31.12.2011 (10 years) (7 years) (5 years) Global MSCI World Global MSCI World Global MSCI WorldAcc. Return 41.42 -2.69 32.67 22.38 -0.12 -9.88Return (p.a.) 3.53 -0.27 4.12 2.93 -0.02 -2.06Return difference (p.a.) 3.80 1.19 2.03 Standard Dev. (p.a.) 11.92 14.95 11.72 14.25 12.98 15.66Sharpe Ratio 0.00 -0.25 0.05 -0.04 -0.27 -0.36Beta 0.65 0.69 0.70 Tracking Error (p.a.%) 7.03 6.32 7.04 Information Ratio 0.54 0.19 0.29

ValueInvest LUX Global delivered this excess

return with a lower downside risk than that

of the market expressed by the MSCI World

Index. In the life span of the Global fund, the

stock market has suffered two major set-

backs – in 2002 and in 2008. On both occa-

sions, the Global fund displayed its protective

Va LU e I n V e S t 1 : 2 0 1 26

Decomposition of return - sectors

Figure 4 shows that the positive contribution

to the total returns delivered by ValueInvest

LUX Global derives from exposure to vari-

ous sectors with earnings stable properties

but also from more cyclical sectors such as

Department Stores and Wireless Telecommu-

nication. The most negative contribution to

performance came from the sectors Hotels,

Resorts & Cruise Lines (Thomas Cook which

is now sold) and Data Processing and Out-

sourcing (CSC).

Country exposure

Figure 5 shows the country exposure. The

selection of companies and the composition

of the portfolios are based on an investment

process that cuts across countries and sec-

tors. ValueInvest LUX Global only includes

companies and sectors that have been iden-

tified positively by our investment process.

The company selection has resulted in a large

exposure to companies based in Europe, the

USA and Japan.

By the end of 2011, the portfolio exposure to

Far Eastern countries and Emerging Markets

was low.

ValueInvest Global Japan

ValueInvest LUX Global AMSCI World

RUNDE ENDER: ARC LOWER VERTICAL 20

MSCI JapanValueInvest LUX Japan A

-15.3%

14.9% 9.6%

14.0%

-5.3%

-22.2%

30.8%

10.4%

41.4%

-32.4%

11.7% 5.4%

16.5%

26.3%

7.5%

-1.6%

-38.1%

-6.1% -2.5%

26.8% 19.6%

-2.7%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Acc. wholeperiod

2010 2011 Acc. wholeperiod

4.4%

15.8% 21.5%

-4.0%

-21.7%

-0.2%

0.8%

19.6%

39.5%

14.0% 6.4%

44.7%

-4.8% -13.6%

5.0%

-11.5%

-26.1%

3.6%

23.6% 21.0%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

2003 2004 2005 2006 2007 2008 2009

1.8%

2.0%

34.6%

19.9%

10.0%

8.8%

7.3%

4.7%

4.2%

2.7%

2.4%

1.6%

0% 10% 20% 30%

Cash

Other Countries

USA

Japan

United Kingdom

Switzerland

France

Netherlands

Belgium

Ireland

Austria

Canada

Figure 5 Country exposure

Figure 3 Decomposition of return - countries Figure 4 Decomposition of return - sectors

United States 53.8%

Switzerland 23.7%

20%

Japan 10.5%

Ireland 9.4%

Italy 2.6%

0%

Canada -2.2%

Sweden -4.2%

Austria -7.5%

France -9.2%

Netherlands -9.4%

Belgium -12.4%

-20%

Hong Kong -25.9%

United Kingdom -29.3%

Pharmaceuticals 37.0%Packaged Foods and Meats 20.2% 20%Department Stores 14.7%Household Products 11.2%Wireless Telecommunication Services 7.7% 5%IT Consulting & Other Services 4.0%Brewers 2.9%Distillers & Vintners 1.3% Oil & Gas Exploration & Production 1.0% 0%Environmental & Facilities Services -0.7%Systems Software -1.3%Household Appliances -1.6%Advertising -1.9%Soft Drinks -2.8%Industrial Machinery -2.8%Integrated Telecommunication Services -2.8%Office Electronics -3.7%Home Entertainment Software -4.1%Integrated Oil & Gas -5.0%Food Retail -7.9%Agricultural Products -11.9%Data Processing & Outsourced Services -17.6% -20%Hotels, Resorts & Cruise Lines -36.0%

The numbers in Figure 3-7 are at 31.12.2011.

Va lu e I n V e s t 1 : 2 0 1 2 7

Figure 7 Characteristics - internal portfolio group accounts

Figure 6 Company exposure

Company top 10 Country Sector Industry Risk category Weight

GlaxoSmithKline United Kingdom Health Care Pharmaceuticals A 5.9%Nestle Switzerland Consumer Staples Packaged Foods & Meats A 5.2%Kimberly-Clark United States Consumer Staples Household Products A 4.8%General Mills United States Consumer Staples Packaged Foods & Meats A 4.8%Microsoft United States Information Technology Systems Software C 4.3%Delhaize Belgium Consumer Staples Food Retail B 4.2%ConAgra Foods United States Consumer Staples Packaged Foods & Meats B 4.2%Pfizer United States Health Care Pharmaceuticals B 4.1%Ahold Netherlands Consumer Staples Food Retail B 3.7%Roche Switzerland Health Care Pharmaceuticals A 3.6%

Company exposure

Figure 6 shows the 10 largest portfolio posi-

tions, which represent 44.8% of the total

portfolio with exposure ranging from 3.6%

to 5.9%. The portfolio is well diversified with

the 10 largest positions mainly invested in

the categories of earnings stability, A and B.

Internal portfolio group accounts

Figure 7 shows our consolidated balance

sheet and profit and loss account for all com-

panies in the portfolio based on data from

» our Fair Value Database. The group accounts

are a tool for monitoring risk in the port-

folio, viewed as one company and provide

insight into the quality and stability of the

overall portfolio, level of leverage, cyclicality

based on exposure to the five risk categories,

and finally, upside potential and underlying

growth used to calculate the Fair Value of

the portfolio.

Comparing the portfolio characteristics in the

group accounts with the market characteris-

a S S e t S l I a b I l I t I e S Marketable securities 6.1% Interest bearing debt 4.9% Cash 8.0% Creditors 10.6%Own shares 0.1% Other 9.1% Debtors 12.0% Short term debt 24.6% Inventories 8.2% Other 4.0% Interest bearing debt 22.8% Current assets 38.3% Other 5.4% long term debt 28.2% Associated companies 2.3% Tangible fixed assets 25.6% Pensions 3.5% Intangible fixed assets 27.3% Other provisions 1.5% Other 6.5% total provisions 5.1% total fixed assets 61.7% Minority interests 1.7% equity 40.5% total assets 100.0% total liabilities 100.0% p R o f I t a n d lo S S a C Co u nt R I S k C ate g o Ry

Turnover 100.0% Costs -78.0% CategoRy a 32.2% Gross profit 22.0% Depreciations -5.8% CategoRy b 39.8% Associated companies 0.4% Minority interests -0.4% CategoRy C 15.7% operating profit 16.2% Goodwill amortisations -0.5% CategoRy d 10.2% Financials. net. -1.4% Tax -3.8% CategoRy e 2.1% Extraordinary activities -1.9% Net profit 8.6% CategoRy total 100.0% Return to fair Value 135.9% Weighted risk premium 53.1% earnings yield 10.9% net debt/op. profit years 1.1 growth factor -3,7% Weighted interest rate level 3.3%

ValueInvest LUX Global

offers a higher return poten­

tial and earnings yield in

combination with higher

exposure to earnings sta­

bility (risk categories A and

B) as well as a stronger

balance sheet.

tics shown in Figure 3 under the »Stock mar-

kets« section, ValueInvest LUX Global offers

a higher return potential and earnings yield

in combination with higher exposure to earn-

ings stability (risk categories A and B) as well

as a stronger balance sheet.

Va lu e I n V e S t 1 : 2 0 1 28

Definitions for ValueInvest LUX- explanations of terms used in the magazine

EP E R F O R M A N C E

Beta

Beta is a ratio that shows how the return

on the portfolio has fluctuated against the

benchmark return. A beta of 1 means that

the portfolio will follow the benchmark. If,

however, the beta is higher than 1, fluctua-

tions will be stronger for the portfolio than

the benchmark – meaning that the port-

folio will increase or decrease more than

the benchmark. If, on the other hand, the

beta is less than 1, then the portfolio will

increase or decrease less than benchmark.

Earnings Yield

The earnings yield reflects the return

(before tax) an investor would receive if

the company was taken over, all outstand-

ing shares were bought at the current

stock price, the net debt was paid out and

assuming that the investor would then

receive the full operating profit - (operat-

ing profit (1+growth)) / (total market cap. +

net debt). The earnings yield for the total

portfolio would then assume that all hold-

ings are acquired 100%. Importantly, the

earnings yield should always be analyzed in

conjunction with the earnings stability. The

more stable the earnings (i.e. risk category

A), the higher probability of getting the

expected earnings yield.

Fair Value

In our internal portfolio group accounts, the

Fair Value is calculated on the basis of the

aggregated earnings for all the companies

discounted at the required rate of return

deducted by the net debt: (((operating

profit) * (1+growth)) / (global risk free rate

of return * (1+ risk premium)) – net debt

(+ if positive liquidity).

Global Screening

The Fair Value calculation in the global

market screening excluding Financials is

based on analyst consensus estimates of

operating profits for the current (or latest

unreported) fiscal year.

Growth Factor

The growth factor (earnings growth)

applied in the Fair Value calculations can

only go two years out in the future. How-

ever, we do take more than two years of

earnings expectations into the calcula-

tion if the growth factor is expected to be

negative more than two years ahead. In the

portfolio group account the growth factor

is the expected growth in the aggregated

earnings for all the portfolio companies.

Information Ratio

Information ratio is a measure of how an

actively managed portfolio has performed

relative to a benchmark. The active return

(return beyond benchmark return) obtained

by deviating from the benchmark is com-

pared to the benchmark risk, which is calcu-

lated as the standard deviation of excess

returns (tracking error). The information

ratio indicates whether a deviation from

the benchmark has been rewarded and a

positive information ratio indicates that the

portfolio has outperformed the benchmark.

Net debt / EBITDA

The ability to repay debt with the operat-

ing profit generated in number of years.

The net debt is defined as short and long

term interest bearing debt plus pension

liabilities after deduction of cash and mar-

ketable securities. The level of net debt

tolerated depends on the stability in earn-

ings. A company in risk category A would

be required to be able to repay debt within

5 years, B 4 years, C 3 years, D 2 years and

finally E 1 year of EBITDA.

Portfolio Group Accounts

Our internal portfolio group accounts are

the consolidated balance sheet and profit &

loss account for all the companies included

in the portfolio based on data from Value-

Invest Asset Management’s Fair Value

Database. They are a tool for monitoring

the risk in the portfolio as if it was a sin-

gle company and provide a snap-shot of

the quality and stability of the combined

portfolio; the level of leverage, the level of

cyclicality based on the exposure to the

five risk categories, and finally the upside

potential and underlying growth assump-

tion used to calculate the Fair Value of the

portfolio. Also the portfolio group accounts

can be used to compare the portfolio with

the overall global market excluding Finan-

cials. The characteristics of the global port-

folio versus the global screening excluding

financial stocks are: higher earnings stabil-

ity, lower net debt, higher earnings yield

and finally a higher return potential based

on a conservative growth estimate.

Return to Fair Value

This is the upside potential to the calcu-

lated Fair Value against the current market

value of the portfolio.

Risk Category

As a shareholder and owner of a company,

the risk we are concerned about is related

to the volatility in earnings. How fast and

how sure can we be to get our money back

from the future earnings. Five risk catego-

ries have been established A, B, C, D and E,

where A is the least cyclical companies, and

E the most cyclical companies. All compa-

nies in our global universe have been clas-

sified into one of these five risk categories.

In order to minimize and limit the downside

risk of the portfolio, at least 2/3 of the

portfolio must, at any time, be invested in

the risk categories A, B and C.

Risk Premium

The risk premium is the additional return

required above the global risk-free rate of

interest to reflect the riskiness, i.e. earn-

ings volatility, of an investment. Based on

an extensive analysis of a minimum of 10

years of earnings history for 8,000 global

companies the risk premium has been

scaled and calibrated for the five risk cate-

gories A, B, C, D and E. For risk category A

the risk premium is 25%, B 50%, C 75%,

D 100% and E 150%. The required rate of

return used to calculate the value of the

operating profit is then derived as follows;

(1+risk premium) * global risk-free rate.

Sharpe Ratio

The Sharpe ratio is a measure of portfolio

returns relative to risk and is calculated by

using the portfolio excess returns - returns

beyond the risk-free rate of return (set at

3.5%) divided by the standard deviation of

portfolio returns. Investors will seek the

highest excess returns per risk unit, and if

the portfolio has a positive excess return,

then the higher the Sharpe ratio the better.

Tracking Error

Tracking error is a relative risk measure and

measures the standard deviation of the

active return (return beyond benchmark

return) obtained by deviating from the

underlying benchmark. Equity portfolios

which shadow the stock market closely will

have a low tracking error. A tracking error,

e.g. of 8% p.a., indicates that the annual

returns are likely to be within + / - 8% com-

pared to benchmark returns. Please also

see the explanation for information ratio.

Weighted Interest Rate Level

A global risk-free interest rate is applied

in all the Fair Value calculations since the

investment universe is global equities. The

global risk-free interest rate is derived from

an average of the historical rates and the

weighted global current rates in order to

smooth out any short-term fluctuation in

interest rates which should not influence

the value of a company (Fair Value).

Weighted Risk Premium

The weighted risk premium of the port-

folio is the portfolio weighted share of

risk category A (25%), B (50%), C (75%), D

(100%) and E (150%) multiplied by the risk

premiums.

E A R N I N G S Y I E L D

Va lu e I n V e s t 1 : 2 0 1 2 9

JapanReporting > ValueInvest LUX Japan- delivered a positive return of 5.0% in 2011

ValueInvest Global Japan

ValueInvest LUX Global AMSCI World

RUNDE ENDER: ARC LOWER VERTICAL 20

MSCI JapanValueInvest LUX Japan A

-15.3%

14.9% 9.6%

14.0%

-5.3%

-22.2%

30.8%

10.4%

41.4%

-32.4%

11.7% 5.4%

16.5%

26.3%

7.5%

-1.6%

-38.1%

-6.1% -2.5%

26.8% 19.6%

-2.7%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Acc. wholeperiod

2010 2011 Acc. wholeperiod

4.4%

15.8% 21.5%

-4.0%

-21.7%

-0.2%

0.8%

19.6%

39.5%

14.0% 6.4%

44.7%

-4.8% -13.6%

5.0%

-11.5%

-26.1%

3.6%

23.6% 21.0%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

2003 2004 2005 2006 2007 2008 2009

1.8%

2.0%

34.6%

19.9%

10.0%

8.8%

7.3%

4.7%

4.2%

2.7%

2.4%

1.6%

0% 10% 20% 30%

Cash

Other Countries

USA

Japan

United Kingdom

Switzerland

France

Netherlands

Belgium

Ireland

Austria

Canada

Figure 1 Historical returns 31.12.2002-31.12.2011

in general. Measured since inception until

31.12.2011 the standard deviation was 32%

lower than for the market in general.

Historical returns

Figure 2 shows the historical results at 5-

and 7-year periods. Both periods outper-

formed the MSCI Japan Index, in combination

with a lower risk, measured by the annual

standard deviation. The portfolio is charac-

terized by a low beta in both periods as well

as a high tracking error, which indicates large

differences in portfolio composition relative

to the MSCI Japan Index.

Decomposition of return - sectors

Figure 3 shows the various sectors that con-

tributed to the return delivered by Value-

Invest LUX Japan. The sectors Food Retail,

Pharmaceuticals, and IT Consulting & Other

Software generated the most positive contri-

butions whereas the most negative contribu-

tions came from Home Entertainment Soft-

ware and Household Appliances. The relative

distribution of the gains and the losses is

also shown.

Company exposure

The 10 largest portfolio positions are shown

in Figure 4. The 10 largest holdings represent

44.3% of the total portfolio with individual

exposure ranging from 4.2% to 5.3%. There

ValueInvest LUX Japan delivered a positive

return of 5.0% in 2011 against a negative

return of 11.5% from the MSCI Japan Index.

In the 9 calendar years of ValueInvest LUX

Japan’s existence, the portfolio has accumu-

lated a positive return of 39.5% compared to

a positive return of 21.0% for the MSCI Japan

Index.

The outperformance that ValueInvest LUX

Japan delivered was generated with a lower

standard deviation than that for the market

Figure 2 Historical returns incl. key figures

ValueInvest luX Japan 31.12.2004-31.12.2011 31.12.2006-31.12.2011 (7 years) (5 years) Japan MsCI Japan Japan MsCI JapanAcc. Return 15.38 -0.31 -1.11 -27.63Return (p.a.) 2.06 -0.04 -0.22 -6.26Return difference (p.a.) 2.11 6.04 Standard Dev. (p.a.) 11.29 15.69 12.15 16.07Sharpe Ratio 0.05 -0.10 -0.14 -0.48Beta 0.54 0.55 Tracking Error (p.a.%) 7.48 8.42 Information Ratio 0.28 0.72

Both periods delivered higher returns compared to the MSCI Japan Index, in combination with a significantly lower risk, measured by the annual standard deviation.

Va lu E I n V E s t 1 : 2 0 1 210

Japan

is good diversification in the portfolio and

the 10 largest companies are mostly clas-

sified in risk category B with relatively high

earnings stability.

Internal portfolio group accounts

Figure 5 shows our consolidated balance

sheet and profit and loss account for all com-

panies in the portfolio based on data from

ValueInvest Asset Management’s Fair Value

Database. The group accounts are a tool for

monitoring the risk of the portfolio, taken as

a single company.

They provide a picture of the quality and sta-

bility of the overall portfolio, level of leverage,

cyclicality based on exposure to the five risk

Figure 3 Decomposition of return - sectors

Food Retail 23.6%Pharmaceuticals 20.4% 20%IT Consulting & Other Services 11.9%Apparel Retail 11.2%Packaged Foods & Meats 6.2%Wireless Telecommunication Services 5.9%Brewers 5.5%Education Services 4.6%Oil & Gas Exploration & Production 4.1%Oil & Gas Refining & Marketing 3.7%Household Products 2.8% 0%Office Electronics -7.0% -20%Household Appliances -24.0%Home Entertainment Software -69.0%

Figure 4 Company exposure

Company top 10 Country Sector Industry Risk category Weight

Konica Minolta Japan Information Technology Office Electronics C 5.3%Asahi Group Japan Consumer Staples Brewers B 4.8%Astellas Pharma Japan Health Care Pharmaceuticals B 4.4%Eisai Japan Health Care Pharmaceuticals A 4.4%Itochu Enex Japan Energy Oil & Gas Refining & Marketing D 4.3%Circle K Sunkus Japan Consumer Staples Food Retail B 4.3%Seven & I Holdings Japan Consumer Staples Food Retail B 4.3%Secom Japan Industrials Security & Alarm Services B 4.2%Nippon Flour Mills Japan Consumer Staples Packaged Foods & Meats B 4.2%Mitsubishi Tanabe Japan Health Care Pharmaceuticals B 4.2%

The numbers in Figure 3-5 are at 31.12.2011.

Figure 5 Characteristics - internal portfolio group accounts

a S S e t S l I a b I l I t I e S Marketable securities 10.9% Interest bearing debt 6.8% Cash 12.2% Creditors 9.2%Own shares 0.0% Other 10.6% Debtors 14.8% Short term debt 26.7% Inventories 6.9% Other 6.6% Interest bearing debt 11.2% Current assets 51.5% Other 2.7% long term debt 13.9% Associated companies 2.9% Tangible fixed assets 24.6% Pensions 1.6% Intangible fixed assets 11.2% Other provisions 0.3% Other 9.8% total provisions 1.9% total fixed assets 48.5% Minority interests 1.4% equity 56.1% total assets 100.0% total liabilities 100.0% p R o f I t a n d lo S S a C Co u nt R I S k C ate g o Ry

Turnover 100.0% Costs -83.1% CategoRy a 6.5% Gross profit 16.9% Depreciations -5.0% CategoRy b 61.5% Associated companies 0.2% Minority interests -0.3% CategoRy C 15.2% operating profit 11.8% Goodwill amortisations -0.8% CategoRy d 13.0% Financials. net. 0.1% Tax -4.5% CategoRy e 3.8% Extraordinary activities -0.5% Net profit 6.1% CategoRy total 100.0% Return to fair Value 151.5% Weighted risk premium 62.4% earnings yield 14.7% net debt/op. profit years no debt growth factor -2.1% Weighted interest rate level 3.3%

categories, and finally, the upside potential

and underlying growth rate applied to calcu-

late the Fair Value of the portfolio.

Comparing the portfolio characteristics in the

group accounts with market characteristics

shown in Figure 3 under the Stock Markets

section, it can be concluded that the portfo-

lio offers a higher return potential and higher

earnings yield in combination with higher

exposure to earnings stability (risk categories

A and B) and a stronger balance sheet.

ValueInvest LUX Japan

offers a higher return

potential and earnings

yield in combination

with higher exposure to

earnings stability (risk

categories A and B) as

well as a stronger

balance sheet.

Va lu e I n V e S t 1 : 2 0 1 2 11

casescasesMicrosoft still has a significant cash position, which is, paradoxically,

both comforting and worrying: on the one hand, we like companies

not burdened by debt, on the other, excess cash can be misspent. One

restriction on cash use for U.S. companies is taxes to pay if they repa-

triate income retained abroad. Microsoft has however been taking

steps to reduce its cash position. Since we acquired the stock, the divi-

dend has been boosted by 54% in two steps, and now the stock yields

a respectable 2.5%, close to the global average of 2.7% and ahead

of the 2.1% that the U.S. stock market offers. In these volatile times,

technology stocks usually approach these yields not through dividend

increases but through price drops! While we always welcome dividend

increases up to reasonable levels that do not endanger financial inde-

pendence of the business, acquisitions are usually more controversial.

Microsoft’s purchase of Skype for $8.5bn in May raised a few eye-

brows, including ours. The official purpose of acquiring Skype is syner-

gies in areas that involve real-time communication on the consumer

side across all device types. Hence, Microsoft bought operating logic

of real-time communication processes that it could not build itself.

The Windows operating system and

the Office suite of applications are the

core of the company. The divisions

responsible for those products, called

Windows & Windows Live and Micro-

soft Business, respectively, accounted

for nearly 60% of revenues last fiscal

year and provided over 80% of opera-

ting profit, mostly as a result of Micro-

soft’s dominant positions in these

bread-and-butter businesses. The

Vista stumble that gave Microsoft a black eye was more than made up

for by the success of its replacement, Windows 7, which has been dri-

ving Microsoft’s revenue growth over the last couple of years. Howe-

ver, Microsoft has not yet got its act together in operating systems for

mobile devices, where younger and nimbler competitors such as Goog-

le seem to have an upper hand, and Apple seems to be in a league of

its own with its in-house link to hardware. In the Office range of produ-

cts, the company has been able to avoid mistakes, and infrequent but

quite regular new versions allow Microsoft to notch sales and profits

higher. Like with Windows, switching costs for customers in these pro-

ducts are quite high. Contrary to common perception, today’s Microsoft

is much more than the Windows operating system and the Office pro-

duct suite. One segment that has been moving Microsoft forward in

MicrosoftMicrosoft

by Denis kostyukovich, Cfa, portfolio Manager, ValueInvest asset Management s.a.

Microsoft has been part of our global portfolios since the spring

of 2009. In those gloomy days for equity investors, our valuation

showed that we were paying 55-60% of Fair Value for a high-quality

company with a net cash position. Our investment process dictates

the need for a safety margin of at least 35%. Stock price declines

that had lasted several quarters combined with low interest rates

made Microsoft accessible to us for the first time in almost two deca-

des, according to our reconstruction of the company’s and markets’

conditions during that period. The major concern for investors at that

time was that the company had run out of the rapid growth which it

had enjoyed for a couple of decades. Anti-competitive investigations

in the US and in Europe with high amounts of settlements or fines

were also fresh in investors’ memory. It appeared to us that the mar-

ket, already very jittery in an uncertain environment, got frightened

by relatively poor quarterly results from Microsoft and expectations

of more disappointments. Its Vista operating system was seen as a

failure. Two and a half years later, we see that the company is still

able to grow revenue and operating profit at double-digit rates as

Windows 7 (with 450m copies sold) and Office 2010 have become

the fastest-selling product versions Microsoft ever brought to the

market. Moreover, we reckon the stock is an attractive investment

even without this growth.

What we found having analyzed the case was that the business

model of the company was not in any immediate danger apart from

the impact of the »normal« cyclical slowdown. The company’s domi-

nant position in the system software market was not under threat,

as the switching costs for the customers were and remain too high.

While it is true that new disruptive technology or new software stan-

dards like Linux could endanger Microsoft’s competitive position in

the future, so far we have seen a very limited impact on the company.

The main point in this respect is that we want the management to

take any potential threats seriously, and not discounting them as nui-

sance from the strength of its current status as a software power-

house. It looks like Microsoft missed the recent rapid advance of light

portable computers and other mobile devices, but seems to take the

development of web-based applications (cloud computing) seriously.

Va lu E I n V E s t 1 : 2 0 1 212

recent years is the Server and Tools division which sells such products

as Windows Server, Microsoft SQL Server, Windows Azure, Visual Stu-

dio, System Center products, Windows Embedded device platforms,

and Enterprise Services. Through this division, Microsoft also offers

developer tools, training, and certification. Half of the division’s reve-

nue comes primarily from multi-year volume licensing agreements,

which provide quite stable revenue streams. Remarkably, Server and

Tools’ revenue and operating profit grew every year since it became

a reportable segment with attributed financial data going back to

2002. Today, it represents 25% of revenue, with moderate growth

expected to continue.

At the time of our initial analysis, the weak points in Microsoft were

the Online Services division and the Entertainment and Devices divi-

sion. The online strategy has not worked out as planned, and it is still

quite uncertain whether Microsoft will succeed in building economies

of scale in this business segment where its most serious competitor

is Google. Among Microsoft’s offerings in this division is the search

engine Bing, MSN, adCenter, and advertiser tools. Revenue is mostly

generated through the sale of search and display advertising. Unfor-

tunately, almost three years later, Microsoft has not been able to

move forward on the online front in terms of financial performance.

Bing has been steadily gaining market share, and Microsoft sought to

expand its reach through an alliance with Yahoo!. However, revenue

stays volatile, and the company has been losing more than $2bn per

year for the last 3 years in the Online Services division. The company

is now trying to find cross-divisional synergies to boost economic

viability of this troubled division. One example of a step in this direc-

tion is the integration of Bing across other products such as the

Xbox game console and Windows Phone. Skype, which will become

a separate division, will most likely also have some interplay with the

existing online business.

We were also concerned about the Entertainment

and Devices division, where Microsoft’s Xbox game

console competes with Sony’s PlayStation and

Nintendo’s Wii. This business was just emerging

from losses of more than $1bn per year when we

first bought the stock. However, the division seems to be fulfilling

its turnaround potential. Microsoft has been able to capitalize on the

connectivity capabilities of Xbox and a relatively broad selection of

games for the platform. In addition, the introduction of Kinect, a moti-

on-sensing device for game control, a year ago breathed new life into

the console sales. As a result, the division earned more than $1bn pre-

vious fiscal year. Although we realize that double-digit growth rates

for Microsoft could very soon become a thing of the past, our valua-

tion indicates that even without growth Microsoft stock is an attrac-

tive investment, at least at the low interest rates currently obser-

ved. It is quite likely that the stock is in a long transition stage where

so-called »growth« invertors are turning away from Microsoft while

so-called »value« investors have not yet accepted the stock as their

own. Slower growth rates probably act as a deterrent, while robust

cash generation and still dominant market positions with high switch-

ing costs for customers are not yet fully appreciated. There are objec-

tive reasons for a secular slowdown in revenues. Moreover, we expect

some deterioration in gross profitability, a continuation of the trend

observed over recent years. This trend has been driven mostly by the

increasing share of sales in emerging markets, where volume growth

is high but prices are lower, and by higher costs of online products. On

the positive side, there are still several potential catalysts. Despite a

string of losses in Online Services, Microsoft has not given up, and its

determination may eventually pay off as it looks for ways to extract

synergies. The mobile operating system business is another oppor-

tunity where a breakthrough could be taken very positively by the

market, and Microsoft does have the resources to expand its leading

position in computer operating systems to other devices and build

what it calls »the 3rd mobile ecosystem«. Finally, there seems to be

a growing consensus that some fresh blood in Microsoft’s leadership

could sharpen the company’s strategy and make it more flexible and

responsive to technology shifts.

As of late December, Microsoft’s stock trades at 42% of Fair Value,

offering an upside potential of almost 140% by achieving Fair Value.

We apply an earnings growth of 4% to the company’s earnings this

year, assuming they stay flat thereafter. Another angle to view Micro-

soft’s value is to look at earnings yield. If we bought the company

100% and paid out the excess cash to ourselves we would »own«

the operating earnings from the Company. These operating earnings,

including the mentioned 4% expected growth, would give us a return

of close to 15% before tax on our full investment. We see this as

an attractive risk/return trade off when considering global 10-year

government bond yields around 2%.

casescases

Va lu e I n V e s t 1 : 2 0 1 2 13

gin, Next distinguishes itself by being the one company within its

sector, with the smallest fluctuations during the last 10 years. Next

Retail has delivered an average operating margin of 14.2% in the last

9 years, and in 2007 they realised an operating margin of exactly

14.2% before the financial crises kicked in for real. Impressively Next

has only seen its margin fall to 13.2% in 2008, which in its history is

regarded as the worst since »The Great Depression« only to see it

back at 14.2% in 2009, the year after. A rather impressive feat for a

company classified as a C-category, where fluctuations in earnings

are not uncommon.

Besides being a company which has shown strength even in reces-

sion, Next has, as already indicated, been able to develop Next Direc-

tory from a pure catalogue business for customers in the UK to a

successful international internet business today. Earnings wise this

division has gone from contributing 22% of the operating profit in

2002 to 38% in 2010 with a very impressive operating margin of

23.7% against 13.8% in 2002. Furthermore the semi annual results

2011 showed that Next Directory has done even better and account-

ed for 45% of Next’ total operating profit. It is worth mentioning two

milestones in the development; in 2006 the online sales overtook the

catalogue sales, and at the same time they managed to streamline

costs by new improved stock facilities and better logistics. Thereby

an increase in operating margin was achieved from 14.1% to 18.6% in

one single year, whereof 3.8%-point of this increase can be attribut-

ed to a reduction of costs. The second leap happened in 2009, where

Next Directory expanded internationally, whereby the operating

margin, due to an increase in sales (and product mix) increased from

19.3% in 2008 to almost 24% in 2010. Next has hereby shown, in a

difficult period for many retail businesses, that they have been able

to retain a stronghold via their shops, and at the same time developed

their business profitability by increasing online sales.

The way Next has developed shows

a high degree of market insight and

appears as a company with a deep

knowledge of their clients. Further-

more Next is a company with an

ability to navigate the economic trends, incl. the development in raw

material costs, and especially an ability to predict future trends in the

consumers’ general economic health. The company has also shown

that they are not influenced by the general publics’ mood swings,

which is mostly either very optimistic or very pessimistic. Next made

the following statement in January 2009: »We anticipate that con-

sumer demand will remain weak during 2009, although we would

caution against some of the more extreme economic forecasts«. This

shows a clear vision at a time when many retail businesses were in a

pure defence mode (albeit fair to say this due to economic hardship).

This way Next prepared for a consumer who was weak, but far from

finished and in 2009 the company managed to increase its operating

Large exposure within clothes retail and on top of that in the UK

may sound risky. It does not get better when you think about that

we bought the English retail chain Next back in June 2008, at a time

when the outlook was very different from today and it would get

even darker in the months to follow. All the ingredients for a danger-

ous cocktail were present, but despite the odds, this has not been

the case. Next has, contrary to common belief, been one of the best

investments and this not just in 2011, but from day one when Next

became part of our portfolios.

The clothes brand Next was established in 1982 in the UK, at first for

women and since in 1984 and 1987 for men and children respectively.

Next Home (products for the home) was launched in 1985; the same

year Next opened its first department store in London. Next Retail

has 500 shops in England and Ireland combined. Next Directory, their

catalogue, was launched in 1988, whilst Next Directory today is a

combination of catalogue and online sales, whereof the online busi-

ness became available in 1999 and today has more than 3m active

customers. The latest summer catalogue had an impressive 1.400

pages combining clothes and homeware. At the beginning Next Direc-

tory online was only available for customers in the UK, but in 2009

they expanded to include the USA and other countries and today

they deliver to 44 countries worldwide. In addition to this Next has

180 shops outside the UK.

The challenges for a retail chain such as Next are numerous. To get

the fashion exactly right is one thing, another is the almost impossi-

ble task of predicting the future spending power of the consumer. In

addition, you also have the challenges of price fluctuations (increases

in particular) in raw materials such as cotton, and wage inflation in

low-wage-producing countries to contend with, which is particularly

difficult in times when customers are weakened economically. The

retail business is a business with occasionally large fluctuations in

income caused by the changes in the market, which has meant that

several players, especially smaller ones, have been forced to close in

these so-called »slumps«, and even larger players with well-known

brands can find themselves in the danger zone because of the

decrease in income (and cash flow) and the thereof inability to service

their debt. We have classified the industry and Next as a C-category,

which means a medium risk on our scale, which runs from A to E.

Regardless of the sector invested in, we always rank earnings sta-

bility high on our list. In this regard, measured on its operating mar-

NextNext

By Claus Juul, Portfolio Manager, ValueInvest Asset Management S.A.

VA lu e I n V e S t 1 : 2 0 1 214

profit in both Next Retail and Next Directory by 12% and 16% respec-

tively. When we evaluate the potential of an increase in operating

profit we base it on the company’s own expectations. For 2012 Next

does not forecast a necessity to increase the sales prices as a result

of the price increases in raw materials, as the inflation pressure is

decreasing. Furthermore, Next is starting to buy goods from cheaper

production areas such as South India, Northwest China and Bangla-

desh. In addition there is a general easing of the capacity pressure at

the suppliers, as some retail chains have simply disappeared following

the crises of 2008/2009. Without expecting a consumer high, Next is

predicting that 2012 will be better than 2011, albeit with a slow pro-

gress which will only become noticeable from Q2 2012.

The risk related to the Next shares is of course that the expectations

are high and it is expected that Next will not disappoint by always

getting the fashion right and trends spot on, and Next has acknowl-

edged this and is aware that the fashion risk is high. As an example,

Next has in 2011 already secured a larger and broader selection of

goods earlier in the production cycle for the 2011/2012 season by

negotiating better conditions and ensuring supply security when

compared to 2010. In addition, Next has slightly increased the produc-

tion in own factories. In other words; larger quantities, additional col-

our combinations etc, which leads to better purchasing conditions and

better profitability for Next, but also a higher risk, in case the clothes

ranges fail to impress the consumer. As Next said about the manoeu-

vre in connection with the semi annual report last year: »so far the

riskier, less flexible approach has been successful«. The bet is also

reasoned by the fact that last year, Next was caught in the middle

of the mentioned capacity problems in the production centre

of China. This led to a lack of desired colour schemes with-

in some of the best selling clothes ranges, for women in

particular, and Next had to declare ’sold out’ within a few

weeks. Some would most likely call this a bit of a luxury

problem, but nonetheless, Next saw this as a problem and loss of

income, which we think echoes a rather ambitious company.

Cash Return to Shareholders

Next has in the last 5 years bought back 26% of company shares, and

46%, if you expand this period to 10 years. This act demands a rela-

tive solid cash flow generation when the average market value for

Next in the 10-year period has been GBP 3.4 bn. On top of this, you

need to take into account a rather attractive dividend policy, where-

by Next via dividends has returned in the area of 2.8%-5.6% yearly.

Apart from 2008, where the dividend was unchanged, the company

has increased the dividend per share in all of the 10 years from 27.5

pence per share in 2001 to 78 pence per share in 2010. Despite the

willingness to pay out to the shareholders, Next is still a very strong

company financially. Next has thereby used 28% of the debt capaci-

ty the company has when we take our growth expectations of -3%

of operating profit into account. In other words; Next can »afford« a

drop in the operating profit to -74% before the company exceeds our

debt criteria.

The company is no longer part of the top 10 largest positions in the

portfolio, as we have reduced our holding a fraction due to the cur-

rent stock rises and the fact that Next no longer is amongst the

cheapest shares in the portfolio, however it still trades at 50% of Fair

Value with a dividend yield of 3.4%.

We anticipate that

consumer demand

Will remain Weak

during 2009,

although We

Would caution

against some of

the more extreme

economic forecasts

15

Today the term »lost decades« clings to

Japan and has almost become a synonym

for »no growth and deeply indebted«, and

one actually talks about, that other devel-

oped countries are catching the »Japanese

di sease«. Japanese stagnation is notoriously

famous, but maybe there is a hidden truth

beneath the surface, and what does this

mean for investments in Japanese stocks?

Historical development of the Japanese

stock market

Judged by the historical development of

the Japanese stock market (see graph page

18), it is not difficult to understand the talk

about the lost decades. The Japanese stocks

have never been able to regain the lost

ground since the peak reached in 1989. For

the unlucky investor who spent his life sav-

ings on the Japanese stock market at the

end of the 1980ies, it will have resulted in

a negative return of 75% in nominal terms

measured in JPY. The stock market is back

to the level of December 1983. The strong

economic growth during the 1980ies with

massive trade surpluses and a strong belief

in superior Japanese management resulted

in a euphoria, which, combined with finan-

cial deregulation and monetary policies from

the Bank of Japan in the 1980ies, paved the

way for aggressive speculation in stocks and

in the property market. However, we should

not forget that the long decline of the Japa-

nese stock market was caused by the valu-

ation of Japanese stocks which had reached

ridiculous heights: the investors were willing

to pay 71 times the earnings for the Japa-

nese stock market in comparison to 15 times

for the American stocks. At the end of 1989

the value of the Japanese stock market had

overtaken that of America and become the

world’s largest. Not a small feat for a country

whose industry was totally destroyed during

WWII, a country that only had a population

less than half of that of the USA and in addi-

tion lived on an island only 4% the size of the

total area of the USA.

At the time it was also said that the Emper-

or’s palace in Tokyo was worth more than

the whole state of California. The American

professor of economics J. Barkley Rosser Jr.

noted in 1990, that the combined value of all

land in Japan was 50% higher than the val-

ue of land in the rest of the world; property

prices had reached astronomical heights. The

euphoria had, as so many times before on the

stock market, spun out of control, driven by

the imagination of continuous astronomical

growth rates and expectations of a »Japan

Incorporated« that would take over the world

with an economy that would rapidly overtake

that of America. Yet another example of set-

ting aside realism and common sense in con-

nection to valuation, exactly the same pat-

tern that led to the inflating of the IT bubble

and the unavoidable burst in 2000.

If the long-term development of the Japa-

nese stock market is a guideline for the

future, it looks pretty bleak. As an investor, it

is not something you want to live through.

Big challenges for the Japanese society

The Japanese society is facing many chal-

lenges today; lack of economic growth, an

astronomical debt and public budget deficit,

a political system which seems paralyzed

and not capable of the necessary structural

changes, and a demography which makes

matters even worse. And as if these struc-

tural problems were not enough, Japan was

hit by a devastating earthquake in March

2011. The earthquake triggered a tsunami

which led to a nuclear crises, of which the

full scale is not yet known. At best, one can

hope that the reconstruction after the tragi-

cal earthquake is seen as a catalyst for the

Japanese economy. At the moment many

would ask themselves, why they should even

consider buying Japanese stock; would one

end up with just another lost decade? It is

conventional wisdom that the current Japa-

nese stock market is cheap and will remain

cheap due to budget deficit and a rapidly

ageing population. In the following section

we will try to give an insight into the circum-

stances which contribute to the uncertainty

surrounding the Japanese future and inter-

pret the myth of Japan’s lost decade. But to

understand the Japan of today, we have to

know the historical development and what in

fact is behind the Japanese Miracle.

Japan’s resurrection after World War II

The Japanese Miracle was created from a

mixture of heavy state interference, pro-

tectionism, and industrial innovation. Japan

would outcompete many of the established

Japan - from greatness to decline?

Article by Klaus Petersen, CFA, Portfolio Manager, ValueInvest Asset Management S.A.

The Japanese Miracle has faded; the headlines back from the 1980ies have changed from being partly

admiration for Japan's industrial capability to partly a direct fear of its global economic dominance.

VA lu e I n V e S t 1 : 2 0 1 216

»

producers of everything from electronics

to cars, in both Europe and the USA. The

re-construction after WWII was the start-

ing point for the Japanese Miracle and in the

1960ies Japan rose like the bird Phoenix from

the ashes and the economy went full steam

ahead. In 1960 the combined Japanese GDP

(gross domestic product) was USD 44 bn.,

and by 1990 it had risen to USD 3,053 bn.

Japan had become a growth engine and a

role model for the rest of Asia. The meticu-

lous state interference and planning via the

Ministry of International Trade and Industry

(MITI) were instrumental for Japan’s resur-

rection. MITI is a collaboration between the

state and the private industrial sector, where

MITI coordinated and promoted those indus-

tries they had handpicked as the most impor-

tant for the future growth. Furthermore, MITI

established Japan Development Bank, who

could offer cheap funding to the business

community’s investments. MITI also ensured

that Japan had easy access to cheap foreign

technology and at the same time established

import restrictions to avoid too many for-

eign imports flooding the Japanese market.

They simply protected the national producers

against foreign competition. Another impor-

tant point in the understanding of Japan’s

success lies in the strong network of the

keiretsu. In the period after the Meiji resto-

ration (Meiji period from 1868-1912 consti-

tutes a modernisation and industrialisation

of the Japanese society) and to the end of

WWII the Japanese business community was

dominated by the zaibatsu. The zaibatsu

were family-owned conglomerates with their

own bank, which could finance the industrial

activities. The zaibatsu were so powerful,

that during the occupation the U.S. military

governor decided to break up these monopo-

lies with the intention to implement a mar-

ket-driven capitalistic system. However, after

the Americans gave back the control to the

Japanese, there was a relaxation of the anti-

monopoly legislation, and businesses got

together in keiretsus, which in contrast to the

zaibatsu were not family-owned. The keiret-

su linked, for example, producers to sub-sup-

pliers, amongst others, via cross-ownership

many of the manufacturers, especially the

American, did not achieve exactly the same

standard. Soon other Japanese car manufac-

turers like Datsun (Nissan), Honda and Mazda

followed suit, and it would not take long

before Toyota and the other manufacturers

started to conquer the more expensive car

classes. Today the Japanese car manufactur-

ers are large international players, respected

for their high quality and technical know-

how. Sony is yet another great example of

how Japan introduced innovative technology.

In the period between 1950 and 1979 Sony

introduced, among others, the following: a

revolutionary pocket radio, a transportable

TV, a video camera for personal use, and last

but not least, the predecessor of today’s

iPod, the Walkman. Nintendo, which by the

way is the oldest manufacturer of video

game consoles, is a present-day example of

an established company that has become

a »game-changer«. In 2006, using creative

thinking and innovation, Nintendo introduced

the Wii which was a relatively cheap way to

make video games more interactive with the

help of motion sensors. In addition to that,

the Wii appeals to a broader audience than,

for example, Sony’s PlayStation and Micro-

soft’s Xbox 360. The Wii has become a huge

success and has until now sold more than

89 million units. The world of technology is

tough with a short product lifespan and time

will tell if Nintendo can repeat the success

with the new generation of the Wii. Another

example of Japanese technological knowl-

edge and innovation is the hybrid car. Hybrid

and thus established control of the supply

chain and thereby the quality. Cross-own-

ership had more to do with strengthening

of the business relationships and a defence

against aggressive financial players and com-

petitors than with actual investment. It is a

kind of brotherhood of Japanese business

community. However, cross ownership turned

out to be an expensive experience for Japan

once the bubble burst and the aftermath

forced many companies to sell out of their

holdings.

Innovation was the cornerstone of the

Japanese Miracle

After World War II the Japanese had estab-

lished a very efficient and well-oiled produc-

tion machine, which could produce a wealth

of groundbreaking innovations. One of the

most important contributors to the resurrec-

tion of Japan was the country’s very motivat-

ed and dedicated work force, which sidelined

individuality and short-term self-interest in

the quest for increased productivity. This

was one of the main reasons why Japan

could produce cheaper and better than most

European and American competitors. The

Japanese workers quickly accepted the just-

in-time-concept and combined it with a par-

ticularly strong quality control. The Japanese

revolutionised the assembly line industry in

the 1950ies and 1960ies and created the

Toyota Production System, which is the fore-

runner for the concept of »Lean Manufactur-

ing«. Japan’s success in the automobile indus-

try is one of the best exhibits of how Japan

managed to shake the established American

and European manufacturers. At the begin-

ning of the 1960ies most people could not

help smiling when they saw the small cheap

Japanese cars on the street, however that

would soon change. In the 1960ies Toyota

entered the cheap end of the American mar-

ket with their model Corona. The car was

both cheap and reliable and it did not take

long before many Americans had taken the

Toyota to heart and the Corona became no.2

car in the garage for the American middle

class. The high quality and the reliability were

part of the reason for the success whereas

VA lu e I n V e S t 1 : 2 0 1 2 17

» cars are not a new invention, but Toyota was

the first to successfully launch a mass-pro-

duced hybrid car. Toyota Prius was launched

in Japan in 1997 and very quickly became a

success on the global markets too, not least

in the USA, where the car achieved cult sta-

tus amongst the famous who wanted a

»green« image by driving in the least pollut-

ing car on the American market! Per August

2011 Toyota has sold more than 2 million

Prius cars. So let us agree: Japan can still sur-

prise when it comes to innovation and prod-

uct development, even if the critics often say

that Japan lacks the creativity and venture-

based environment needed to breed »disrup-

tive innovation« and new »game-changers«.

The economic growth and the myth

of the lost decade

It is true that Japan has not managed to

return to the historical growth rate which

it enjoyed when the Japanese Miracle was

going ahead at full speed. When the specu-

lative bubble burst, it brought a long and

painful decline of the bank balances and de-

leveraging in the companies, and now many

observers think that the Bank of Japan did

not stimulate the economy in time. The will-

ingness to take risks disappeared into thin

air and gave way to a new focus on savings

rather than consumption, which put a heavy

burden on growth of the economy in the

period that followed, but the result is, that

today Japan has accumulated considerable

savings. The size of the country’s economy is

often expressed by the GDP which comprises

the value of all the finished goods and ser-

vices produced within the country. Looking

at the growth rate in this aggregated figure,

it is easy to conclude that Japan has been at

a standstill. In the last two decades the Japa-

nese growth has been stuck in the slow lane

with a yearly growth of the GDP of just 1%

measured in constant prices. In contrast, the

American economy in the same period, pro-

duced a growth rate that was 2.5 times as

high as Japan’s, driven by an indomitable opti-

mism amongst the American consumers, who

in contrast to the Japanese consumers have

not been inhibited by a high savings quota,

but happily took out consumer loans when

the disposable income could no longer fulfil

their wishes.

There are two contributing factors that influ-

ence a country’s long-term growth potential.

Firstly, the demographic situation plays a

major role; and secondly, the growth in pro-

ductivity. A country with a relatively young

population and growth within the working

age population (we have chosen to define

this group as 20-64 years of age) will have

better conditions for growth than a simi-

lar country where the working population

is declining. However, a population growth

alone is not enough; it is also important to

have growth in the productivity. The growth

in productivity is dependent on the ability to

keep a continual technological development,

which can enhance and improve economic

efficiency. It takes a technological break-

through to enhance the productivity and

investment alone cannot improve it. Measur-

ing Japan’s success in terms of its develop-

ment in the aggregate economy does not

give a fair picture and does not show if Japan

has utilised its growth potential or not.

Demographic development in the working

age population 20-64 years

It is no secret that Japan has the world’s old-

est population with a median age of almost

45 years (half of the population is older than

45 years!), and the problem of a lacking (low)

growth can most definitely be attributed to

the demographic development. Japan has

ended up in what The Economist describes

as a demographic vortex, where one of the

lowest birth rates in the world of 1.32 chil-

dren per woman (for Denmark 1.85), has

caused the total population to fall. There are

more people dying than being born. UN esti-

mates that the population will fall from the

current 127 million to 109 million in 2050

based on UN’s »Medium-fertility« progno-

sis. The number of Japanese above 65 years

will in 2050 constitute more than 1/3 of the

population, and as the Japanese at the same

time have a life expectancy of 82.7 years, it

will put extreme pressure on the public econ-

omy going forward and the young can look

forward to shouldering the burden. It is esti-

mated that up until 2050 the working popu-

lation will be shrinking by nearly 1% yearly,

and this means that there will only be 1.3

workers to provide for 1 pensioner in 2050. In

2010 the ratio was 2.6. It may seem strange

that Japan has not done anything to prevent

the predictable demographic challenges and

that the Japanese society is still somewhat

closed, which has precluded the possibility

Source: VIAM calculations based on data from International Monetary Fund,World Economic Outlook Database, September 2011

The development in the Japanese economy compared to USA and UKHistorical development of the Japanese stock market

Source: Bloomberg.

-8

-6

-4

-2

0

2

4

6

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Curr

ent

Acc

ount

Bal

ance

in %

of

GDP

% o

f GD

P

USA Japan

0

50

100

150

200

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

General Government net debt General Government gross debt

75

125

175

225

275

325

1950

1956

1962

1968

1974

1980

1986

1992

1998

2004

2010

2016

2022

2028

2034

2040

2046

2052

2058

2064

2070

2076

2082

2088

2094

2100

Inde

x W

orki

ng A

ge P

opul

atio

n 20

-64

year

s (1

950

= 10

0)

JapanUSAGermanyChinaUK

Working Age Population (20-64 years)peaked in 1997

Japan USA UK

Japan USA UK

90

100

110

120

130

140

150

160

170

180

190

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Annual growth in GDP in constant prices per working age population. 2001-2010: Japan 1.1%, USA 0.5% and UK 0.8%1981-2010: Japan 1.9%, USA 1.5% and UK 1.7%

2881,37

1219,25

728,61

0

500

1000

1500

2000

2500

3000

3500

dec/80 dec/81 dec/82 dec/83 dec/84 dec/85 dec/86 dec/87 dec/88 dec/89 dec/90 dec/91 dec/92 dec/93 dec/94 dec/95 dec/96 dec/97 dec/98 dec/99 dec/00 dec/01 dec/02 dec/03 dec/04 dec/05 dec/06 dec/07 dec/08 dec/09 dec/10 dec/11

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

jun/98

dec/98

jun/99

dec/99

jun/00

dec/00

jun/01

dec/01

jun/02

dec/02

jun/03

dec/03

jun/04

dec/04

jun/05

dec/05

jun/06

dec/06

jun/07

dec/07

jun/08

dec/08

jun/09

dec/09

jun/10

dec/10

jun/11

dec/11

Div

iden

d Yi

eld

%

Dividend Yield Topix - Japan Dividend Yield S&P 500 - USA

90

110

130

150

170

190

210

230

250

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Annual growth GDP in constant prices.2001-2010: Japan 0.7%, USA 1.6% and UK 1.4%1981-2010: Japan 2.2%, USA 2.7% and UK 2.2%

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y pe

r wor

king

pop.

20-

64 y

ears

(ind

ex =

100

in 1

980)

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y (in

dex

= 10

0 in

198

0)

Topi

x in

JPY

-8

-6

-4

-2

0

2

4

6

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Curr

ent

Acc

ount

Bal

ance

in %

of

GDP

% o

f GD

P

USA Japan

0

50

100

150

200

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

General Government net debt General Government gross debt

75

125

175

225

275

325

1950

1956

1962

1968

1974

1980

1986

1992

1998

2004

2010

2016

2022

2028

2034

2040

2046

2052

2058

2064

2070

2076

2082

2088

2094

2100

Inde

x W

orki

ng A

ge P

opul

atio

n 20

-64

year

s (1

950

= 10

0)

JapanUSAGermanyChinaUK

Working Age Population (20-64 years)peaked in 1997

Japan USA UK

Japan USA UK

90

100

110

120

130

140

150

160

170

180

190

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Annual growth in GDP in constant prices per working age population. 2001-2010: Japan 1.1%, USA 0.5% and UK 0.8%1981-2010: Japan 1.9%, USA 1.5% and UK 1.7%

2881,37

1219,25

728,61

0

500

1000

1500

2000

2500

3000

3500

dec/80 dec/81 dec/82 dec/83 dec/84 dec/85 dec/86 dec/87 dec/88 dec/89 dec/90 dec/91 dec/92 dec/93 dec/94 dec/95 dec/96 dec/97 dec/98 dec/99 dec/00 dec/01 dec/02 dec/03 dec/04 dec/05 dec/06 dec/07 dec/08 dec/09 dec/10 dec/11

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

jun/98

dec/98

jun/99

dec/99

jun/00

dec/00

jun/01

dec/01

jun/02

dec/02

jun/03

dec/03

jun/04

dec/04

jun/05

dec/05

jun/06

dec/06

jun/07

dec/07

jun/08

dec/08

jun/09

dec/09

jun/10

dec/10

jun/11

dec/11

Div

iden

d Yi

eld

%

Dividend Yield Topix - Japan Dividend Yield S&P 500 - USA

90

110

130

150

170

190

210

230

250

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Annual growth GDP in constant prices.2001-2010: Japan 0.7%, USA 1.6% and UK 1.4%1981-2010: Japan 2.2%, USA 2.7% and UK 2.2%

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y pe

r wor

king

pop.

20-

64 y

ears

(ind

ex =

100

in 1

980)

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y (in

dex

= 10

0 in

198

0)

Topi

x in

JPY

VA lu E I n V E S T 1 : 2 0 1 218

»

of introducing fresh blood to the working

population via immigration. A clear piece of

evidence, that Japan is not a multicultural and

open society, is the fact that 98.5% of the

population are Japanese.

The demographic development can seem

daunting, but one has to remember that it is

based on predictions and extrapolations that

are subject to uncertainties. However, it is

definitely a positive sign that the birth rate

in Japan has reached the bottom, and Japan

may not have to face the doom and gloom

predicted by the demographic extrapolations.

A possibility could be to import the missing

labour force from the neighbouring Asian

countries in order to lighten the burden of

a working person, but there are also some

more obvious options. An analysis made by

the government and published in 2010 con-

cludes that the women in Japan represent a

considerable unexploited workforce resource,

which could be activated by offering more

flexibility and better pay. It is estimated, that

if women did not stop working when they got

married or had children, they would increase

the workforce by up to 4.5 million people.

It would be easy to think that big societal

challenges of a rapidly ageing population

are a phenomenon specific to Japan, but

this is not the case. Several countries will,

within a foreseeable future, find themselves

in a similar position due to low birth rates

and improved living standards, which have

increased the life expectancy of seniors con-

siderably. The working age population has,

amongst others, already peaked in Germany

and has now started to fall. The Chinese

growth monster will, according to UN’s esti-

mates, experience a peak of the working age

population in 2019, and thereafter decrease

and hence slow down the economic growth.

It is estimated that, currently there are 7.9

workers per pensioner in China, which will

decrease to 2.2 workers providing for a pen-

sioner by 2050. This can have serious con-

sequences for the Chinese economy, and it

is naive to think that China is better prepared

than Japan!

Japan vs. USA and UK’s GDP per working

age population 20-64 years

In the period of 1980-2010 the Japanese

GDP per capita has actually increased more

than the American. A rising GDP per capita

means that the Japanese living standard

has increased, not decreased. The Japanese

have become wealthier, and looking from this

perspective we should not be talking about

»the lost decades«. The growth rate for the

aggregated economy for Japan has been low,

but the growth has been achieved despite

the decline in the working-age population

since 1997. The population in the working

age is the cornerstone of a country’s produc-

tive potential. Daniel Gros from Project Syn-

dicate (The Guardian 17/1 2011) has analysed

the growth of GDP per working age popula-

tion and stated that Japan during the latest

decade has fared better than the USA and

several other countries. This is also illustrated

in the graph below (based on VIAM calcula-

tions). Furthermore, Daniel Gros concludes

that it is not fair to use Japan as an example

of stagnation. He would rather see Japan as

an example of how to get the best possible

growth out of a limited potential.

High economic growth is no guarantee

of high stock return

Growth-seeking investors tend to crowd

investments in regions and countries with

the most favourable economic growth poten-

tial. With this in mind, it is easy to understand

why many investors have chosen not to

invest in Japan, a country with structural lack

of growth. It is intuitively logical to draw the

conclusion that economies in rapid growth

will automatically give the best returns. Eco-

nomic growth increases the standard of liv-

ing of the population; however, it does not

automatically lead to a higher return for the

stock investors. Several analyses have found

a negative correlation between economic

growth and stock returns. As an example; in

the Credit Suisse Global Investment Returns

Yearbook 2010, Elroy Dimson, Paul Marsh,

and Roy Staunton from the London Busi-

ness School have analysed this relation for

19 countries in the period from 1900 to 2009

and found that the correlation between real

stock returns and growth of the GDP in con-

stant prices per capita is actually slightly

negative (-0.23). In the same studies they

have even divided countries into quintiles

based on 5 years of historical growth in GDP

and for each year constructed portfolios

according to such quintiles. The conclusion

is, that the group with the lowest growth

has delivered a return similar to, or higher

Source: VIAM calculations based on data from International Monetary Fund, World Economic Outlook Database, September 2011.

Japan vs. USA and UK’s GDP per working age population 20-64 yearsDemographic development in the working age population 20-64 years

Source: VIAM calculations are based on data from United Nations, Department of Economic and Social Affairs, Population Division (2011). World Population Prospects: The 2010 Revision, CD-ROM Edition Medium-fertility variant, 2011-2100.

-8

-6

-4

-2

0

2

4

6

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Curr

ent

Acc

ount

Bal

ance

in %

of

GDP

% o

f GD

P

USA Japan

0

50

100

150

200

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

General Government net debt General Government gross debt

75

125

175

225

275

325

1950

1956

1962

1968

1974

1980

1986

1992

1998

2004

2010

2016

2022

2028

2034

2040

2046

2052

2058

2064

2070

2076

2082

2088

2094

2100

Inde

x W

orki

ng A

ge P

opul

atio

n 20

-64

year

s (1

950

= 10

0)

JapanUSAGermanyChinaUK

Working Age Population (20-64 years)peaked in 1997

Japan USA UK

Japan USA UK

90

100

110

120

130

140

150

160

170

180

190

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Annual growth in GDP in constant prices per working age population. 2001-2010: Japan 1.1%, USA 0.5% and UK 0.8%1981-2010: Japan 1.9%, USA 1.5% and UK 1.7%

2881,37

1219,25

728,61

0

500

1000

1500

2000

2500

3000

3500

dec/80 dec/81 dec/82 dec/83 dec/84 dec/85 dec/86 dec/87 dec/88 dec/89 dec/90 dec/91 dec/92 dec/93 dec/94 dec/95 dec/96 dec/97 dec/98 dec/99 dec/00 dec/01 dec/02 dec/03 dec/04 dec/05 dec/06 dec/07 dec/08 dec/09 dec/10 dec/11

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

jun/98

dec/98

jun/99

dec/99

jun/00

dec/00

jun/01

dec/01

jun/02

dec/02

jun/03

dec/03

jun/04

dec/04

jun/05

dec/05

jun/06

dec/06

jun/07

dec/07

jun/08

dec/08

jun/09

dec/09

jun/10

dec/10

jun/11

dec/11

Div

iden

d Yi

eld

%

Dividend Yield Topix - Japan Dividend Yield S&P 500 - USA

90

110

130

150

170

190

210

230

250

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Annual growth GDP in constant prices.2001-2010: Japan 0.7%, USA 1.6% and UK 1.4%1981-2010: Japan 2.2%, USA 2.7% and UK 2.2%

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y pe

r wor

king

pop.

20-

64 y

ears

(ind

ex =

100

in 1

980)

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y (in

dex

= 10

0 in

198

0)

Topi

x in

JPY

-8

-6

-4

-2

0

2

4

6

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Curr

ent

Acc

ount

Bal

ance

in %

of

GDP

% o

f GD

P

USA Japan

0

50

100

150

200

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

General Government net debt General Government gross debt

75

125

175

225

275

325

1950

1956

1962

1968

1974

1980

1986

1992

1998

2004

2010

2016

2022

2028

2034

2040

2046

2052

2058

2064

2070

2076

2082

2088

2094

2100

Inde

x W

orki

ng A

ge P

opul

atio

n 20

-64

year

s (1

950

= 10

0)

JapanUSAGermanyChinaUK

Working Age Population (20-64 years)peaked in 1997

Japan USA UK

Japan USA UK

90

100

110

120

130

140

150

160

170

180

190

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Annual growth in GDP in constant prices per working age population. 2001-2010: Japan 1.1%, USA 0.5% and UK 0.8%1981-2010: Japan 1.9%, USA 1.5% and UK 1.7%

2881,37

1219,25

728,61

0

500

1000

1500

2000

2500

3000

3500

dec/80 dec/81 dec/82 dec/83 dec/84 dec/85 dec/86 dec/87 dec/88 dec/89 dec/90 dec/91 dec/92 dec/93 dec/94 dec/95 dec/96 dec/97 dec/98 dec/99 dec/00 dec/01 dec/02 dec/03 dec/04 dec/05 dec/06 dec/07 dec/08 dec/09 dec/10 dec/11

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

jun/98

dec/98

jun/99

dec/99

jun/00

dec/00

jun/01

dec/01

jun/02

dec/02

jun/03

dec/03

jun/04

dec/04

jun/05

dec/05

jun/06

dec/06

jun/07

dec/07

jun/08

dec/08

jun/09

dec/09

jun/10

dec/10

jun/11

dec/11

Div

iden

d Yi

eld

%

Dividend Yield Topix - Japan Dividend Yield S&P 500 - USA

90

110

130

150

170

190

210

230

250

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Annual growth GDP in constant prices.2001-2010: Japan 0.7%, USA 1.6% and UK 1.4%1981-2010: Japan 2.2%, USA 2.7% and UK 2.2%

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y pe

r wor

king

pop.

20-

64 y

ears

(ind

ex =

100

in 1

980)

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y (in

dex

= 10

0 in

198

0)

Topi

x in

JPY

VA lU E I N V E S T 1 : 2 0 1 2 19

» than, the one originating from the stocks in

the portfolio of the group with the highest

growth. The same is true for the risk-adjust-

ed returns. Growth is not irrelevant, but high

economic growth in previous years is not a

guarantee of any future stock returns. If one

could predict the economic growth correctly,

and if the prediction differed from the gener-

al consensus of expectations, then one could

achieve a higher return. However, in most sit-

uations, that is unfortunately not the case.

It can be expected that the growth in the

aggregate earnings in a country will follow

the growth of the GDP, but as the investors

only have a stake in the listed companies that

they currently own and do not have a stake

in »new« private companies, the return to

the shareholders will not necessarily increase

at the rate of growth of the overall economy.

In addition, a higher economic growth does

not necessarily lead to a higher profitability.

With an increase in standard of living workers

will demand higher salaries, and a larger part

of the profits will have to cover such costs.

Identifying an industry with a high aggregate

growth going forward does not guarantee

high return, and there are several examples

of industries that have enjoyed rapid growth

without benefitting from higher earnings

and favourable returns for the sharehold-

ers. Just look at the airline industry. Jeremy

Siegel (Russell E. Palmer Professor of Finance

at the Wharton School of the University of

Pennsylvania) has put forward two other

plausible explanations for the lacking correla-

tion between GDP growth and stock returns.

Firstly, the large listed companies on most

stock markets are typically global companies

and their earnings are therefore less depend-

ent on the domestic market and its economy.

Secondly, the stock market has already incor-

porated the expected economic growth in

share prices, which means that the investors

pay a higher multiple for the earnings.

Investors tend to pay too much for growth

as optimism takes over, facing lower returns

going forward, similar to what happened in

Japan in the 1980ies, when the investors

were willing to pay 71 times the earnings.

The flipside of this tendency is that compa-

nies in countries with low economic growth

run the risk of being valued at low multiples

relative to their earnings potential, a situa-

tion that bodes well for higher prospective

returns. It is the well known fact of value

beating growth in the long term. Finally, it

should be pointed out that surprises in the

economic growth have great influence on

stock prices in the short run. Stock prices

fall when the risk of an economic downturn

is looming. Other more extreme cases that

could lead to a total collapse of the economy

such as war can in worst case lead to a loss

of 100%.

the Japanese companies are turning to

the growth markets

The Japanese domestic market does not

inspire confidence in future growth, and

many Japanese companies have therefore

increased their investments in Asia. Growth

has to be generated outside of Japan, and

the Japanese companies have been rather

successful in increasing the export to the

surrounding growth markets. The Japanese

economy is now more closely linked to Asia

than to Europe and the USA. An impressive

56.3% of Japan’s total exports went to Asia

in 2010, and China has become Japan’s larg-

est export market, representing 19.8% of

total exports in 2010. This should be com-

pared to 16.5% and 12.0% for the USA and

Europe, respectively. In 2010 Japan had a

trade surplus with Asia, which was 65% high-

er than that with the USA and Europe com-

bined. Ten years earlier Asia only accounted

for less than 35% of the trade surplus with

the USA and Europe.

Japan’s strength lies hidden in its

industrial heritage

The strength of the Japanese economy is the

fact that Japan, unlike other developed econ-

omies, has not only maintained its industrial

heritage, but also developed a strong compe-

tiveness for such industries as e.g. car manu-

facturing and electronics based on high qual-

ity and innovation. After the earthquake in

March 2011 it became obvious how important

Japan actually is in the global supply chain.

Car manufacturers all over the world were

missing components and had to slow down

the production. Japanese companies are dom-

inating the market within a large selection of

products and components, and according to

IMF (IMF Country Report No. 11/183) Japan is

producing 1/5 of the world’s semiconductors,

and in addition controls 90% of the produc-

tion of Bismaleimide Triazine resin which is

used in the production of integrated chips

Current Account; Japan versus USA Japan’s public debt mountain

Source: International Monetary Fund, World economic Outlook Database, September 2011. Source: International Monetary Fund, World economic Outlook Database, September 2011.

-8

-6

-4

-2

0

2

4

6

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Curr

ent

Acc

ount

Bal

ance

in %

of

GDP

% o

f GD

P

USA Japan

0

50

100

150

200

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

General Government net debt General Government gross debt

75

125

175

225

275

325

1950

1956

1962

1968

1974

1980

1986

1992

1998

2004

2010

2016

2022

2028

2034

2040

2046

2052

2058

2064

2070

2076

2082

2088

2094

2100

Inde

x W

orki

ng A

ge P

opul

atio

n 20

-64

year

s (1

950

= 10

0)

JapanUSAGermanyChinaUK

Working Age Population (20-64 years)peaked in 1997

Japan USA UK

Japan USA UK

90

100

110

120

130

140

150

160

170

180

190

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Annual growth in GDP in constant prices per working age population. 2001-2010: Japan 1.1%, USA 0.5% and UK 0.8%1981-2010: Japan 1.9%, USA 1.5% and UK 1.7%

2881,37

1219,25

728,61

0

500

1000

1500

2000

2500

3000

3500

dec/80 dec/81 dec/82 dec/83 dec/84 dec/85 dec/86 dec/87 dec/88 dec/89 dec/90 dec/91 dec/92 dec/93 dec/94 dec/95 dec/96 dec/97 dec/98 dec/99 dec/00 dec/01 dec/02 dec/03 dec/04 dec/05 dec/06 dec/07 dec/08 dec/09 dec/10 dec/11

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

jun/98

dec/98

jun/99

dec/99

jun/00

dec/00

jun/01

dec/01

jun/02

dec/02

jun/03

dec/03

jun/04

dec/04

jun/05

dec/05

jun/06

dec/06

jun/07

dec/07

jun/08

dec/08

jun/09

dec/09

jun/10

dec/10

jun/11

dec/11

Div

iden

d Yi

eld

%

Dividend Yield Topix - Japan Dividend Yield S&P 500 - USA

90

110

130

150

170

190

210

230

250

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Annual growth GDP in constant prices.2001-2010: Japan 0.7%, USA 1.6% and UK 1.4%1981-2010: Japan 2.2%, USA 2.7% and UK 2.2%

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y pe

r wor

king

pop.

20-

64 y

ears

(ind

ex =

100

in 1

980)

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y (in

dex

= 10

0 in

198

0)

Topi

x in

JPY

-8

-6

-4

-2

0

2

4

6

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Curr

ent

Acc

ount

Bal

ance

in %

of

GDP

% o

f GD

P

USA Japan

0

50

100

150

200

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

General Government net debt General Government gross debt

75

125

175

225

275

325

1950

1956

1962

1968

1974

1980

1986

1992

1998

2004

2010

2016

2022

2028

2034

2040

2046

2052

2058

2064

2070

2076

2082

2088

2094

2100

Inde

x W

orki

ng A

ge P

opul

atio

n 20

-64

year

s (1

950

= 10

0)

JapanUSAGermanyChinaUK

Working Age Population (20-64 years)peaked in 1997

Japan USA UK

Japan USA UK

90

100

110

120

130

140

150

160

170

180

190

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Annual growth in GDP in constant prices per working age population. 2001-2010: Japan 1.1%, USA 0.5% and UK 0.8%1981-2010: Japan 1.9%, USA 1.5% and UK 1.7%

2881,37

1219,25

728,61

0

500

1000

1500

2000

2500

3000

3500

dec/80 dec/81 dec/82 dec/83 dec/84 dec/85 dec/86 dec/87 dec/88 dec/89 dec/90 dec/91 dec/92 dec/93 dec/94 dec/95 dec/96 dec/97 dec/98 dec/99 dec/00 dec/01 dec/02 dec/03 dec/04 dec/05 dec/06 dec/07 dec/08 dec/09 dec/10 dec/11

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

jun/98

dec/98

jun/99

dec/99

jun/00

dec/00

jun/01

dec/01

jun/02

dec/02

jun/03

dec/03

jun/04

dec/04

jun/05

dec/05

jun/06

dec/06

jun/07

dec/07

jun/08

dec/08

jun/09

dec/09

jun/10

dec/10

jun/11

dec/11

Div

iden

d Yi

eld

%

Dividend Yield Topix - Japan Dividend Yield S&P 500 - USA

90

110

130

150

170

190

210

230

250 1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Annual growth GDP in constant prices.2001-2010: Japan 0.7%, USA 1.6% and UK 1.4%1981-2010: Japan 2.2%, USA 2.7% and UK 2.2%

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y pe

r wor

king

pop.

20-

64 y

ears

(ind

ex =

100

in 1

980)

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y (in

dex

= 10

0 in

198

0)

Topi

x in

JPY

VA lu e I n V e S t 1 : 2 0 1 220

and circuit boards. For most consumers Japan

is the invisible sub-supplier of important

components and principal goods. Japanese

components are part of numerous products,

and in many products Japan has a high share

of the value added. The mentioned examples

provide some ground for optimism and illus-

trate how Japan, during many years, has been

able to maintain a trade surplus and accumu-

late considerable reserves.

The debate regarding Japan’s lost decades

dies down when you compare the develop-

ment of Japan’s current account with, for

example, to that of the USA. Since 1990 the

Japanese current account surplus has risen

by 346%. In the same period the American

current account deficit has risen by a stag-

gering 496%. It turns out all these years

have been the lost decades for the USA, not

Japan! The engine of the American economy

has been driven by a consumer feast. By uti-

lising loan finance options for personal con-

sumption needs, the Americans (and several

other nations in Western Europe) have pro-

pelled consumer spending to unsustainable

levels and thereby used the buffer that could

have helped in the current economic down-

turn.

The heavy burden of debt

The burden of debt creates severe challenges

for the Japanese society and demands action

in order to restore the faith in the country’s

ability to deal with its fiscal situation. From

1990 to 2010 the debt has risen consider-

ably and more than tripled. This is not due to

expansive fiscal policies by Japan, but rather

to the increase in expenses linked to the

ageing population not offset by an increase

in taxes. IMF expects that in 2011 the gross

debt will reach 233% of GDP. But in contrast

to the majority of the other indebted devel-

oped countries, previously also known as the

»rich« countries, Japan’s situation is more

stable in the short run, due to the fact that

95% of the sovereign debt is held domesti-

cally. Until now Japan has therefore been less

dependent on the mood swings of the inter-

national credit markets and has been able to

maintain an extremely low interest rate (10-

year rate is 1.03% at present) and thereby

avoided an explosive growth of financing

costs. The fortunes saved within the private

sector are expected to absorb the country’s

financing needs in the medium term. Accord-

ing to the Bank of Japan, the local banks have

an astronomical deposit surplus of USD 2,316

bn (Bank of Japan October 2011). Even if the

Japanese state is deeply indebted one should

not forget that the Japan of today is the

world’s largest creditor nation with an inter-

national net receivable figure in the region of

USD 3,202 bn (IMF Q1 2011). This surpasses

even China. These reserves could, in princi-

ple, be recalled if needed. If you include the

financial assets of the Japanese state in the

debt calculation one will see a fall in debt

(official net debt) to 131% of GDP for 2011

(estimate), and then the debt looks much less

intimidating.

Is it at all possible for Japan to lower the debt

level, and if so, what is needed? One cannot

expect that economic growth is the sole

an swer. Japan needs a fundamental change

of the current system, reducing public spend-

ing and slowing down growth in social secu-

rity combined with an increase in taxes. In

2010 Japan had a budget deficit of 9.2% of

GDP, higher than the average of the devel-

oped economies, which is unsustainable

taking into account the high level of debt.

On the positive side, Japan has relatively

good options of increasing their tax revenue

because the actual tax burden is low. Com-

pared to the GDP the tax revenue is actually

amongst the lowest within the OECD coun-

tries. A 5% income tax for an average middle-

income family of 2 adults and 2 children is

another example showing the low level of

taxes. In an introduction to a debate from the

IMF (IMF Staff Discussion Note June 16, 2011

- »Raising the Consumption Tax in Japan:

Why, When, How?«), it is pointed out that it

would be obvious to increase the consump-

tion tax, which at present is only 5% - the

lowest in the world. The European average is

20%. The consumption tax was introduced

in 1989 with a rate of 3% which in 1997 was

increased to 5%. The advantage of increas-

ing the consumption tax is that it is linked

to consumer spending and hence affects a

broad selection of the population in contrast

to an increase in income tax. This means that

pensioners would also bear part of the bur-

den when the huge savings are converted

to consumption, and this way it would not

just be the working population with a salary

who will bear the cost. In the previously men-

tioned introduction to debate it is estimated

that a gradual increase of the consumption

tax to 15% would give revenue in the area of

5% of GDP, and as long as Japan could find

cost cuts of similar size, the debt would peak

and start to decline before 2020. Japan’s 6th

prime minister in just 5 years, Yoshihiko Noda,

has announced that he wishes to double the

consumption tax by 2015. This is a step in

the right direction, but Noda does need to

get political support. Finally, Japan could also

get some help reducing the debt load from

an unexpected place. What if the JPY sudden-

ly weakened considerably? Japan’s impressive

reserve is placed in foreign assets – among

others US Treasury bonds, which would

increase in value in JPY and on paper reduce

the net debt in a blink of an eye.

Is Japan a »contrarian bet« or a

»value trap«?

Opinions on Japanese stocks are still much

divided. It is easy to find arguments for a

pessimistic scenario and because of this,

relatively many international investors have

chosen to fear the worst and refrained from

investing in Japanese stocks; they share

the opinion that the Japanese stocks are a

potential »value trap«. Japanese stocks look

cheap, but it is feared that they will remain

cheap as a consequence of the major struc-

tural and social challenges Japan is facing. As

if this is not enough; Japan is at the bottom

of the international analyses of Corporate

Governance - not least because of its rela- »

Is It at all possIble for Japan to lower the debt level?

Va lu e I n V e s T 1 : 2 0 1 2 21

tively widespread safeguards against hostile

takeovers, such as cross-ownership or »poi-

son pills« - which all in all has made investors

lose their appetite. All this, however, does not

mean that all companies put aside the inter-

est of their minority shareholders! And at the

same time foreign investors, who after all

own more than ¼ of the combined stock mar-

ket, will continue to put pressure on the Japa-

nese companies.

The social challenges and a low aggregate

economic growth going forward are not

unique to Japan. These attributes are also a

reality for many of the developed economies,

that for a number of years have lived beyond

their means and now have to pay the price.

These countries’ governments have to real-

ise that they have to balance the budget,

and there is no economic scope to support

the private consumption. This would inhibit

growth in the long term. We do not want to

downplay Japan’s challenges, but there is

more to the story than meets the eye, and

Japan has definitely still got the possibil-

ity to influence and change its course. Cer-

tain factors set Japan apart from several of

the developed countries. One of them, as

mentioned before, is Japan’s strong grip on

its industrial heritage and jobs. »Made in

Japan« is a strong brand. It is said that Japan’s

growth has been burdened by large savings

and lack of consumer spending, but over time

Japan has, with the help from investments

and a well-oiled export machine, accumu-

lated considerable reserves and maintained a

positive current account. Today, this is some-

thing that the other »rich« countries envy.

We can then hope that the ageing Japanese

population will start spending going for-

ward. The demographic projection for the

Japanese population has become some kind

of an apocalyptic prophecy, but the declin-

ing population, in itself is not the problem;

the problem is that the working population,

that need to provide for an increasing num-

ber of pensioners is decreasing. However,

there is enough reason for confidence, as

Japan historically has shown that improve-

ments in productivity can help lift the burden

Dividend yield Japan versus USA

source: Bloomberg data.

-8

-6

-4

-2

0

2

4

6

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Curr

ent

Acc

ount

Bal

ance

in %

of

GDP

% o

f GD

P

USA Japan

0

50

100

150

200

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

General Government net debt General Government gross debt

75

125

175

225

275

325

1950

1956

1962

1968

1974

1980

1986

1992

1998

2004

2010

2016

2022

2028

2034

2040

2046

2052

2058

2064

2070

2076

2082

2088

2094

2100

Inde

x W

orki

ng A

ge P

opul

atio

n 20

-64

year

s (1

950

= 10

0)

JapanUSAGermanyChinaUK

Working Age Population (20-64 years)peaked in 1997

Japan USA UK

Japan USA UK

90

100

110

120

130

140

150

160

170

180

190

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Annual growth in GDP in constant prices per working age population. 2001-2010: Japan 1.1%, USA 0.5% and UK 0.8%1981-2010: Japan 1.9%, USA 1.5% and UK 1.7%

2881,37

1219,25

728,61

0

500

1000

1500

2000

2500

3000

3500

dec/80 dec/81 dec/82 dec/83 dec/84 dec/85 dec/86 dec/87 dec/88 dec/89 dec/90 dec/91 dec/92 dec/93 dec/94 dec/95 dec/96 dec/97 dec/98 dec/99 dec/00 dec/01 dec/02 dec/03 dec/04 dec/05 dec/06 dec/07 dec/08 dec/09 dec/10 dec/11

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

jun/98

dec/98

jun/99

dec/99

jun/00

dec/00

jun/01

dec/01

jun/02

dec/02

jun/03

dec/03

jun/04

dec/04

jun/05

dec/05

jun/06

dec/06

jun/07

dec/07

jun/08

dec/08

jun/09

dec/09

jun/10

dec/10

jun/11

dec/11

Div

iden

d Yi

eld

%

Dividend Yield Topix - Japan Dividend Yield S&P 500 - USA

90

110

130

150

170

190

210

230

250 1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Annual growth GDP in constant prices.2001-2010: Japan 0.7%, USA 1.6% and UK 1.4%1981-2010: Japan 2.2%, USA 2.7% and UK 2.2%

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y pe

r wor

king

pop.

20-

64 y

ears

(ind

ex =

100

in 1

980)

GDP

in c

onst

ant

pric

es in

loca

l cur

renc

y (in

dex

= 10

0 in

198

0)

Topi

x in

JPY

of the working population. Japan also has the

possibility to draw on an unused work force

among the women, but that would call for a

change of attitude. The demographic projec-

tion is a prognosis that is subject to uncer-

tainty and nobody is able to predict the exact

birth rate with certainty.

Dividend yield Japan versus usa

The Japanese stock market is an interest-

ing hunting ground for the pure bottom-up

value investor. It contains many overlooked

and undervalued companies. This is also the

explanation for the relatively high propor-

tion of Japanese shares in our global portfo-

lio. A common characteristic of many Japa-

nese companies is their strong balance sheet

which, in most cases, is a remnant from the

post-bubble period when debt reduction

and savings had priority over investments.

According to ValueInvest Asset Management

S.A.’s screening of the Japanese stock mar-

ket (exclusive of financial companies), almost

40% of the companies with a market value of

€1 bn. or higher have no debt and carry a net

cash position. Of course, we do not favour

passive accumulation of cash by the com-

panies; we wish to see spending on projects

which will increase earnings and hence trans-

late into distributions to the shareholders.

Historically, Japanese companies have not

exactly been renowned for their generous

dividends, but today just over 90% of the

companies in the screening pay dividends.

The graph also shows that the dividend yield

of the Japanese stock market over time has

become more competitive compared to, for

example, the U.S. stock market. In a low-

growth scenario for the general economy,

dividends will be an important contributor

to the return from stocks. All the companies

in our Japanese portfolio pay dividend. The

upside potential of our Japanese portfolio

is large, and over time, as the market starts

focussing more on fundamental values, we

should see handsome returns from these

undervalued companies.

In Japan, active portfolio management pays

off. Our Japanese portfolio has, based on

a stringent stock selection process with

focus on the quality of the balance sheets

and earnings stability, given our investors a

return which is considerably better than that

of the general Japanese stock market. In the

past 3 calendar years the annual return (EUR)

has been 8.2% versus 4.2% for MSCI Japan. In

the past 7 calendar years, the portfolio has

anually returned 2.1% versus 0.0% (note that

historical return is no guarantee of future

returns).

Today Japan might seem incapable of coping

with the paramount challenges facing the

country, but Japan and the Japanese people

have historically demonstrated both the abili-

ty to act and the ability to change when nec-

essary: both the Meiji-restoration in 1868 and

the second time during the American occu-

pation after World War II are good examples.

It would definitely be wrong to dismiss Japan.

Production and innovation have not left

Japan, and, most importantly, many Japanese

stocks are fundamentally cheap.

»

Va lu e I n V e s T 1 : 2 0 1 222

ValueInvest LUX

Incorporated on 12 September 2001,

ValueInvest LUX SICAV is an open-

ended investment fund regulated by

the CSSF in Luxembourg and consists

of two Euro-denominated sub-funds

focusing exclusively on value invest-

ing (figure A). Investment certificates

are sold through a number of financial

institutions in Luxembourg, Germany,

Austria, Sweden and Switzerland.

Please refer to www.valueinvest.lu

where net asset value is updated on a

daily basis and further information on

prospectus, Key Investor Information

Document (KIID), subscription form,

etc. is available.

ValueInvest Asset Management S.A.

ValueInvest Asset Management S.A.

was founded on 6 February 1998.

The company is domiciled in Luxem-

bourg and is under the supervision of

the CSSF. ValueInvest Asset Manage-

ment S.A. is investment manager of

ValueInvest LUX SICAV and one of

the few asset management compa-

nies in Europe to focus exclusively on

investment in value stocks. Moreover,

ValueInvest Asset Management S.A.

is investment advisor to Investerings-

foreningen ValueInvest Danmark and

offers discretionary contracts for ma-

nagement of equity portfolios.

Contact information

Interested investors are always wel-

come to contact Jacob Vendelbo or

Markus Wiering either by phone, by

sending a fax or an e-mail to obtain

more information on ValueInvest LUX

SICAV.

Please also refer to the homepage

www.valueinvest.lu for further

information.

ValueInvest Asset Management S.A.

36, rue Marie-Adelaïde

L-2128 Luxembourg

Tel: +352 315 155

Fax: +352 315 155 31

Jacob.Vendelbo@valueinvest.lu

Markus.Wiering@valueinvest.lu

Fund name ISIN Codes

ValueInvest LUX, Global ACap. Dist.

LU0135991064LU0135990504

ValueInvest LUX, Japan ACap. Dist.

LU0135991148LU0135990769

Figure A

PHO

TO: VA

LUEIN

VEST A

SSET MA

NA

GEM

ENT S.A

.

Company informa-tionCompany information

VA LU E I N V E S T 1 : 2 0 1 2 23

www.valueinvest.lu

Common sense.Solid investment principles.

ASSET MANAGEMENT S.A .H O U S E O F VA L U E

DANMARK

As value investors we solely invest in companies

trading at prices significantly below their Fair Values. To limit

downside risks further, we focus on companies

with high earnings stability and low debt.

ValueInvest AssetManagement S .A .36, rue Mar ie-Adela ïdeL-2128 Luxembourg

Tel : +352 315 155Fax: +352 315 155 31

info@valueinvest . luwww.valueinvest . lu

www.valueinvest.lu