SPARX Asset Management

The GOOD Fund (Asia) Strategy Can investors do GOOD while focusing on what they do best?

Introduction

The "GOOD Fund" is a concept that is the result of deep deliberation as to how an Asset Management firm can make an impactful contribution to society while adhering to its core function as a value-maximizing, risk-minimizing custodian, and fiduciary of client assets.

Our core ideology is simple - GOOD investments that do GOOD. We believe that our primary role is to provide our clients with GOOD investments - invest in companies that deliver superior 'long-term' returns. In our process of delivering GOOD investments, we want to do GOOD - invest in companies that contribute positively to society.

While we could argue that both aspects are deeply interconnected and that only companies that contribute positively to society could deliver superior long-term value creation, keeping both goals distinct allows us as investors to make a conscious effort to consider long-term societal benefits through our investment decisions.

Both aspects of this ideology have a lot of subjectivity and achieving both goals could have multiple paths. However, the "GOOD fund" has chosen a path that is deeply rooted in SPARX's fundamental philosophy and process. To understand the GOOD fund, it is important to understand the essence of the SPARX way of investing.

The SPARX Way

SPARX is one of the largest independent asset managers in Japan. The 35-year-old firm, listed on the Tokyo Stock Exchange, was founded by Shuhei Abe at the peak of the Japanese bubble. Before founding SPARX, Abe worked with George Soros in New York. The seed for our humble entrepreneurial origins came from an investment report on takeover opportunities in Japan prepared by Mr. Abe which was sent out to investors across New York. Mr. Abe received a response from one investor who was willing to seed him and that became the foundation of SPARX as we know it today.

SPARX was founded in July 1989 and the Japanese indices peaked in December 1989. What followed in Japan was over 30 years of being caught up in a deflationary spiral and even today the major Japanese indices are just around the peak levels we saw in December 1989. Despite the enormously difficult market conditions during this period, SPARX was able to not only survive but thrive with all of SPARX's Japan strategies beating the TOPIX by a good margin(i). Our success can be attributed to our incessant belief in being a fundamentally driven, bottom-up stock picker with a unique investment process & philosophy.

Inspired by the Buffett-Munger school of thought, we try to find underappreciated companies and underappreciated aspects of well-known companies. Additionally, we consider ourselves prospectors - searching for gold in an exceptionally large investment universe - which has led to SPARX's specialization in mid- and small-sized companies. Our process starts with casting a wide net, leaving few stones unturned. We are sector-agnostic, meaning every new analyst at SPARX starts out conducting desk research across their investable universe one name at a time followed by one-on-one meetings with senior management of companies that the analyst finds interesting. The personal interest of the analyst is paramount as no one is forced to cover sectors they do not personally find appealing. An average analyst at SPARX meets around 150 companies a year. The key to our research process is to empower the analyst to do independent research (sell-side research is never the primary source of research) in his style, while adhering to SPARX's investment philosophy, to find great companies. SPARX actively encourages analysts to spend more time on actual research as opposed to non-value additive administrative tasks (long-form meeting reports, memos summarizing quarterly reports etc.). Due to this unique investment style, most analysts at SPARX eventually become portfolio managers and all portfolio managers continue to retain their analyst function and engage in research and meeting companies.

During our research process, we are of the view that most entrepreneurs and businesses have a story worth listening to and the core part of our research involves understanding the origin story, the evolution, the business model and the value creation and value drivers within the business model. Applying this approach across a large universe of companies, we can see commonalities between good entrepreneurs/businesses. While analyzing the financial performance of businesses is particularly important, our long-term mindset forces us to go one step deeper to analyze financial performance in the knowledge that a business, like people, has both good and tough times. Equating the spirit of a business to that of a human allows us to analyze events, traits and features of the business and the entrepreneur that could potentially determine sustainability and longevity.

Throughout its 35-year history, SPARX has built a knowledge base of over three thousand companies in Japan through the above-mentioned approach.

The GOOD fund - ASIA

The GOOD fund - ASIA is an all-cap strategy (with a mid-small cap tilt) that invests in companies in the Asia ex-Japan universe with two specific criteria - (i) superior 'long-term' returns and (ii) contribute positively to society.

We view the world slightly differently. We believe that we are at a critical juncture in history. There is large-scale economic and social change happening. We believe that in today's world, the only way for a business to ensure sustainability and longevity is for the business to contribute positively to society. We believe that good returns and positive societal contributions are no doubt interlinked and there cannot be GOOD investments that do not do GOOD. We want to find such companies in Asia.

GOOD Investments

SPARX's original legacy is rooted in identifying winners among Japanese mid & small cap companies - a segment that is generally under-covered, underappreciated and as a result under-owned. Analyzing this segment comes with a lot of challenges - limited disclosures, relatively younger companies, and limited opportunity for cross-research. Owning this segment also comes with another set of challenges - lack of liquidity, limited free float, potential for largedrawdowns exacerbated by low liquidity etc. These challenges make this segment of the market seem riskier because the market continues to equate volatility to risk. Through our experience of successfully running one of the largest small-cap funds in Japan, SPARX has proved over 30 years that investing in smaller companies is not necessarily riskier than investing in larger ones.

Based on parallels seen from analyzing Japanese mid-small cap companies over the last 35 years, we see tremendous opportunities in the Asian mid-small cap space to find companies that could become the next mid or large-cap leaders in their respective segments. The environment in Asia today is remarkably similar to what we experienced in Japan - an exceedingly long tail of mid-small cap companies playing out similar themes that have played out in mature markets like Japan.

Our goal is to find 5x10 and 10x10 companies- companies that can grow five to ten times in ten years (a 17-25% earnings CAGR). To quantify our path to getting there - (i) we want to invest in the growth of Asia - companies that grow at least 30-50% faster than that of their respective country GDP (ii) we want to invest in good stewards of capital - companies that can generate a normalized 3-5% excess return on their cost of capital. By buying such businesses at reasonable prices with a long-term horizon, you would theoretically and logically end up with returns above market returns over time.

Doing GOOD

In contrast with the more common approaches to investing this way our approach to companies that do good/contribute positively to society is different because we are focused on our companies being directionally good rather than trying to measure the quantum of good and utilizing rigid measurement and disclosure requirements. We acknowledge that ours is an approach with a lot of subjectivity, but it is no different from our core investment activity - which is a very subjective process.

We prefer this approach to the alternative - a very rigid, rule, measurement, and disclosure - based approach - the prevalent ESG / sustainability investing approach. There are several limitations to the current ESG investing framework:

  • Our primary cause of disagreement is that to ensure standardization, the framework has become rigid, laying too much importance on reporting and disclosures, and unfairly placing a higher weightage on the amount and quality of disclosures rather than the actual impact on society/investors. As a result, the framework is:
    • Punitive to (i) Asian companies and (ii) Small companies - a lot of whom are still catching up with their Western peers or do not have the same size and scale as their larger peers to allocate tremendous resources to a measurement and reporting regime.

    • Punitive to mid & small-sized boutique / independent asset management firms who want to pursue ESG / sustainable investment strategies. The dedicated workforce requirements for research, compliance and reporting to manage ESG strategies make it economically unviable for smaller firms. With greater pools of money being allocated to ESG / sustainable strategies, the concentration of such strategies in the hands of a few large players is not a desirable outcome for investors.

    • Unfairly rewarding asset-light business models while punishing manufacturers, capital-intensive businesses etc. who under their business operations create more of a tangible impact on their physical environment (air, land, water). This results in undesirable portfolio concentrations skewed towards certain sectors (more allocation to tech & services for example) without creating any incremental societal benefits.
    • Propping up an entire industry of intermediaries, just like in the financial services industry, who add little value to the entire investment or promote sustainability agenda other than to aid measurement and reporting - the various certification bodies, scoring bodies, the ESG data companies, the sustainability auditors etc.

  • The framework focuses too much on the status quo while ignoring intent, incremental positive change and the challenges that accompany the introduction of sudden change into complex business models.

  • The ESG scoring system, like any prescriptive rule-based system of its kind, is ripe for manipulation. Greenwashing efforts by corporates to meet the letter of good ESG investing but not its spirit are rampant and are a direct outcome of the desire to look good rather than to do GOOD.

Going back to our approach of supporting companies that are directionally GOOD, a very multi- layered and subjective topic, we decided to adopt the UN SDG goals as our guide to define what constitutes GOOD. Adopting the UN SDG goals as a guide allows us to identify the areas where private enterprises can supplement the efforts of the government to create societal benefits. That being said, we are not an SDG fund.

Our goal with this strategy is not to create a new asset type or to market this strategy to fit specific labels that appeal to clients. We believe that doing GOOD creates and enhances economic value over the long-term which promotes sustainability and longevity of a business. We believe it is in the long-term economic interest of all investors to invest in GOOD companies.

(i) SPARX Japan Small & Mid Cap Strategy (Composite) - Inception (1999) to 30th Nov 2023 - 493.22% excess over hybrid of MSCI Japan Small without dividends until 2000/12, MSCI Japan Small with dividends from 2001/1, and Russell/Nomura Small Cap Total Return from 2018/10 (net of fees)



DISCLAIMER

This document has been prepared by SPARX Asset Management Co., Ltd. ("SPARX") for informational purposes only to professional investors who are expected to make their own investment decisions without undue reliance on this presentation. This document has been distributed based upon your request. The views and strategies described may not be suitable for all investors. Under no circumstances is it to be used or considered as investment advice, a recommendation to buy, an offer to sell, or a solicitation of an offer to buy or sell securities in any vehicle managed by SPARX. An offering will be made only by the confidential offering memorandum, subscription agreement and other relevant documentation of any fund managed by SPARX which should be read in their entirety. We accept no liability whatsoever for any direct or consequential loss arising from any use of this presentation or its contents. The information is intended solely to report on investment strategies and opportunities identified by SPARX. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. SPARX and its affiliates do not warrant the accuracy or completeness of any of the information or data contained herein. References to specific securities and their issuers are for illustrative purpose only and are not intended to be, and should not be interpreted as investment advice or, a recommendation, offer or solicitation for the purchase or sale of any financial investment. This presentation does not constitute tax advice and as such investors should be advised to consult their own tax advisers regarding the tax consequences of their investment activities. Investment return and principal will fluctuate, so that a client's initial investment may increase or decrease. Investing in securities markets involve risks like those arising from stock and bond markets, currency exchanges rate and interest rate volatility. No part of this material may, without SPARX prior written consent be copied, reproduced or published by any recipient for any purpose. Past performance is not indicative of future performance. Registration as an investment adviser does not imply any special skill or training. There can be no assurance that SPARX's investment objectives will be achieved or investment strategies will be successful.

References to market or composite indices, benchmarks, or other measures of relative market performance over a specified period of time are provided for your information only. Reference or comparison to an index does not imply that the portfolio will be constructed in the same way as the index or achieve returns, volatility, or other results similar to the index.

SPARX Asset Management Co., Ltd. has prepared and presented the relevant part of this report in compliance with the Global Investment Performance Standards (GIPS®). The firm has been independently audited for the period from 1 April 1997 to 31 December 2020. Verification assesses whether (1) the firm has complied with all the composite structural requirements of theGIPS standards on a firm-wide basis and (2) the firm's policies and procedures are designed to calculate and exhibit performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. The firm subject to verification is SPARX Asset Management Co., Ltd. SPARX Asset Management Co., Ltd. is registered with Japanese authorities to conduct an investment management business, an investment advisory and agency business, a Type-1 Financial Instruments business, and a Type-2 Financial Instruments business. The term "Firm" was redefined--effective 15 October 2009 and 30 November 2010--to exclude SPARX Investment & Research, USA, Inc. (SIR) and SPARX International (Hong Kong) Limited (SIHK), respectively, due to the dissolution of SIR and the transfer of SIHK's shares to a third party. SPARX Overseas Ltd. has been excluded from the definition of the firm since December 31, 2013, due to the possibility of the former managing and administering funds managed by entities other than SPARX Asset Management. Private Equity Investments at SPAR Asset Management Co., Ltd. has been excluded from the definition of the firm since December 31, 2016. Nevertheless, the definition of the firm requires that all assets be wholly managed by SPARX Asset Management.

Composite details

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Contact: Global Business Development Division, SPARX Asset Management Co., Ltd. (Tel.+81-3-6711-9160)

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