AVI Japan Opportunity Trust

AVI JAPAN OPPORTUNITY TRUST PLC

ANNUAL REPORT 2023

LEI: 894500IJ5QQD7FPT3J73

Annual Financial Report for the year ended 31 December 2023

The Directors present the audited Annual Report for the year ended 31 December 2023.

Copies of the Annual Report can be obtained from the Company's website ("AJOT" or the "Company") www.ajot.co.uk or by contacting the Company Secretary by telephone on 07702 965 986.

AVI Japan Opportunity Trust plc ("AJOT" or "the Company") invests in a focused portfolio of quality small and mid-cap listed companies in Japan that have a large portion of their market capitalisation in cash or realisable assets.

Notice of Annual General Meeting

The Company's Annual General Meeting ("AGM") will be held at 11.30 a.m. on Wednesday, 1 May 2024, at the offices of the Association of Investment Companies (the "AIC"), 9^th Floor, 24 Chiswell Street, London, EC1Y 4YY. Shareholders will be able to submit questions to the Board and the Investment Manager, Asset Value Investors Limited ("AVI") ahead of the AGM and answers to these, as well as AVI's presentation, will be made available on the Company's website. Please refer to the Notice of AGM for further information and the resolutions which will be proposed at this meeting.

Dividend

The Directors are proposing a final dividend of 0.85 pence per Share for the year to 31 December 2023. Subject to the approval of Shareholders at the forthcoming AGM, the proposed final ordinary dividend will be payable on 24 May 2024 to Shareholders on the register at the close of business on 26 April 2024. The ex-dividend date will be 25 April 2024.

Performance Summary

* For all Alternative Performance Measures, please refer to the definitions in the Glossary in the Annual Report.

COMPANY OVERVIEW

Company Purpose

Discovering overlooked and under-researched investment opportunities, utilising shareholder engagement to unlock long-term value.

Company Objectives and Strategy

AJOT aims to provide Shareholders with total returns in excess of the MSCI Japan Small Cap Index in GBP ("MSCI Japan Small Cap"), through the active management of a focused portfolio of equity investments listed or quoted in Japan, which have been identified by Asset Value Investors Limited as undervalued and typically have a significant proportion of their market capitalisation held in cash, listed securities and/or other realisable assets.

AVI seeks to unlock this value through proactive engagement with management and capitalising on the increased focus on corporate governance, balance sheet efficiency, and returns to shareholders in Japan.

The companies in the portfolio are selected for their high quality, whether having strong prospects for profit growth or economically resilient earnings. By investing in companies whose corporate value should grow overtime, AVI can be patient in its engagement to unlock value.

Benchmark

The MSCI Japan Small Cap Index.

Capital Structure

As at 31 December 2023, the Company's issued share capital comprised 140,836,702 Ordinary Shares of 1p each, of which 400,000 were held in treasury and therefore total voting rights attached to Ordinary Shares in issue were 140,436,702. As at 13 March 2024 it comprised 140,836,702 Ordinary Shares, 400,000 of which were held in treasury, and therefore total voting rights attached to Ordinary Shares in issue were 140,436,702.

Investment Manager

The Company has appointed Asset Value Investors Limited ("AVI" or the "Investment Manager") as its Alternative Investment Fund Manager.

The Association of Investment Companies ("The AIC")

The Company is a member of The AIC.

Website

The Company's website, which can be found at www.ajot.co.uk, includes useful information on the Company, such as price performance, news, monthly and quarterly reports as well as previous annual and half-year reports.

CHAIRMAN'S STATEMENT

"The portfolio is well positioned with a concentrated, yet diverse, collection of high-quality, lowly valued companies, with multiple levers for re-ratings. As a Board, we are confident that AJOT can build on its successful track record of engagement and will continue to deliver attractive returns for investors."

Overview of the Year

On behalf of the Board of Directors ("the Board") I am pleased to present the Annual Report for 2023 for AVI Japan Opportunity Trust plc. The Company was launched in 2018 to take advantage of the rich opportunity set in Japan, believing that the corporate governance reform agenda first espoused in 2013 had gained critical momentum, and that a sea change was imminent. This was not a consensus view, with Japan considered by most to be a perennially cheap and largely irrelevant market for global investors.

2023 then was a year in which (other) investors' enthusiasm for Japanese equities grew and scepticism waned. The strong economic backdrop, ultra-loose monetary policy, low relative valuations, weak yen, and unabated progress on corporate governance reform drew global attention. Notably, at the start of the year the Tokyo Stock Exchange ("TSE") announced it would require companies to disclose capital efficiency improvement plans, particularly by those trading below 1x book value.

Japanese equity markets were buoyant, with the MSCI Japan returning +28.6% over 2023 (in JPY) and the Nikkei seeing its largest one-year rise since 1989, up at +31.0%. This rally, however, was mostly limited to larger cap names, which outperformed their small-cap counterparts by +7.5%.

In this context, it is pleasing to report that your Company ended the year +15.8% in GBP terms, outperforming its official comparator benchmark, the MSCI Japan Small Cap Index, which returned +6.9%. Since its inception, AJOT has delivered returns of +40.5% versus +16.2% for the benchmark. In JPY terms, since inception, returns are significantly higher, at +73.7% vs +43.6% for the benchmark.

Your manager, AVI, has continued constructively engaging with portfolio companies to unlock value. The Board got a first-hand look at their efforts this year, as 2023 marked the first time that we travelled together to Japan. The enthusiastic response from market participants and investee companies alike to our visit was testament to the high regard in which AVI is held and coupled with the unique benefits of the investment trust structure that your Company enjoys, we are more positive than ever on our future prospects. AVI's investment team builds deep relationships with the management of every portfolio company, holding a great number of meetings with senior executives and board directors. This approach has led to numerous shareholder-friendly measures being introduced across multiple companies without requiring public campaigns which has delivered strong results for our investors.

The preferred approach of private engagement has led to notable successes, with detailed letters or presentations sent to nine portfolio companies over the year. Three portfolio companies were the subject of public engagement, including NC Holdings, where three of our shareholder resolutions were successfully adopted.

Dividend

As provided for in the Prospectus at the IPO, the Company intends to distribute substantially all the net revenue arising from the portfolio. The Company paid an interim dividend of 0.85p per share in November 2023, and the Board has elected to propose a final dividend of 0.85p per share, bringing total dividends for the year ended 31 December 2023 to 1.70p per share (2022: 1.55p per share).

Investment Strategy

AJOT listed in October 2018 to take advantage of the highly attractive opportunity to invest in under-valued, over-capitalised Japanese small-cap equities with strong underlying business fundamentals. Active engagement and corporate action are the key to unlocking valuation anomalies and AJOT's track-record has demonstrated the potential absolute and relative returns this approach can deliver.

Over five years since launch, your Company has performed well in the face of multiple headwinds: lacklustre performance of small-cap stocks (MSCI Small Cap Japan has underperformed its larger MSCI Japan brethren by almost 16%); a marked depreciation of the Japanese Yen which has detracted -33% from GBP returns, and a turbulent global environment encompassing a pandemic, rapidly rising interest rates and multiple geopolitical events. The Board remains confident that AVI is well placed to continue executing on the strategy and that there are still plenty of mis-priced investment opportunities.

Share Premium and Issuances

As at 31 December 2023, your Company's shares were trading at a discount of -2.5% to NAV per share. The Board monitors the premium/discount and carefully manages it by periodically issuing or buying back shares. During 2023, we employed the Company's authorised block listing facility to increase our shares in issue by 3,375,000 while 985,000 shares were bought back during the period. As of 31 December 2023, 140,436,702 shares were in circulation, a pleasing increase from the 80,000,000 shares at AJOT's launch.

The Directors believe that the performance of the Company since IPO should be attractive to a larger pool of investors and are constantly exploring avenues to grow AJOT.

Debt Structure and Gearing

As described in the Prospectus, the Board supports the use of gearing to enhance portfolio performance. The Company has in place a ¥2.9 billion debt facility, which was renewed on 2 February 2022 and subsequently extended to 5 April 2024 on the same terms while renewal terms are being agreed. As at 31 December 2023, ¥2.93 billion (£16.3 million) of the facility had been drawn and net gearing stood at 1.6%.

Board Trip to Japan

In September the Board travelled to Japan for its first visit. Meeting with a variety of advisors, market participants, lawyers and the Tokyo Stock Exchange, it provided Directors with a deeper understanding of the opportunity set and of how the Company can be best positioned to benefit. The Board had the opportunity to meet with six portfolio companies, including a laboratory tour and tasting experience at T Hasegawa's R&D facilities outside Tokyo. In Osaka, it was a great privilege when Konishi, your Company's 4^th largest position, invited the Board to their historic headquarters built in 1903. This was the first time a foreign company had been invited to the site and it was pleasing to see the depth of the ties AVI has built with the company.

The Board left encouraged with the changes underway in Japan and the evident success of AVI's engagement efforts. Overall, it was a highly fruitful visit, which confirmed that this time really is different in Japan.

Outlook

At the end of November, news broke that Toyota Motors - one of Japan's last holdouts to reform its balance sheet - will partially unwind its cross shareholding in parts maker Denso. In December, the TSE announced that it would add further pressure by calling on 1,000 plus companies that have parent-subsidiary relationships or that have listed or equity affiliates to increase disclosure around their rationale for having listed subsidiaries and their efforts to ensure their independence. Just after the end of the year in January, the TSE then released the names of 1,115 companies that disclosed information regarding actions to implement policies conscious of cost of capital and share price, shaming the 2,160 that did not.

The mounting pressure for corporate reform will not subside in 2024. AJOT's focus on finding attractively valued, durable companies and using active engagement to unlock value holds it in good stead to benefit from the changing tide. The portfolio is well positioned with a concentrated, yet diverse, collection of high-quality, lowly valued companies, with multiple levers for re-ratings. As a Board, we are confident that AJOT can build on its successful track record of engagement and will continue to deliver attractive returns for investors. The portfolio as at the year end had 49% of its market cap covered by net cash and investment securities and traded at an 8.7x EV/EBIT multiple.

In the coming weeks I shall be meeting any institutional investors who would like to sit down with me, and I hope to see as many Shareholders as possible at our AGM in May. The Board and I remain available to all our Shareholders - institutional and retail - who may wish to discuss an issue or ask a question. As always, please feel free to reach out to me directly ([email protected]) or contact our broker, Singer Capital Markets, to arrange a meeting.

Norman Crighton

Chairman

13 March 2024

OUR TOP 10 HOLDINGS

1. Nihon Kohden (9.7% of portfolio, 15.3x EV/EBIT)

Nihon Kohden is a medical equipment manufacturer. It has compounded sales over the past 20 years at 4.9%, with sales declining in only four of the past 38 years, and has grown its overseas business to just over a third of sales. We expect this growth to continue as the business benefits from increased global healthcare expenditure and a shift to higher value-add digital solutions.

2. TSI Holdings (8.7% of portfolio, 4.9x EV/EBIT)

TSI Holdings owns a portfolio of diversified apparel brands. Its unique focus on athleisure and outdoor wear sets it apart from competitors, but it trades at a steep discount due to a bloated balance sheet. Net cash, investment securities and real estate account for 92% of TSI's market cap, obscuring the underlying business. Were TSI to trade in line with peers, there would be a +100% upside to the current share price.

3. Takuma Co (8.6% of portfolio, 6.7x EV/EBIT)

Takuma builds waste treatment plants for municipalities in Japan, and with a labour shortage, there is increasing demand for companies to operate these plants after construction. Our strong conviction lies in Takuma's shifting business model, towards recurring maintenance and operation contracts, which we don't think is reflected in Takuma's 3.9x EV/EBIT multiple at present.

4. Konishi (8.5% of portfolio, 5.4x EV/EBIT)

Konishi is famed for its household glue brand BOND. It has a dominant market share across the domestic adhesives market and successfully expanded its business into infrastructure repair works. We believe Konishi has potential to grow its adhesive offering into more industrial applications and to establish itself overseas, which is not reflected in the lowly 5.4x EV/EBIT valuation.

5. Shin-Etsu Polymer (7.4% of portfolio, 7.3x EV/EBIT)

Shin-Etsu Polymer manufactures an assortment of devices, but its main product is a container used to carry semiconductor silicon wafers. It is a listed subsidiary of Shin-Etsu Chemical, and our base case is that Shin-Etsu Polymer is taken over. The companies' business operations are intertwined, and the management of both companies have made indications that they are open to addressing the parent/child listing issue.

6. DTS Corp (7.4% of portfolio, 9.9x EV/EBIT)

DTS provides IT-related services to Japanese corporations. Its business is expanding into Digital transformation-related ("DX") fields such as cloud, robotics and IoT ("Internet of Things"). Japanese companies have underinvested in their IT infrastructure, with antiquated processes and complex legacy systems. With encouragement from the Government, we believe companies will dramatically increase their IT expenditure - much to the benefit of DTS.

7. Eiken Chemical (6.5% of portfolio, 7.9x EV/EBIT)

Eiken Chemical is a manufacturer of medical diagnostics equipment, operating a high-quality business with a proven track record of growing sales. Eiken Chemical holds a dominant market position in Colon Cancer Screening, with an overwhelming global market share in excess of 70%. Furthermore, Eiken Chemical is set to experience structural growth from the ageing population and is a vulnerable takeover target with an open shareholder register. Our engagement will focus on capital allocation, operational improvement, and shareholder communication.

8. Wacom (5.6% of portfolio, 20.0x EV/EBIT)

Wacom is a global leader in digital pen solutions. It is uniquely positioned to benefit from the growing adoption of digital pens. Its dominant market position allows Wacom to be at the forefront of technological innovation, developing solutions that utilise big data, artificial intelligence, and virtual reality. Investors underappreciate the growth potential of Wacom's technology, but under the leadership of the relatively new President and with improved investor communication, we think this will change.

9. Jade Group (5.5% of portfolio, 13.1x EV/EBIT)

JADE GROUP (formerly LOCONDO) operates a fast-growing, capital light, fashion e-commerce business. In 2022, JADE GROUP acquired a stake in Reebok Japan which it has flawlessly integrated into its logistics network. There is a long growth runway for e-commerce in Japan and JADE GROUP is well positioned to benefit.

10. NC Holdings (4.9% of portfolio, 7.0x EV/EBIT)

NC Holdings owns an eclectic mix of businesses, including solar panel consulting, conveyor belts and - the most attractive - car parking systems. Each standalone business has its merits, but they have no synergies combined. This partly explains why the business trades on 7.0x EV/EBIT vs our fair value of over 10.0x.

INVESTMENT MANAGER'S REPORT

"At the time of writing, we are building positions in five new names, which, on average, trade on an EV/EBIT multiple of 4.0x, with 106% of their market cap covered by cash, securities and rental real estate. In each of these positions, we see an avenue to upsides in the order of 50 - 100% and the potential for us to become large shareholders."

Dear AJOT Shareholders,

During the period from 1 January to 31 December 2023, your Company returned +15.8% in GBP. This compares with a return for the benchmark, the MSCI Japan Small Cap Index, of +6.9%. Over the course of the period, the Yen depreciated by -11.5% against the Pound, which has been a headwind to Sterling-based returns. In Yen, AJOT's NAV has increased by +31.0% over the period and +73.7% since launch.

It was a pleasing end to your Company's fifth anniversary year. In a year that strongly favoured large-cap value stocks, where AJOT has little exposure, the continued outperformance of the portfolio is a testament to the strategy of generating idiosyncratic returns from a concentrated portfolio of high-quality, overcapitalised, undervalued companies. Driving returns were TSI Holdings (share price +68% in Yen), Konishi (+65%) and JADE GROUP (+96%). TSI Holdings saw its share price rerate following the disclosure of management initiatives to address the low valuation, while Konishi benefitted from +35% earnings growth over the past 12 months, with JADE GROUP on track to grow its operating profits by +76% this year.

The Japanese Yen weakness was driven by a more cautious approach to moderating Yield Curve Control ("YCC") from Kazuo Ueda, the newly appointed Bank of Japan ("BoJ") governor. With core inflation expected to stabilise around the BoJ's 2% goal, the BoJ are in no rush to adjust loose monetary policy. With the real effective exchange rate of the Yen trading at the cheapest level since the 1970s, on balance, we believe the chances of Yen strength outweigh the risk of further weakness. This, however, is not a prediction, and it doesn't factor into our investment allocation. If the Yen were to strengthen it could be a helpful reversal of the headwind we have faced over the past years.

Setting aside the weak Yen, in local currency terms, it was a remarkable period for the Japanese stock market, as the TOPIX gained +28.3% (JPY). This outpaced the S&P 500's +25.7% gain (USD), the MSCI Europe Index's +15.8% gain (EUR) and the FTSE All Share's +7.9% gain (GBP). Investors appeared buoyed by the Tokyo Stock Exchange ("TSE")'s announcement requiring companies to disclose actions aimed at improving corporate value, particularly those trading at a price-to-book ratio of less than 1x. This marked the first time the TSE had explicitly focused on a valuation metric, which clearly resonated with investors.

Adding further pressure on corporate reform, the Ministry of Economy Trade & Industry ("METI") finalised its guidelines for corporate takeovers. The guidelines contained encouraging wording that we believe might pave the way for more unsolicited takeover approaches. The Financial Services Agency ("FSA") is currently reviewing the tender offer rule and concert party regulation, aiming to simplify current regulation. In December, the TSE announced its intention to call on the over 1,000 companies in parent-subsidiary relationships or that have listed equity affiliates to enhance disclosure regarding the rationale for having listed subsidiaries. Although not a regulatory change, Toyota Motors, one of Japan's last holdouts to reform its balance sheet, announced in November that it will partially unwind its cross shareholding in Denso. The direction of travel is clear, with shareholders, regulators and the Government all pushing in the same direction.

In August, we welcomed Shuntaro Shimizu, our newest addition to the Japan team. Shuntaro, joined from Bain & Company's Tokyo office, brings valuable financial experience gained at the Bank of Japan and holds an MBA from Stanford School of Business. He concentrates on applying his consulting expertise to engage with our portfolio companies and research new ideas.

The EV/EBIT of the portfolio increased from 6.0x to 8.7x over the year. This was in part driven by the strong portfolio performance but also from a conscious effort to invest in higher quality companies where we discern greater opportunity for business growth. Due to the concentrated nature of the portfolio, Nihon Kohden and Wacom, trading on EV/EBIT multiples of 15.3x and 20.0x, respectively, had an outsized effect on the aggregate portfolio valuation, with the median EV/EBIT of the portfolio being a more modest 6.9x.

The strong markets have not diminished the opportunity set and there continue to be pockets of deeply mispriced companies. At the time of writing, we are building positions in five new names, which, on average, trade on an EV/EBIT multiple of 4.0x, with 106% of their market cap covered by cash, securities and rental real estate. In each of these positions, we see an avenue to upsides in the order of 50-100% and the potential for us to become large shareholders.

AVI Shareholder Engagement

Shareholder engagement in Japan continues its rise unabated, with one broker noting that Japan is undergoing its third activist investor boom. The number of shareholder proposals from engagement funds grew from just under 60 last year to a record-high 82 this year and more shareholders expressed their disappointment with poor management, with support for incumbent Presidents falling.

We contributed to the 82 shareholder proposals this year by filing shareholder proposals at SK Kaken and NC Holdings. In the case of SK Kaken, this is the third consecutive year in which we have submitted proposals to the AGM. Although we have achieved some success, such as the company disclosing Scope 1 and 2 greenhouse gas emissions, increasing the number of outside directors, and conducting a 5-for-1 stock split, the company has refused to improve shareholder returns. Despite gaining 35% support, which, considering the founding family's nearly 50% control, represents a majority of minorities, SK Kaken persists in maintaining a measly 12% dividend pay-out ratio, resulting in cash accumulating each year. So long as we are shareholders, we will continue to apply pressure on the family to improve the situation.

At NC Holdings ("NCHD"), in a notable first for AVI and a very rare occurrence at Japanese AGMs in general, we had three shareholder proposals successfully passed, with a further three receiving majority shareholder support. Two dividend-related resolutions were approved, including an increase in the dividend pay-out ratio to 70%, and the establishment of a stock-compensation plan tied to achieving a three-year total share price return of over 50% and an average three-year ROIC of over 10%.

While we are pleased with this success, we are disappointed that our shareholder proposals to appoint two highly qualified outside directors did not pass. In addition to largely ignoring shareholder views for the past two years, the board opposed six resolutions that achieved majority shareholder support, engaged in intimidation and baseless threats related to purported concert party issues, targeted our investment team members by name in both their public and private rebuttals, and even attempted, unsuccessfully, to claim that NCHD's business was of national interest to evade scrutiny at the AGM. We will continue to engage with management and seek solutions to improve NCHD's corporate value over the coming year.

Towards the end of the year, after almost five years of private engagement, we released a public statement expressing our opposition to Digital Garage's board of directors and their misguided strategy. Critiquing the ill-fated midterm plan released in May 2023, we announced our intention to vote against all directors at the upcoming AGM. We believe our statement was well received and contributed to raising awareness among other investors about the necessary actions Digital Garage needs to take to address its undervaluation.

Our private engagement accounts for most of our work, and over the period, we sent 8 presentations and 17 letters to portfolio companies. In our private engagements, we cover more topics than shareholder proposals allow, with a strong emphasis on operational improvement, including strategies for margin enhancement and growth. Our engagement is tailored and specific to each company, with our in-depth understanding highly appreciated by management. We perceive ourselves as providing a service akin to investment consultants.

At the heart of our shareholder engagement is a long-term approach, and while improvements might not be reflected straight away, we believe that through our suggestions we are helping management create better businesses, ultimately leading to higher returns for all shareholders. In all cases, a track record demonstrating our readiness to make our concerns public significantly enhances our credibility in interactions with boards and management.

While we can't discuss all the details of our private engagement, it was a busy period, and there are several situations which we see coming to a head in 2024, whether that be shareholder proposals, mid-term plans or potential privatisation events. We believe the potential for alpha generation through engagement has never been higher, and we are excited by the abundant opportunities in the year ahead.

PORTFOLIO TRADING

Buying Activity

The largest purchase over the period was Takuma, the waste treatment plant builder and operator, which entered the portfolio in April. Having observed Takuma from the sidelines for several years, we witnessed the share price boom +150% higher in an ESG-fuelled bubble in 2021, only to decline by -46% to the price at which we started buying. Given its open shareholder register (32% foreign ownership), a structural tailwind, and a shifting business model to more recurring maintenance work (already 50%), we believe that Takuma's lowly 6.7x EV/EBIT valuation multiple is entirely unjustified. Almost half of Takuma's balance sheet assets are held in cash and listed securities, accounting for just over 60% of the market cap. We plan to start engaging with management on solutions to address the undervaluation in advance of next year's mid-term plan.

The second largest purchase was Eiken Chemical, a diagnostics company specialising in the manufacture of medical chemicals that react with body samples to provide a diagnosis for cancer, disease or infection. The market is attractive, with high regulatory barriers to entry, a razor/razor blade style business model and stable growth driven by increased diagnostics healthcare expenditure. Eiken Chemical has produced a number of niche products, with the most exciting being its Colon Cancer screening test, called FIT (Faecal Immunochemical Test), which accounts for around 40% of sales.

While generating low margins from the sale of its analyser, Eiken Chemical earns high-margin recurring income from the subsequent sales of bottles and solutions, providing recurring sticky income. Eiken Chemical's global dominance is driven by its testing accuracy and consistency, proprietary technology in its buffer solution, and the recognition of the OC-Sensor in over 100 journals, enhancing brand recognition and trust with healthcare providers.

The appeal of the diagnostics business is not lost on investors, with a set of peers, both domestic and global, trading on an EV/EBIT of 26x vs Eiken's 8x. We believe the disparity, in part, is driven by a misunderstanding of its niche business model, the roll-off from high margin COVID-related reagents, and a bloated balance sheet (32% of assets in net cash). We see almost +100% upside to the current share price, and if the company achieves its 2030 plan, possible with the successful launch of a DNA based stool test, over +200% upside.

Selling Activity

The largest sale was our long-standing position Fujitec, where we generated a +111% ROI and a +32% IRR over our almost five-year holding period. This tremendous success was driven by shareholder engagement, starting from the release of our public presentation in May 2020, and culminating with the recent overhaul of the board of directors and ousting of the founding family President. When we first invested in Fujitec, it was trading on a 4.7x EV/EBIT multiple, a significant discount compared to its peers trading on 16.8x. Over the life of the investment, that radically changed, and at the time of selling, Fujitec was trading on a 23.3x EV/EBIT multiple, a premium to peers' 20.4x. We took the difficult decision to sell the position based on valuation grounds, believing that the exciting prospects for value creation under the new board were reflected in the higher valuation.

We sold our position in C Uyemura, which we had been reducing for some time, generating an 87% ROI and 21% IRR over the life of our investment. We sold the last of our stake in Teikoku Electric, following a strong appreciation in the share price. Although it was only in the portfolio for a year, we generated a 52% ROI, amounting to a 92% IRR.

As has been the case for a few years, our tolerance for companies with intransigent and entrenched management who refuse to listen to shareholder voices has diminished. This explains our exits from Papyless, Pasona, Tokyo Radiator and NS Solutions, as well as the reduction of our stakes in two other small positions. AVI's approach is one of cooperative rather than confrontational engagement, in contrast to some other activist approaches. There are too many well-run and undervalued companies in Japan, with management teams who want to create value for shareholders, to waste our time with uncooperative companies that show little interest in shareholder concerns.

Contributors

TSI Holdings

TSI Holdings ("TSI"), one of the largest listed apparel companies in Japan, was the leading contributor in 2023, with its 68% share price increase adding 335bps to performance. TSI entered the portfolio in July 2022, and has generated a return on investment of 44%.

TSI's strong performance can be partly attributed to the TSE's initiative to pressure companies to address poor capital efficiency. As a follow-up to the 2022 TSE market classification review, in March 2023, the TSE requested listed companies to raise awareness around their corporate value, particularly if their shares were trading at a price-to-book ratio ("PBR") below 1.0x. TSI holds a large amount of non-core business assets such as cash and deposits, investment securities and rental real estate, and remarkably, its PBR remains at c. 0.5x.

We believe the business side of TSI has also attracted investor interest. TSI, along with other Japanese apparel companies, faced challenges stemming from the impacts of COVID-19. Nevertheless, consumer sentiment recovered strongly in 2023, with the economy further stimulated by inbound demand from surrounding Asian countries acting as a tailwind.

In addition to the supportive macroeconomic trends, TSI is implementing operational changes to improve its efficiency. Specifically, TSI focused on revitalising its historically strong but currently underperforming brands, such as nano universe, through a rebranding initiative and reform that involved strengthening senior frontline members. Consequently, nano universe, whose performance had been on a downward trend over the past few years, began to exhibit signs of recovery in 2023. Furthermore, the company has been working towards delivering higher margins, targeting 4.3% operating margins by 2025 compared to the current lowly 0.9%.

In terms of engagement, we have deepened our constructive dialogue on operational improvement and capital policy. As highlighted earlier, TSI remains significantly undervalued, with a PBR of 0.5x, and we believe there is still substantial upside to be unlocked through our supportive engagement efforts.

Konishi

Konishi, a company engaged in manufacturing of adhesives and civil engineering, achieved a share price return of +65% over the period, adding 320bps to performance. Following intense private engagement with Konishi's senior management, the company released a mid-term plan in May 2023, pledging to either invest or return to shareholders all cash generated over the next three years. The plan also outlined a three-year EBITDA growth target of +35% (of which +19% growth is forecast to be achieved in the first year).

This marked the first time Konishi had disclosed a capital allocation plan and its first commitment to buying back shares. A few weeks after the mid-term plan, Konishi announced an 8.5% share buyback which sent the share price +10% higher, and has been increasing further since. Aside from greater market recognition following the mid-term plan, earnings growth has buoyed the share price. Profits grew +71% over the six-month period to 30 September 2023 (Konishi's interim), driven by price increases coupled with softening raw material prices.

Despite the +65% share price growth, Konishi's EV/EBIT multiple increased only modestly from 4.0x to 5.4x. While Konishi have shown discipline in their capital allocation for the next three years, they have not addressed the current large cash pile, which, including listed securities, accounts for 47% of Konishi's market cap. We will continue to engage with the company on improving capital allocation, amongst other operational measures, and foresee a bright future for the company and its share price.

JADE GROUP

JADE GROUP (formerly LOCONDO) ("JADE"), an apparel ecommerce company, achieved a near doubling of its share price, up +96% and adding 179bps to performance. Full-year profits in February 2023 came in above forecasts (¥991m vs. ¥900m), but it was the company's +33% sales and +76% profit growth forecast for the year ending February 2024 that propelled the share price. By the 9-month mark at the end of December, operating profits had grown +99.9%.

JADE had been heavily investing in logistics infrastructure, leading to ballooning fixed costs weighing on profits and resulting in unutilised warehouse capacity. Last year it won the right to manage the Reebok brand in Japan through a joint venture with Itochu. Having already made the warehouse capacity investments, the company benefited from the power of operating leverage, with Reebok's incremental sales flowing straight to the bottom line. This year's profit guidance is in line with the mid-term plan, and management estimate that with further accretive acquisitions, they can grow profits by another 34% next year.

Alongside these results, JADE announced a 3.6% share buyback, which was well received. CEO Yusuke Tanaka's insightful 14-page shareholder letter detailed the company's history, what management have learned and management's growth strategy. He made a compelling argument as to why JADE justifies a ¥30bn-50bn market cap, much higher than the current ¥23bn market cap. While it will require flawless execution of the plan to achieve the higher end of that range, we do not think it is entirely unrealistic.

Across AVI funds, we are JADE's largest shareholder, owning just under 10% of the shares, and have maintained regular engagement with the company. We are optimistic about the company's growth prospects, which we don't think are being fully reflected in its 13x EV/EBIT multiple.

After the year end in February 2024, JADE announced the acquisition of Magaseek, which will see Gross Merchandise Value ("GMV") double and, although not yet confirmed by the Company, double its profits over the coming years. At the time of writing, JADE's share price is up +29% after the year end.

Shin-Etsu Polymer

Shin-Etsu Polymer, a semiconductor wafer case manufacturing company, saw its share price increase by +53%, adding 220bps to performance. The strong return was propelled by increased scrutiny from the TSE on the archaic practice of listed parent/subsidiary structures. Despite the challenging business environment this year for Shin-Etsu Polymer, with wafer manufacturers adjusting their inventory weighing on the demand for wafer carrier cases, the business performed resiliently and has forecast modest sales and profit growth of +2.5% and +2.0% respectively.

Trading on an EV/EBIT of just 7.6x, with net cash amounting to about 33% of the market cap at the year end, Shin-Etsu Polymer is still undervalued, owing to its parent/subsidiary structure with Shin-Etsu Chemical, who own over 50% of the shares. With Shin-Etsu Chemical being both a customer and supplier of Shin-Etsu Polymer, there are potential conflicts of interest. The absence of a majority independent board, coupled with the presence of former Shin-Etsu Chemical employees as directors, raises governance concerns. While we appreciate that management have made modest improvements, we believe these measures do not adequately address key issues enough to rectify the company's undervaluation.

We have put forward proposals to both Shin-Etsu Polymer and Shin-Etsu Chemical in private, seeking to achieve a majority independent board and to dissolve the listed structure entirely. We hope both companies will recognise the current shortcomings and take further action to grow corporate value and protect shareholders' interests. Pressure from the TSE, shareholders and wider stakeholders to address conflicts from parent/subsidiary structures will not wane.

Nihon Kohden

Nihon Kohden, was the 5th largest contributor, adding 200bps to performance with a +42% share price return. Nihon Kohden is a global leader in medical equipment manufacturing, renowned for launching the world's first AC-powered EEG machine. The company is now diversified across patient monitors, ventilators and defibrillators.

Earnings over the year were respectable, with Nihon Kohden continuing to benefit from overseas growth and increased healthcare expenditure. As management work towards a refreshed strategy with their May 2024 mid-term plan, there has been a distinct absence of market-moving announcements from the company. Rather, it was the disclosure from a well-known US activist fund that it had purchased 5% of Nihon Kohden's shares that drove the share price higher. We have admired this fund's engagement with Nihon Kohden's peer, Olympus (a large-cap Japanese company not held in the portfolio) and referenced the success of Olympus' transformation plan in our engagement to Nihon Kohden.

Although Nihon Kohden's discount to peers has narrowed since we initiated our position, currently trading on an EV/EBIT multiple of 15x compared to peers' 20x, we believe this doesn't fully capture the substantial potential we envision for the business. Under the leadership of President Ogino, the Grandson of Nihon Kohden's founder, we see a pathway for the business to improve operating margins from 10% to 15% and transition its focus from lumpy medical equipment sales to recurring digital services. Coupled with 5% projected annual sales growth, we estimate that over the next five years operating profits have the potential to nearly double.

Although the transformation is still in its early stages, we are confident it can be achieved. It is encouraging to see another activist investor recognise the potential, and we look forward to continuing our engagement ahead of the May 2024 mid-term plan. We still see over +100% upside to the prevailing share price.

Detractors

Digital Garage

Digital Garage, which operates one of Japan's largest payment settlement businesses, was the leading detractor from performance in 2023, with a -19% fall in its share price reducing performance by 216bps.

The weak share price can be attributed, in no small part, to the release of a profoundly disappointing mid-term plan in May. Leading up to the release of the mid-term plan, AVI had been engaging with Digital Garage extensively, having sent a letter to the Board advocating for all strategic options to be considered. This year, we submitted a 72-page presentation as part of our ongoing engagement, addressing matters such as shareholder communication, group strategy and the inefficient holding structure.

Rather than listening to our concerns, as well as those publicly raised by another shareholder, management persisted with its suboptimal strategy. The mid-term plan fell short of addressing the holding structure and the questionable 20% stake in listed Kakaku.com, nor did it make a convincing case as to how, without change, the performance of the payment business would improve. The negative share price reaction demonstrated that we were not alone in our disappointment.

After careful consideration, in November 2023 we issued a press release aiming to spur management into action. The release conveyed concerns regarding Digital Garage's corporate governance and the credibility of its directors, whilst also announcing our intention to vote against their re-election at the June 2024 AGM.

Unfortunately, at the end of the year, defiant to the trend of reducing cross-shareholdings, Digital Garage issued 5.25% of its treasury shares to Resona HD, with Resona HD committed to purchasing an additional 4.75% in the market. In return, Digital Garage intends to hold discussions regarding the acquisition of shares in a Resona HD subsidiary and setting up a venture fund together. We are perplexed as to what led management to believe that issuing deeply undervalued shares in such a convoluted manner would create value for shareholders. The lack of concrete tie-ups with Resona HD suggests a hastily executed deal, where it appears the primary beneficiaries are the advisors and management focused on protecting themselves from shareholder accountability.

Digital Garage has been in the portfolio since inception, and despite initially being a strong performer, its returns have eroded, leading us with a rather underwhelming return on investment of +6.2% and an IRR of +2.6% over the holding period. Over the past three years, Digital Garage's share price has declined by -1.8%, in contrast to the TOPIX, which has returned +41.1%. Over longer periods the relative performance has fared no better.

With the current leadership and status quo strategy, we would not be surprised if Digital Garage continues to erode shareholder value. Despite our lack of faith in management's ability to drive shareholder value, the shares do trade at a significant undervaluation. Overtime, we anticipate reallocating the position to more attractive opportunities.

NC Holdings

NC Holdings was the second largest detractor in 2023, reducing returns by -151 bps. NC Holdings primarily operates multi-storey parking and conveyor belt businesses in Japan. AJOT initiated its position in NC Holdings in June 2021, and has experienced a total return of -3.5% in GBP or +12.7% in Japanese Yen over the period.

During the AGM season in June 2023, we submitted shareholder proposals to NC Holdings regarding the revision of stock-based remuneration and dividends. Notably, three proposals were successfully passed, including a special resolution.

NC Holdings had previously encountered challenges in adequately disclosing the company's mid-long-term management policy for enhancing corporate value. NC Holdings neither conducts financial results briefing meetings nor publishes supplemental IR presentations. However, following the period of our public campaign, NC Holdings announced in June 2023 that it is committed to disclosing information on the management direction that the board of directors intends to pursue in order to improve its enterprise value, including the specific measures that they plan to implement. We await the disclosure with great interest, eager to see how NC Holdings will communicate concrete growth strategies, investment plans, capital efficiency improvement policy and business portfolio strategies in the near future.

In terms of business, we understand that potential growth areas include the expansion of the free line conveyor business, which is the business of conveying earth and sand by conveyor for civil engineering works in general, and the expansion of sales to local municipalities. We have engaged in constructive dialogue with management regarding the implementation of a shift away from dependence on non-growth domains, such as coal-fired power plants. We believe that the company's medium- to long-term commitment to growing these businesses will contribute to a better understanding by the market of the potential value of the company.

We expect to realise the upside through ongoing constructive dialogue, addressing business management, capital policy and investor relations disclosure.

SK Kaken

SK Kaken, a manufacturer of construction coating paints, was the third largest detractor, reducing performance by 70bps as its share price drifted -10% lower over the course of the year.

We continued our public engagement initiative, 'Painting a better SK Kaken', and for the third consecutive year we submitted shareholder proposals to SK Kaken's AGM. Our engagement has broadly focused on capital allocation, liquidity enhancement, corporate governance and shareholder communications. At this year's AGM, we campaigned for the return of the excess cash accumulated on the balance sheet to shareholders via dividends, along with the cancellation of treasury shares. While we achieved majority support from minority shareholders, the resolution was not passed, primarily due to the founding family's significant ownership stake.

On a more positive note, despite repeatedly resisting our suggestions for the past four years, management finally took steps in the right direction, as they conducted a 5-for-1 stock split, reduced the director tenure and transitioned to a company with an audit and supervisory committee, greater board independence and improved disclosure of ESG performance and quarterly results. Although we are pleased with the progress on these points, further action is needed to rectify the undervaluation, with SK Kaken currently trading on a negative EV/EBIT multiple, underscored by net cash covering 103% of the market cap.

SK Kaken has been in the portfolio since inception, and despite our engagement efforts has been a poor performer, yielding a return on investment of -18.4%, with an IRR of -4.4%. With a remarkably cheap valuation and stable business, we still see significant upside, albeit the timing of realising this upside is in the hands of the family.

Outlook

The cascade of regulatory improvements in 2023 is, in our view, a seminal moment in the long and winding road to unlocking the enormous value trapped in Japanese companies. We see abundant opportunities to exploit mispriced companies in a highly inefficient market. The concentrated nature of our portfolio and large upsides leaves us excited about the potential to generate significant alpha. This was evidenced by Alps Logistics and JADE GROUP, who, at the time of writing have seen their share prices appreciate by +51% and +29% respectively in 2024.

Joe Bauernfreund

Asset Value Investors Limited

13 March 2024

PORTFOLIO CONSTRUCTION

The objective of AVI's portfolio construction is to create a concentrated position in about 15-25 holdings, facilitating a clear monitoring process of the entire portfolio.

AVI picks stocks that meet our investment criteria and once we decide to invest, a minimum position size of approximately 2% of the portfolio is initiated. In determining position sizes, AVI is mindful of liquidity and the likely timing of any catalysts to unlock value. A key consideration is the make-up of the shareholder register, a proxy for how receptive management might be to our suggestions. The portfolio is diverse in the industries within it, but we are sector-agnostic and select investments based on quality and value.

Portfolio value by sector

Equity portfolio value by market capitalisation

INVESTMENT PORTFOLIO

LEI: 894500IJ5QQD7FPT3J73

FURTHER INFORMATION

AVI Japan Opportunity Trust Plc's annual report and accounts for the year ended 31 December 2023 and the notice of meeting for the Company's AGM will be available today on www.ajot.co.uk.

It will also be submitted shortly in full unedited text to the Financial Conduct Authority's National Storage Mechanism and will be available for inspection at https://data.fca.org.uk/#/nsm/nationalstoragemechanism in accordance with DTR 6.3.5(1A) of the Financial Conduct Authority's Disclosure Guidance and Transparency Rules.

Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) is incorporated into, or forms part of this announcement.