AVI JAPAN OPPORTUNITY TRUST PLC

INTERIM REPORT 2023

LEI: 894500IJ5QQD7FPT3J73

Interim Report for the six months ended 30 June 2023

The Directors present the unaudited Interim Report for the six months ended 30 June 2023.

Copies of the Interim 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 +44 (0) 333 300 1950.

AVI Japan Opportunity Trust plc ("AJOT" or "the Company") invests in a focussed 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.

Dividend

An interim dividend of 0.85 pence per Ordinary Share for the period ended 30 June 2023 has been declared and will be paid on 3 November 2023 to Ordinary Shareholders on the register at the close of business on 6 October 2023 (ex-dividend date is 5 October 2023).

Performance Summary

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

Chairman's Statement

"Japan has demonstrated it can produce strong returns on investments in 2023, and with the continued macroeconomic tailwinds, and potential for increased foreign allocation, it is an exciting time to be finding new opportunities in the region."

Norman Crighton, Chairman

Performance and Introductory Comments

Welcome to the fourth Interim Report for AVI Japan Opportunity Trust plc ("the Company", or "AJOT"), covering the period from 1 January 2023 to 30 June 2023. When I last wrote to you, the environment for global markets was hostile - with seemingly persistent inflation, fears of stagnant growth, and war in Europe. These factors have not yet subsided, but the market's attention has turned to Japan, growing increasingly bullish in recent months. The combination of a strong economy, low inflation, corporate governance improvements and a late re-opening from COVID has generated optimism for Japanese equities. So far, the lion's share of this market rally has been focused on large-cap names, with the MSCI Japan Index disjointedly returning +23.8% vs. the MSCI Japan Small Cap Index which returned only +15.4% (in JPY).

Turning to AJOT more specifically, absolute returns were significantly hampered by an outsized 13.5% weakening in the Japanese Yen against the pound, but in spite of this, the portfolio performed strongly returning +4.9% in the period. This represents an outperformance of the benchmark, the MSCI Japan Small Cap Index, which returned -0.4% and of the Company's peers of UK-listed Japan smaller companies investment trusts, which fell an average of -0.6%*. The Board believes AJOT's strategy is proving resilient and successful.

The opportunity set among small-cap names remains rich. Foreign investors have predominantly allocated their capital into larger equities with greater liquidity rather than taking time to investigate small-cap opportunities. The Tokyo Stock Exchange has been promoting measures to encourage better capital efficiency among Japanese corporates, including the soft requirement of maintaining a price-to-book ratio above 1.0x. Given nearly half of all names on the index currently trade below book value, this provides a strong backdrop for active engagement with your portfolio's companies.

In this period, your manager, AVI, embarked on two public campaigns and sent letters or presentations, in private, to a further six portfolio companies. AVI's Japan team, including Tokyo-based Jason Bellamy, spends considerable amounts of time engaging intensely with the portfolio. To improve the reception of our suggestions, the team is building deep relationships with management, having conducted meetings in Japan with several Chairmen/CEOs of our portfolio companies.

Predicting economic trends is difficult, but from an investment perspective one can reduce risk by exercising discipline and investing into companies based on underlying quality and valuations. Your Company's focus remains on investing into companies with solid fundamentals where there is also an opportunity for active engagement. The portfolio's weighted average EV/EBIT multiple is an attractive 7.8x, and on average net cash and investment securities account for 56% of portfolio companies' market caps.

No country or company is immune to the contagion risk of high inflation elsewhere in the world, but with Japan having recently bucked its deflationary slump, and inflation running only slightly north of 4%, the outlook for the Japanese economy is encouraging. Tourism has returned, GDP has been lifted by increased capex, and foreign investors have been progressively allocating more funds to the Japanese markets. This might finally be the stimulus Japan's economy needed.

Japan has demonstrated it can produce strong returns on investments in 2023, and with the continued macroeconomic tailwinds, and potential for increased foreign allocation, it is an exciting time to be finding new opportunities in the region.

Dividend

The Board has elected to propose an interim dividend of 0.85 pence per share. As stated in the Prospectus at the Initial Public Offering ("IPO"), the Company intends to distribute substantially all the net revenue arising from the portfolio and is expected to pay an annual dividend, but this may vary substantially from year to year.

Investment Strategy

AJOT listed in October 2018 to take advantage of the highly attractive opportunity to invest in under-valued, over-looked Japanese small-cap equities with strong underlying business fundamentals. We believed - and very much still do - that active engagement and corporate dialogue will allow for the unlocking of valuation anomalies unavailable in other global developed markets, with the potential for attractive absolute and relative returns.

As the five-year anniversary of AJOT's launch approaches, your Company has performed well despite the uncertain environment and poor relative performance of small-cap Japanese stocks (MSCI Small Cap Japan has underperformed its larger MSCI Japan counterpart by almost 10%). The Board remains confident that AVI is well placed to continue executing on the strategy and that there are still plenty of mispriced investment opportunities.

Share Premium and Issuances

As at 30 June 2023, your Company's shares traded at a discount of -0.8% to Net Asset Value per share. Over the period under review, this ranged from a -6.0% discount to a +3.5% premium. The Board monitors the discount/premium situation carefully, ensuring investors are protected on the downside from a widening discount while also taking advantage of the premium to grow the Company.

During the period the Board issued 4.4m new shares, including 0.6m shares from treasury after they were purchased earlier in the year. The total outstanding shares in issue was 140,836,702 at the end of the period - a healthy 76% increase compared to the 80,000,000 shares at your Company's launch in October 2018. Also, during the period, AVI purchased 150,000 shares as part of its ongoing commitment to invest one quarter of its management fee in AJOT shares.

Debt Structure and Gearing

At the end of the period, AJOT had £15.9 million worth of Yen debt, with gross gearing standing at 9.5% of NAV. Owing to recent sales and the time taken to build new positions, net debt stood at 3.0% of NAV.

Annual General Meeting

The Company's Annual General Meeting was held on 2 May 2023. All resolutions were passed with at least a 99% approval.

Closing Remarks

The Board would like to thank Shareholders for their continued trust and support. If you have any queries, please do not hesitate to contact me personally (norman.crighton@ajot.co.uk) or alternatively speak to our broker Singer Capital Markets to arrange a meeting.

Norman Crighton

Chairman

14 September 2023

* The peer group includes the members of the Association of Investment Companies (AIC) Japanese Smaller Companies sector, namely Atlantis Japan Growth Fund, Baillie Gifford Shin Nippon, JP Morgan Japan Small Cap Growth & Income, and Nippon Active Value Fund. Performance calculated using data sourced from Morningstar.

Investment Manager's Report

"It feels that the stars are starting to align in Japan. Our approach to engaging with undervalued, high-quality companies is bearing fruit and, particularly if we see a reversal in Yen weakness and increased flows into small caps, we could be in for a period of strong NAV growth."

Joe Bauernfreund

Portfolio Manager

During the period from 1 January to 30 June 2023, your Company returned +4.9% in GBP. This compares with a return for the benchmark index, the MSCI Japan Small Cap Index, of -0.4%. Over the course of the past six months, the Yen depreciated by -13.5% against the Pound, which has been a headwind to Sterling-based returns.

In local currency terms, it was a buoyant period for the Japanese stock market as the MSCI Japan Index gained +23.8% (in JPY), far exceeding the S&P 500 (+8.6%, in USD), the MSCI Europe Index (+2.7%, in EUR) and the FTSE All Share (-0.5%, in GBP). Were it not for Yen weakness, AJOT's NAV would have returned +21.5% over the period and +61.0% since launch.

The Japanese Yen weakness was driven by a cautious tone from Kazuo Ueda, the newly appointed Bank of Japan ("BoJ") governor, which disappointed those anticipating an imminent end to the BoJ's Yield Curve Control ("YCC") policy. Latest data for June showed a 4.2% increase in core inflation (excluding food and energy) which is starting to flow through to higher wages. We think it isn't a matter of if we will see material adjustments to YCC, but when - which would be a boon for the Yen.

Over the period however, small-caps lagged, with the MSCI Japan Small Cap Index returning only +15.4%. With the rally led by large-cap value, the MSCI Japan Value Index appreciated +22.8% (both in JPY). During a period of strong foreign flows into Japan, it is typical to see early capital allocated towards large cap names. As the rally is sustained, however, we would expect there to be a trickle-down effect as capital seeks out smaller and better valued opportunities. Given AJOT's portfolio has an average market cap of £675m, we are well placed to benefit.

The Tokyo Stock Exchange ("TSE") followed through on its announcement at the end of last year calling on companies to address low valuations. This is mostly aimed at the 1,800 companies in Japan that trade on a price to- book ratio of less than 1x. Companies will need to determine why the market evaluates their shares so lowly and disclose plans to improve the valuation. It is an encouraging step, highlighting regulators' intentions to continue using their powers to promote governance reforms.

We continued to actively increase our portfolio concentration, with the top ten holdings accounting for 73% of NAV, up from 67% at the end of 2022. Such concentration allows us to dedicate more time to research and engagement with each company. We continue to generate new ideas, with two new positions entering the portfolio over the period and one shortly after period end.

It feels that the stars are starting to align in Japan. Our approach to engaging with undervalued, high-quality companies is bearing fruit and, particularly if we see a reversal in Yen weakness and increased flows into small caps, we could be in for a period of strong NAV growth.

AVI Shareholder Engagement

Shareholder engagement in Japan continues its rise unabated, with one broker saying that Japan is facing 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 year in a row where we have submitted proposals to the AGM. While we have had some success - with 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 near 50% control, represents a majority of minorities, SK Kaken continues to pay-out a measly 12% dividend pay-out ratio, with cash accumulating every year. So long as we are shareholders, we will continue to pressure the family to improve the situation.

At NC Holdings ("NCHD"), in what was a first for AVI and a very rare event at Japanese AGMs generally, 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 formation 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 tried, unsuccessfully, to claim that NCHD's business was of national interest to avoid scrutiny at the AGM. We will continue to engage with management and seek solutions to improve NCHD's corporate value over the coming year.

Our private engagement accounts for most of our work, and over the period, inclusive of the two companies where we engaged both privately and publicly, we sent six presentations and five letters to eight companies. We cover more topics in our private engagement than we can through our shareholder proposals, and we place a lot of emphasis on operational improvement, including margin enhancement and growth strategies. Of course, we still engage on balance sheet enhancement, and over the period had success with our long-term investment in Konishi. Management released a mid-term plan, which for the first time included a capital allocation plan with a commitment to share buybacks. A few weeks after the mid-term plan, Konishi announced an 8.5% share buyback which sent the shares +10% higher the following day.

We take a long-term approach to shareholder engagement, and while improvements might not be reflected straight away, we believe that through our suggestions we are helping management create better businesses, and that this will ultimately lead to high returns for all shareholders. In all cases, a track record that shows a willingness to take our concerns public adds significant credibility in our interactions with boards and management.

Portfolio Trading Activity

Annualised turnover for the first half of the year was a healthy 39%, with a buoyant market providing plenty of opportunities to recycle capital from winners into laggards and new ideas. We exited six positions entirely and two new companies entered the portfolio.

Sales

The largest sale was Fujitec, a longstanding investment 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, all the way through to the recent upheaval 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 of value creation from the new board are reflected in the higher valuation.

We exited a longstanding 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. Similarly, 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. That explains our exits from Papyless, Tokyo Radiator and NS Solutions, as well as the reduction of our stakes in two other small positions. 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 with no interest in shareholders.

Purchases

The largest purchase over the period was Takuma, the waste treatment plant builder and operator, which entered the portfolio for the first time. We have been watching Takuma from the sidelines for several years, seeing the share price boom +150% higher on an ESG-fuelled bubble in 2021, only to fall -46% at which point we started buying. For a business with an open shareholder register (32% foreign ownership), a structural tailwind, and a shifting business model to more recurring maintenance work (already 50%) we think Takuma's lowly 3.5x EV/EBIT valuation multiple is wholly 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 the undervaluation ahead of next year's mid-term plan.

Fuji Soft was another new addition to the portfolio, as we continue to invest in companies that stand to benefit from increased digitalisation in Japan. We join another activist, 3D Investment Partners, who have led a public campaign to successfully appoint new outside directors. We believe in a privatisation event there is over 50% upside, and that management can do a better job of realising their real estate portfolio. Cash, investment securities and real estate account for 47% of the market cap.

We continued building our relatively new positions in TSI Holdings and Nihon Kohden, which ended the period as the two largest positions.

Contributors/Detractors

TSI Holdings

TSI Holdings, a diversified apparel holding company, was the largest contributor to returns with a +77% share price increase for the period adding 332bps to performance. Since our first investment in July 2022, the share price has gained +137% and is up +67% on our average purchase price.

Share price performance at the start of the period was spurred by the announcement of a 5.8% share buyback (following a 6.6% buyback last year) and the resignation of the founding-family Chairman. Following this the company announced results in June which showed good progress towards achieving their 4.3% operating margin goal by 2025. Management forecast +5% sales growth next year and a 2.9% operating margin, which would mark the highest operating profit in TSI's history. Unsurprisingly, the market took this well.

While it is hard to justify the +77% increase based solely on those announcements, TSI was trading on a remarkably low valuation at the start of the year. 182% of its market cap was covered by net cash, investment securities and real estate, implying a negative value for its apparel business. We couldn't find a justification for the discount at the time, and sometimes if a stock doesn't have a reason for trading on a discount, it doesn't need one to correct.

Despite the strong share price return, TSI still has net cash, investment securities and realisable real estate covering 96% of its market cap, and we see a further +113% upside. We own just over 6% of the voting shares and plan to engage with management on measures to further rectify the undervaluation although, given the spate of buyback announcements and improved attitudes towards shareholders, we think we are pushing on an open door.

JADE GROUP

JADE GROUP (formerly LOCONDO) ("JADE"), an apparel ecommerce company, achieved a share price return of +65% over H1 2023, adding 179bps to performance as the second largest contributor.

Full-year profits came in above forecasts (¥991m vs. ¥900m), but it was the company's +33% sales and +76% profit growth forecast for next year that propelled the share price. JADE had been heavily investing in logistics infrastructure, with ballooning fixed costs weighing on profits and 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 wonders of operating leverage, with Reebok's incremental sales flowing straight to the bottom line. Next year's whopping 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% the year after next.

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 for why JADE justifies a ¥30bn-50bn market cap, some 100% higher than the current ¥20bn market cap.

While it will take flawless execution of the plan to meet the higher end of that range, we do not think it is entirely unrealistic. Across AVI funds, we are JADE's largest shareholder, owning 11% of the shares, and have been regularly engaging with the company. We are optimistic about the company's growth prospects, which we don't think are being fully appreciated by investors in its 11x EV/EBIT multiple.

Konishi

Konishi, a company engaged in manufacturing of adhesives and civil engineering, achieved a share price return of +36% over the period, adding 123bps to performance.

After intense private engagement with Konishi's senior management, during the period, the company released a mid-term plan committing to investing or returning all of its cash over the next three years and outlined a three-year EBITDA growth target of +35% (of which +19% growth is forecast to be achieved in the first year). This was the first time Konishi 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 shares +10% higher. Despite the buoyant share price Konishi still only trades on an EV/EBIT of 5.1x which on next year's guidance falls to 4.1x. 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 59% of Konishi's market cap. We will continue to address this issue along with encouraging Konishi to expand into industrial applications and overseas.

Digital Garage

Digital Garage was the largest detractor over the period, with its share price falling -16%, reducing returns by 173bps. Digital Garage is a holding company whose key assets are its stake in Kakaku.com and its payment settlement businesses.

The stake in Kakaku.com is non-core, and despite management's assertations, it has failed to generate meaningful synergies with the payments business. Kakaku.com's share price has been remarkably weak after failing to capture COVID rebound demand in its restaurant reservation business, and with sell-side analysts questioning the validity of its price comparison website business model. Kakaku.com is trading on a price-to-earnings ratio of just under 18x, the bottom end of its range and at a similar level to the COVID lows.

Digital Garage's share price decline over the period is a stark reversal of the strong +32% share price return in Q4 of last year. This reversal is attributable almost entirely to Digital Garage's announcement of a hugely disappointing mid-term plan. We have been engaging with Digital Garage extensively, and ahead of the mid-term plan, sent a letter to the Board calling for all strategic options to be considered to address the inefficient holding structure.

Instead of listening to our concerns and those raised publicly by another shareholder, management released an entirely underwhelming set of proposals. This plan failed to address the holding structure or justify why Digital Garage needs to retain its 20% stake in Kakaku.com. Additionally, it failed to make a convincing case as to how, without change, the performance of the payment business will improve. The negative share price reaction demonstrates that we are not alone in our disappointment with the mid-term plan, and we are exploring next steps. We added modestly to the position on weakness taking us through to a 3% shareholding.

Pasona Group

Pasona was the second largest detractor over the period as its share price fell -11%, reducing returns by 70bps. Pasona is a staffing company providing dispatch workers and outsourced processing services throughout Japan.

The company has a 50% stake in listed company Benefit One, a corporate benefits platform, worth 178% of its market cap. Benefit One is a market leader and has achieved consistent growth, compounding EBIT over the past five years at +7%. It has 11.6m captive members on its platform, about 17% of the 67m employed workers in Japan, providing stable cash flows and an opportunity to sell additional services. However, over the period its share price fell -23%.

With 178% of Pasona's market cap accounted for by its stake in Benefit One, the market attributes a negative valuation to Pasona's operating business. While Pasona's operating businesses are not the most efficient and the Founder has a penchant for overspending, the -61.3% discount seems overly harsh. However, given that Pasona is majority controlled by the Founder and there is no room for engagement, we have been slowly reducing the position, with it accounting for 2.6% of NAV at the end of the period vs 3.8% at the start.

SK Kaken

SK Kaken, a manufacturer of construction paints, suffered a share price decline of -4% over the period, reducing performance by 62bps.

For the third year in a row, we submitted shareholder proposals to SK Kaken's AGM addressing two issues contributing to the company's poor share price performance, low valuation, and potential delisting from the Tokyo Stock Exchange. Specifically, the proposals called for the cancellation of 90% of the 438,400 shares held in treasury, and to increase the dividend from ¥400 per share to ¥800, representing a 30% pay-out ratio.

Despite a high-quality business model and having a dominant share of the domestic construction paint market, SK Kaken trades on a negative enterprise value, a price-to-book ratio of just 0.7x with net cash covering 104% of its market cap. Over the last five years, SK Kaken's share price has fallen -27% while its domestic peers' share prices have fallen an average -6%, and the TOPIX has gained +19%. With 420 shareholders, SK Kaken only narrowly meets the 400-shareholder minimum requirement for listing on the TSE Standard market.

Unfortunately, despite receiving strong support from non-founding family shareholders, SK Kaken has not cancelled its excess treasury shares nor raised its low dividend pay-out ratio. While the company has made some improvements in line with our suggestions, including emissions disclosure, a 5-for-1 stock split and increased outside directors, it hasn't been enough to address the discounted valuation.

Moving forward, we will look to continue our engagement with management to narrow the valuation discount and ensure SK Kaken is acting in the best interests of all shareholders. Although we will continue to be outvoted by the Founding family, our persistence sends a strong message to other companies that we will not give up so easily.

Outlook

The portfolio performed positively over the period, achieving a +5.0% return, compared to the benchmark, the MSCI Japan Small Cap Index, which returned -0.4%. In local currency terms, the performance of the portfolio was even more positive, with a gross total return in 2023 of 22% to date. Overall, the portfolio trades at an attractive average EV/EBIT of 7.8x, with net cash and listed securities covering 56% of the market cap.

The strong performance of Japanese equities shows the power of foreign capital flows and their effect on stock prices. With global funds still underweight Japanese equities, a positive macroeconomic backdrop, low valuations, and an environment ripe for activism, Japan makes for a compelling investment opportunity.

Joe Bauernfreund

Asset Value Investors

14 September 2023