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Investing in Japan’s small-cap stocks is gaining appeal among investors looking to expand their portfolios beyond the familiar territory of large-cap investments. These investors are drawn by the potential for uncharted growth in a market where major Japanese stock indices have surged to multi-decade highs.
Earlier this year, Japan’s equities attained their highest levels since 1990. This was fueled by increased foreign investments, the resilience of domestic macroeconomic fundamentals, a departure from years of deflation, and a revitalised focus on corporate governance reform. Remarkably, over 90% of the stocks listed in Japan’s market fall within the small and mid-cap category, boasting a collective market capitalization of 45 bn yen ($297.36 mn).
Furthermore, as of September 29, 2023, the MSCI Japan Small Cap Index has risen by 18.60% in the last 1 year and 5.87% year-to-date. This is higher than the 1-year returns of 14.57% and year-to-date profits of 3.33% by the MSCI World Small Cap Index during the same period.
“Japanese small caps are less volatile in terms of global economic movements…And there is a high degree of diversity: [there are] many sectors such as banks, securities, raw materials, oils and so on. This means that compared to, for example, US equity, Japanese small caps have a lower correlation with those asset classes,” says Junki Okamoto, Deputy Portfolio Manager at BNP Paribas AM.
Okamoto also touches upon information asymmetry or low coverage by sell-side analysts of small-cap stocks. “For example, on average, Japanese small caps are covered by only one or two people,” he adds.
How to invest in Japan small-cap funds?
With small-cap stocks in Japan offering a wide range of opportunities for investors, we examine three Japanese small-cap funds, two actively managed and one passive strategy.
Eastspring Investments – Japan Smaller Companies Fund – A USD
Commencing its operations in 2008, this Eastspring fund is dedicated to optimising long-term capital growth. It achieves this by predominantly investing in equity and equity-related securities of companies incorporated in, listed in, or primarily operating from Japan from the bottom third in terms of total market capitalisation of all publicly listed equity in the country (market cap of under ¥300 bn). However, the small cap fund may also invest in medium sized and larger companies in order to enhance its liquidity.
The fund has total assets under management of $148.14 mn as of October 31, 2023. It is benchmarked against the Russell/Nomura Mid-Small Cap Index. The Eastspring fund has an initial sales charge of upto 5% and and an annual management fee of 1.5%.
Max Godwin is responsible for managing Eastspring’s Japan Smaller Companies strategies. He has over 20 years of investment experience.
Year-to-date*, the fund has achieved a cumulative growth of 10.9%, while the benchmark has reached 9.5%. Over the past five years, the fund has grown by 0.5%, in contrast to the benchmark’s 0.3%. Since its inception, Eastspring’s Japan Smaller Companies Fund has demonstrated cumulative growth of 7.2%, outpacing the benchmark index, which has grown by 4.2%.*
The fund’s top five major holdings include the electronics company Ricoh (3%), Meidensha Corporation, manufacturer and seller of generators and related products (2.9%), ICT firm Oki Electric Industry (2.8%), chemical manufacturing company Stella Chemifa Corporation (2.8%), and Lintec Corporation, manufacturer of adhesives (2.7%).*
In terms of sectors, the fund has the biggest investments in industrials (25.3%), materials (19.1%), consumer discretionary (17.1%), financials (14.5%), and technology (8.8%).*
BNP Paribas Japan Small Cap – JPY
Established in 1996, the fund has been in operation for nearly three decades. This BNP Paribas Japan Small Cap fund aims to enhance the value of its assets within the medium term by investing in shares of small Japanese firms or small companies operating within Japan.
It employs the Russell Nomura Small Caps (RI) benchmark solely for performance comparison. Unlike other funds in this list, the base currency of the fund is the Japanese yen.
The fund has total assets under management of 85.11 bn yen ($562.20 mn). As of October 29, 2023, the BNP fund had a maximum subscription fee of 3% and a maximum management charge of 0.95%.
For the year-to-date period, the fund has recorded an overall growth of 15.73%, outperforming the benchmark’s 15.19% gain.* Looking at the past five years, the fund has shown growth of 35.96%, in contrast to the benchmark’s 23.49% growth. Since its inception, this BNP fund has achieved a cumulative growth of 301.01, which is notably higher than the benchmark index’s growth of 193.72%.**
The fund’s top five major holdings include ceramics company Maruwa (Owariasahi) (2.78%), Fujimori Kogyo, manufacturer of plastic wrapping materials (2.57%), Meiko Electronics (2.25%), the ICT solutions firm Computer Engr & Consulting (2.14%), and Yakuodo Holdings, a Japanese holding company primarily involved in the retail sector (2.04%).**
Sector-wise, more than 50% of the fund’s allocations are made up of IT (22.34%), industrials (21.55%) and consumer discretionary (16.64%). Other major holdings include materials (11.24%) and financials (8.69%).**
Shunsuke Matsushima has been the portfolio manager of this fund since 2004.
iShares MSCI Japan Small-Cap ETF
Compared to actively managed investment funds, a passive strategy can also be an option for investors as it involves lower costs. One Japan Small Caps ETF on the market is the iShares MSCI Japan Small-Cap ETF which replicates the performance of the MSCI Japan Small Cap Index. The fund has total assets under management of $105.43 mn as of October 31, 2023. With an expense ratio of 0.50%, the iShares ETF is cheaper than the other two funds listed above.
In the last five years, the ETF has given negative returns of 3.72%. Along with that, the fund has risen 5.14% year-to-date, as compared to the 14.25% rise in its benchmark. Additionally, since its inception in 2007, the iShares MSCI Japan Small-Cap ETF has generated 90.88% returns.***
The fund’s top five holdings include JPY cash or the Japanese yen (1%), sporting goods company Asics (0.67%), the corporate group corporation Sojitz (0.64%), the FMCG firm Rohto Pharmaceutical (0.57%) and Fukuoka Financial Group (0.55%).*
Across various sectors, IShares, like the Eastspring fund, has the highest allocation in industrials (22.85%), consumer discretionary (16.86%) and materials (10.72%). They are followed by IT (10.38%) and consumer staples (10.09%).*
*As of October 30, 2023
**As of September 29, 2023
*** As of September 30, 2023
