Japanese small caps have been one of the best performing equity classes in the world over both a 10 and a 20-year time horizon. In local currency terms, Japanese small caps have matched the S&P500 Index over 20 years, something few markets can claim. We think there is more to come.
At the heart of small-cap appeal is the ability to be nimble; to innovate and disrupt, and thereby grow. Led by a new generation of entrepreneurs, Japanese innovation is now more evident than we’ve seen in decades. In addition, there is a further, somewhat unique, appeal when it comes to Japanese small caps: the sector is overflowing with trapped value which is in the process of being unlocked at long last. Growth, innovation, creative-destruction and value. It’s an enticing cocktail.
Broadly speaking, we are focussed on two types of investment scenario in the Japanese small cap space. Firstly, we are looking for companies that are creating significant value for their customers. Secondly, we are focussed on companies where we believe operational or balance-sheet reform is likely to unlock significant latent value for shareholders.
The first category represents companies that are creating their own demand growth through a compelling and scalable value proposition. Importantly, we want to buy these companies when their share prices fail to reflect their intrinsic value, either because they are undiscovered or because the market is unduly myopic. These are not easy to find, but they certainly do exist in Japan.
In terms of the second category, significant and exciting change is afoot. Japan’s corporate sector is now some seven years into a multi-faceted, government-sponsored campaign to force higher returns on capital. A new Stewardship Code, a new Corporate Governance Code, new tax rules, stronger shepherding by the stock exchange, a new Companies Act and rising shareholder activism represent an astonishing set of forces pressuring companies to release trapped value. Excitingly, it’s working.
With each passing week, old corporate taboos are being broken as global corporate standards seep into traditional Japanese boardrooms. We are seeing takeovers at significant premiums, former business allies breaking ties and outbidding each other, value creating spin-offs (e.g. Curves and Koshidaka) and, of course, the emergence of unsolicited, hostile takeovers. Trapped value is starting to be mobilised and we believe the journey has only just begun.
Effective stewardship requires active and engaged investors. At M&G, we are proud of our engagement credentials and intend to bring them to bear to accelerate the release of value from our investee companies. By working in partnership with company management teams, we seek to add value to the businesses we invest in, driving higher returns for our clients, and better ESG outcomes into the bargain.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.