Small- and mid-cap focus sees Japan ITs outperforming OEICs

Japanese investment trusts’ high concentration to small and mid caps has paid off, with the sector outperforming the open-ended space over the past year.

The seven Japanese investment trusts have posted a net asset value average return of 11% over one year, outstripping the IMA Japan sector’s 5.2%, according to Oriel Securities.

The closed-ended vehicles are benefitting from managers moving down the market-cap spectrum and  the Topix Small Cap index’s bull run since the country’s devastating tsunami in March.

Winterflood’s analyst James Brown said small-cap sentiment has improved as the country seeks to redevelop areas damaged by the disaster.

He added it is “extremely unusual” for Japanese investment trusts to produce better returns than open-ended equivalents because they are often more highly leveraged.

“Over the past decade the Japanese closed-ended space has failed to outperform OEICs, as the trusts normally underperform due to the sector’s high levels of gearing, which results in performance deteriorating in a falling market,” said Brown.

“However, with five out of the seven trusts adopting a small- and mid-cap bias, the gearing has paid off, profiting from the Topix Small Cap index returning 13% over one year, while in contrast the large-cap index is down 1.8%.

“The sector’s average gearing stands at 112%, which has helped performance in a rising market.”

Oriel Securities analyst Tom Tuite-Dalton said it is rare to see UK-listed Japanese trusts outperforming their benchmarks.

Tuite-Dalton added the £218m Baillie Gifford Japan trust, run by Sarah Whitley, has been the standout performer, beating its benchmark by 14% over one year.

“The Japanese trusts have done well due to an increased focus down the market-cap scale towards innovative businesses which are tapping into strong consumer demand,” said Tuite-Dalton.

“Discounts have also tightened from 15% to 12% over the year amid the uptick in performance.”

Over the past year, Whitley has been boosting exposure to small-cap internet stocks, adding the likes of Digital Garage, So-net, GMO Internet, Next and Zappallas to the portfolio.

Whitley added Japanese small caps are thriving due to increasing demand from exporters and are relatively immune from the country’s medium-term low growth outlook.

“The country’s major export markets look very encouraging and I have been attempting to find growth from business models that disrupt outmoded domestic industries, in areas where innovation delivers strong prospects and those that can benefit from structural demand trends. This includes increasing internet innovation and automation in Asia,” added Whitley.