Kenichi Amaki, Portfolio Manager, Matthews Asia
For those willing to go through all the leg work, and kiss a few frogs to unearth the gems, looking beyond large and mega-cap companies can be a winning strategy when investing in Japan. Take Japanese small-cap companies for example. They represent only 1.5% of the MSCI Japan Index, but can offer compelling investment opportunities: Approximately 60% of the roughly 1,500- company universe of small caps has fewer than two research analysts covering them. However, many investors focus only on the largest 400 companies in Japan, the household names where there is liquidity, familiarity and much sell-side analyst coverage.
I believe these investors are disregarding many companies that are strong and sustainable growing businesses at reasonable multiples relative to their growth and peers. At Matthews Asia we invest across the market-cap spectrum. Our long-term investment horizon allows the small- and mid-cap holdings to develop into market leaders in their respective industries. As a result, the Matthews Japan Fund complements many other Japan funds in both sector and market-cap weightings.
However, small- and mid-caps have had a rollercoaster ride in 2016. They started the year outperforming large-caps, but then underperformed in the second and third quarters of last year. This was mainly the result of the BOJ's decision to increase its purchases of exchange traded funds (ETFs) which were largely focused on Japan's largest Nikkei 225 stocks. Meanwhile it is likely that if foreign investors - who have shunned the market over the past year -do decide to return to Japan, their first foray might be into more liquid larger-cap securities.
As a result we have seen some sector rotation where some large-caps, particularly value stocks, outperformed more quality growth orientated small cap stocks. However, historically this type of large cap out performance has been short-lived. Instead it is our belief that as macro tailwinds persist in Japan in 2017, the anomaly of small- and mid-cap underperformance from last year should begin to dissipate.
In addition, improved PMIs, accelerating wage growth and the announcement that the Japanese government will expand fiscal spending for the first time in three years all bode well for the strength of the economy. Add into the mix a weaker yen, the prospect of inflation continuing to rise, and improved fund flows into Japan, and you can see how many headwinds have turned into tailwinds. If this growth trajectory continues you would expect small and mid-caps to normalise and catch up in 2017.
So-called flights from quality in markets can test portfolios. The best are those that shoulder the short-term pain and stick to long-term convictions—and at Matthews Asia, we believe that an all-cap approach to Japan can generate good long-term performance.
For our latest views on investing in Japan, please visit https://global.matthewsasia.com/japanfund/
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