Japanese small-cap stock investments will provide superb returns in the long run, we believe, for the following reasons:
q Japan small-cap stocks remain relatively low price level compared with other world stock markets.
The Japan small cap equity market (the OTC index) is still 45% below its historical high level in spite of a strong performance in last year.
q Attractive investment opportunities for Japanese small cap stocks will continue to expand rapidly.
Many attractive companies in new growing industries, such as internet, information technology, outsourcing and healthcare, have gone public since 1997. This trend will accelerate on the back of the establishment of new stock markets for emerging companies. One is called Mothers (market of the high growth and emerging stocks). This market started last November and is operated by the Tokyo Stock Exchange. The other is NASDAQ Japan. This market is scheduled to launch in June. The major listing criteria of these markets is much easier than that of the existing markets. Therefore, we expect many attractive start-ups to go public for the short term.
q The importance of stocks outside the Tokyo Stock Exchange first section is increasing.
Combined Japan OTC and TSE second section market capitalisation is $465bn (e465bn); larger than Swedish market. We are sure that the Japanese small-cap market is big enough for international investors.
q Small-cap stocks have high economic sensitivity.
Historically speaking, when the economic situation is improving, small cap stocks usually outperform large cap stocks because of their economic sensitivity. And our economic forecast is modest recovery for the coming years.
We now turn to our investment strategy for small-cap stocks.
Last year the Nikkei OTC average and TSE second section index greatly outperformed the Topix index because of the higher exposure of IT-related stocks. We expect the relatively favourable performance of small-cap stocks to continue as they have stronger growth potential and higher economic sensitivity.
Our investment strategy is;
q First, we continue to overweight high-quality growth stocks and oversold issues, whose earnings are likely to recover. Last year high-quality growth stocks jumped sharply. But some of them are still undervalued to their growth potential.
q Secondly, we plan to increase the exposure of the relatively small companies with low valuations. Last year the relatively large companies in the TSE second section and OTC market led the rally. So we think some of them are overvalued. Therefore, we will increase the weighting of the smaller stocks with low valuations while reducing the larger stocks.
q Finally, we will maintain selective investments in IT related stocks. As well as foreign stock markets, in Japan, IT-related stocks jumped drastically. Generally speaking, IT-related stocks have strong growth potential. Some fund managers invest heavily in IT-related sector. But we think some Japanese IT stocks are much expensive compared with foreign IT stocks. Therefore, we continue to invest in IT stocks selectively through our intensive research. We think this year the real capability of the fund managers for small cap stocks will be tested.
Hiroyoshi Nakagawa is executive officer, pension fund investment group, with SG Yamaichi Asset Management in Tokyo