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The Japanese equity market is sometimes dismissed by international investors as mature, staid and undynamic; but they make this judgement at their peril

The Japanese economy is in the grip of a profound structural transformation, driven by the rapid adoption of digitalisation and other technological innovations, and Japan’s equity market is home to some of the world’s most vibrant, entrepreneurial and fast-growing companies, at the forefront of innovation in a variety of sectors.

Many of these businesses are young, small cap companies that could prosper over decades, as they realise their growth potential, at home and on the international stage. In fact, Japan’s small caps have outperformed the broader domestic market significantly over the past decade. Yet the sector is under-researched and most investors pay it scant attention.

Not JPMorgan Japan Small Cap Growth and Income plc (JSGI). It specialises in this part of the market, searching out the hidden gems, with the support of a team of over 20 portfolio managers and analysts based in Tokyo, and thus ideally located to identify attractive investment opportunities.

‘Japan’s small caps have outperformed the broader domestic market significantly over the past decade’

JSGI has a diversified portfolio of around 75 stocks and targets quality businesses with competitive advantages and strong growth prospects. And its managers take a long-term perspective, to give their portfolio companies time to realise their full potential.

Japan’s tech revolution may have been slow to get started compared to other nations, but it is now permeating most sectors of the economy. Its world class manufacturers are leading global suppliers of factory automation equipment, robots and electronic parts and materials. Not to be interpreted as a recommendation, some for example, like MEC, one of JSGI’s largest holdings, operate in lucrative niche markets. MEC supplies specialist chemicals used in the production of printed circuit boards, to customers across Asia and Europe.

Another holding, Asahi Intecc, produces medical devices such as catheters and guide wires, while companies such as Taiyo Yuden, IRISO Electronics and Hirano Tecseed, which all feature in JSGI’s portfolio, provide electronic components and specialist products for use in electric vehicles, smart phones and other high tech products.

‘Targets quality businesses with competitive advantages and strong growth prospects’

Digitalisation is transforming many aspects of daily life in Japan, facilitating online banking, medical services, shopping and entertainment, and helping businesses update their work practices and increase productivity.

JSGI has exposure to these trends. For example, it owns SpiderPlus, which provides digital draughting and other services to the construction sector, saving companies many hours of manual work.

The fund also holds Money Forward, Japan’s leading supplier of cloud-based accounting software. This is a new market in Japan, with significant scope for expansion, while, a digital signature service, is replacing traditional personal signature stamps.

JSGI’s managers are active investors, always poised to take advantage of market opportunities as they arise. The recent turbulence in global financial markets provided many such opportunities. This volatility is being caused by rising inflation, interest rate increases and the crisis in Ukraine, and has sparked share price declines in many markets. Japan’s small cap stocks have not escaped. The MSCI Japan Small Cap has fallen substantially since its peak in mid-2021, providing JSGI’s managers with the chance to purchase interesting stocks at lower prices.

‘Gain diversified exposure to the many exciting opportunities on offer in Japan’s small cap space’

One such new addition to the portfolio is Shift, Japan’s top software testing service. JSGI’s managers had been watching this stock for some time and the recent market sell-off gave them the chance to acquire the name at an attractive price. Shift allows software engineers to outsource the low value-added, time-consuming work of testing software. The company has achieved annual revenue growth of more than 40% a year for eleven consecutive years and its long-term prospects are very positive, as its market penetration is still very small.

Trends triggered or accelerated by the pandemic are now embedded in Japan’s daily life and management practices and will continue to drive the development of new products and services for many years to come. Growth, productivity and corporate earnings will increase accordingly, regardless of prevailing economic conditions. JSGI’s portfolio holdings, and its shareholders, could be ideally placed to benefit.

In addition to targeting long term capital growth, JSGI also offers an attractive quarterly dividend, equivalent to an annual dividend yield of about 4%.

JSGI is a relatively low-cost way for investors to gain diversified exposure to the many exciting opportunities on offer in Japan’s small cap space. The fund offers investors the possibility of capital gains, market outperformance, a competitive, regular income, and a front row seat to witness, and benefit from, Japan’s technological transformation.
More information on Japan Small Cap Growth and Income Plc here >
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