Why the time is right to allocate to Japanese smaller caps

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Japanese equities have been on a tear of late. The Topix  rose 20.7% for the 12 months between 31 January 2017 and 31 January 2018. Should the market continue to rise, history does seem to suggest the small cap section is a good place to be. An analysis of comparative returns on the small cap versus large cap sections of the Russell/Nomura Index from 1984 to 2017 suggests small caps outperformed in the vast majority of periods where markets rose.

The benefit of investing in Japanese small caps is also apparent when you consider the question of correlation. Investors who do so have the advantage of lower average correlations versus European, Asian ex-Japan, emerging and US indices. These low correlations are even more evident in small cap indices.

People often talk about alternatives when the question of diversification comes up but this aspect of exposure to Japanese equities is regularly overlooked. We’d argue investors looking for ways to diversify their portfolio would benefit from allocation to small cap Japanese stocks given their tendency to perform with relatively limited reference to the movements of wider global equity indices – an important consideration given the current market turmoil.

Miyuki Kashima – head of Japanese equity investments, BNY Mellon Japan

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