Go for growth with M&G Japan Smaller Companies Fund

"There aren't many markets that can be called "cheap" nowadays," says Brian Dennehy, managing director of FundExpert.co.uk. "But foreign investors are not buying. Global investors have not been so underweight Japan since 2012, at the dawn of Abenomics. In contrast Japanese investors have been piling into their own smaller companies and doing rather well. Japan is benefiting from a range of reforms (much-needed but rare in other developed economies) including a big push to get more women into the workforce. And there is political stability [as] the ruling party has a healthy mandate."

M&G Japan Smaller Companies is the top performing fund in the Investment Association Japanese Smaller Companies sector over one year with a return of 57.7 per cent. This is also ahead of its benchmark - Russell Nomura Mid-Small Index - which returned 38.1 per cent.

This period of strong performance has coincided with the start of a new manager, Johan Du Preez, who took the helm in September 2015, though the fund has also outperformed its benchmark and sector average over three and five years.

M&G Japan Smaller Companies aims to grow its capital over the long term by investing at least 80 per cent of its portfolio in companies that make up the bottom third of all publicly listed companies in Japan, in terms of their stockmarket value.

Its manager focuses on stocks where he believes the share price is not fully valuing the company's sustainable earnings over the medium to long term. His investment approach tends to be contrarian so these companies are typically out of favour with the market. The manager believes that as sentiment in the Japanese market is still muted, there are more opportunities for finding mispriced companies. The fund is also able to use derivatives to reduce risk and costs.

M&G Japan Smaller Companies has a relatively concentrated portfolio of between 30 and 50 stocks - currently it has 39 holdings. Industrials and consumer goods are the largest two sector exposures. And the fund is overweight financials and technology relative to its benchmark index.

Recent additions to the fund include Wacom (6727:TYO), a technology company that manufactures digital input devices such as graphic tablets. Mr Du Preez believes Wacom has strong intellectual property and is the dominant player in its area. Another newcomer is KYB (7242:TYO), a manufacturer of shock absorbers for automobiles and hydraulic components used in construction machinery.

Although the fund has done particularly well over one year its manager has run it for less than two years, so it remains to be seen if he can continue to do well. Investing in a single country and potentially volatile smaller companies also raises the risks. And problems within the Japanese economy such as its ageing population and scale of debt could be detrimental to returns.

However, the manager is following what looks like a good investment process and his investment experience extends far beyond the tenure of this fund. Between 2004 and his appointment to this fund he worked in Prudential's (PRU) asset management business in Asia where he specialised in Japanese equities. And he has worked in investment since 1998.

The fund's investment strategy also means it is well placed to exploit mispriced opportunities among Japanese smaller companies.

So if you have a long-term investment horizon so can stomach volatility over the short-term, and want to tap into potentially strong growth at what seem attractive valuations, M&G Japan Smaller Companies looks like a promising way to do this. Buy. EA.

Source: Morningstar as at 14/03/17, *M&G Investments as at 28/02/17

Performance

Source: Morningstar as at 11/03/17

Top 10 holdings as at 28/02/17 (%)

Source: M&G Investments

Sector breakdown as at 28/02/17 (%)

Source: M&G Investments

IC Tip Rating