Why investing in Japan's smaller and more nimble companies could pay off

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‘One of the most attractive reasons why Japan is a rich hunting ground for growth companies is the underappreciated nature of these businesses,’ says Praveen Kumar, manager of the Baillie Gifford Shin Nippon investment trust.

He argues that investors have an outdated view of Japan, looking at it through the prism of large traditional companies when, in fact, the make-up of the Japanese economy has shifted considerably and there is a sizeable number of smaller and more nimble firms.

Investors have an outdated view of Japan, argues Praveen Kumar, manager of the Baillie Gifford Shin Nippon investment trust

These offer substantial long-term growth opportunities but often fly under the radar of most investors. As Kumar states: ‘When compared to other developed markets, these companies trade on much, much lower valuations.’

In this video, Kumar joins Simon Lambert of This is Money to discuss investing in Japan and what makes Shin Nippon stand out among Japanese-focused investment trusts and funds.

The trust has been operating since 1985 with a focus on investing in high growth smaller companies. It is run by investment management firm Baillie Gifford.

Kumar explains why he feels investing in this type of company in Japan offers a unique opportunity, as high-quality growth prospects here do not attract the level of attention they would in Europe or the US.

Instead, he says many investors still think of Japan as a value investing market. This means the country offers a window into a major global stock market that most growth investors cannot find elsewhere.

He says: ‘A lot of these companies don’t even have proper market coverage, so there is a clear opportunity to add significant value.

‘The fact that it’s quite uncovered and people just don’t seem to be interested means that compared to other developed markets these companies trade on much, much lower valuations for the kind of growth prospects that they have.’

The manager also reveals the aspects that the trust looks for in a business and why strong founder or family ties are important, as well as discussing some of the stocks that Shin Nippon invests in.

‘Typically, these are companies that are founded and run by a management team of founding families themselves – and they tend to have a large stake in the business, so there’s very strong alignment,’ he says.

He adds: ‘If you look at the Japanese economy, there’s been a big shift since the bubble bursting in the 80s and now.

‘The engine really of the Japanese economy is this massive layer of small and midsized companies who quite often fly under the radar, but they’ve established some very critical positions in global industries.’

Despite their strong growth prospects and market positions, the fact that these companies are often overlooked provides an opportunity for better future gains, says Kumar.

He adds: ‘You get the double whammy effect of strong earnings growth and the potential for re-rating, which means that you can generate quite attractive long-term returns for patient investors.’

Kumar says it is important to separate the economy from the stock market, and that while the main broad index, the Topix, is made up of big name companies, these are not the future of Japanese business.

An example of a disruptive company that the trust has held for about a decade is Harmonic Drive, which specialises in making reduction gears for robots.

These tiny pieces of equipment control the precision of how a robot moves, and Harmonic Drive has over half the global market, meaning it can benefit from a huge structurally growing area.

Kumar highlights how Japan has many smaller growth companies that are focused on doing only one thing – and doing it very well. He explains how this is a strength of the new breed of Japanese firms, and how he believes they have the potential to deliver long-term investment returns.

He adds that while many of these companies start as specialists, they can also find opportunities in adjacent areas which give good growth and diversification prospects without tackling the complications investors can find with large global conglomerates.

Find out more about Baillie Gifford Shin Nippon.

This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

Investment in smaller companies is generally considered higher risk as changes in their share prices may be greater and the shares may be harder to sell. Smaller companies may do less well in periods of unfavourable economic conditions.

The Trust’s exposure to a single market and currency may increase risk.

Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The investment trusts managed by Baillie Gifford & Co Limited are listed on the London Stock Exchange and are not authorised or regulated by the FCA.

A Key Information Document is available by visiting bailliegifford.com