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Japanese funds ride on small-cap rally

Japanese Prime Minister Shinzo Abe.

Japanese Prime Minister Shinzo Abe.

Published Jun 9, 2013

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Japanese hedge funds investing in smaller companies are outperforming as trading in small-cap stocks more than doubled this year amid Prime Minister Shinzo Abe’s efforts to revive the third-largest economy.

Monterey Japan Equity Fund, which manages about $100 million (R997.1m), returned 39 percent this year through April as it shifted to small caps, such as property company Raysum, from larger stocks. Hayate Japan Equity Long-Short Fund gained 71 percent by focusing on companies that aren’t followed by analysts, while J-Flag Investment’s long-short hedge fund surged 51 percent. The Eurekahedge Japan Hedge Fund Index gained 18 percent in the period.

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The Jasdaq Stock index, the benchmark for Japanese companies with an average market capitalisation of ¥17 billion (R1.7bn), surged 67 percent through April, as Abe’s administration and the central bank accelerated monetary stimulus to boost the economy.

Japan’s smaller companies are more prone to economic swings as they generate about 80 percent of sales in the domestic market.

“Most of the Jasdaq names were not investable for hedge funds as the liquidity of the market dried up until December last year,” said Masa Yanagisawa, director and head of global prime-finance sales for Japan at Deutsche Securities in Tokyo. “Now it has changed. The directional managers with a mid-to-small-cap bias are performing well.”

The 18 percent return for Japanese hedge funds this year to April 30 compared with a 3.7 percent gain in a Eurekahedge global index in the period. Japan’s broader benchmark Topix index advanced 36 percent in the four months to April 30.

The Jasdaq index only gained 0.5 percent in May after the recent rally that made Japan this year’s best-performing developed equity market. On May 23, the Topix index slid almost 7 percent as bond yields rose. The outperformance of smaller stocks may not continue at the current pace if investors seek the relative safety of larger companies.

“After the rally for the past six months, it’s only natural to see some correction,” said Hisashi Osezawa, chief executive of Tokyo-based J-Flag. “In the long run, small-cap stocks that are more dependent on the domestic market would benefit from an economic recovery.”

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The Jasdaq more than tripled in the three years to 2005 when then prime minister Junichiro Koizumi attempted to clean up the nation’s banking system and boost growth.

The three-year rally outperformed the Topix’s 96 percent gain in the period. “The rally lasted a lot longer back when Koizumi was in power,” said Hayate’s founder Yukihiro Sugihara. “We may have seen a sharper gain compared to the last rally, so it’s only natural to see such a correction.”

Eurekahedge’s Japan Hedge Fund Index fell 1.2 percent in May, based on 11 percent of funds that have reported their performances. The index had risen every month since September through April.

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Abe took office in December pledging a three-pronged strategy of aggressive monetary easing, fiscal stimulus and deregulation that investors have welcomed.

The Japanese leader vowed to deregulate the energy, health and infrastructure sectors and double foreign investment in Japan to ¥35 trillion by 2020, in a preview of the government’s economic growth strategy. He said he would raise investment in the power industry to ¥30 trillion in 10 years and triple private and public investment on highways, airports, and waterworks to ¥12 trillion in the same period.

Average daily trading volume on the Jasdaq exchange has more than doubled this year to 91 million shares from 43 million shares in 2012, according to data compiled by Bloomberg. The average market value of companies in the Jasdaq is less than a 10th of the ¥224bn average market capitalisation of companies in the Topix.

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Changes in margin-trading rules helped, said Sugihara. The Financial Services Agency on January 1 eliminated a three-day wait on rolling over collateral into new trades. Margin accounts allow investors to borrow to buy or sell shares.

Japanese hedge funds gained 6 percent in April after Bank of Japan governor Haruhiko Kuroda pledged an unprecedented monetary easing that helped boost stocks and weaken the yen, Singapore-based data provider Eurekahedge Pte said in a report on May 21.

Singapore-based Monterey in March shifted its bets to mid- to-small cap stocks, including property-related companies such as Kenedix, which will benefit from a recovery in the domestic economy, said Kei Murata, who runs the fund.

In April, Monterey increased its cash positions before Japan’s Golden Week holiday and now is shifting back to larger stocks, Murata said. Companies with market values of ¥200bn to ¥2 trillion are the most investable because of Monterey’s strategy of holding each stock for only three to four days.

“While the correction following the recent run-up may continue for a while, I am not expecting the liquidity to dry up,” Murata said.

“This is a great opportunity for us to be more selective in our investments.”

The Monterey fund posted a negative return in May, Murata said, declining to elaborate on preliminary figures. Not all hedge funds that bet on small caps benefited. Darwin Capital Partners’s Shin-Ka Fund has not made a return this year, said Takafumi Sahoda, founding president of the Tokyo asset manager. The fund returned 19 percent in 2012.

Increased liquidity in the market boosted stocks across the board regardless of valuations or earnings outlook, making it difficult for managers like Darwin Capital, which have been selective in their investments, he said.

Some of Shin-Ka Fund’s short positions didn’t fare well, Sahoda said. Short investments are bets on a decline in value, while long holdings are those the manager expects to rise.

Hayate, based in Tokyo, identifies small companies that are subject to little research by brokerages and are traded primarily by individual investors, said Sugihara.

His $50m fund began taking more long positions in about January, following Abe’s election victory in December, Sugihara said.

Foreign exchange trading services company Money Square Japan, which gained from an increase in currency trading as the yen weakened against the dollar, and Odelic, a maker of light-emitting diodes, or LED, lights, contributed to the gains, Sugihara said.

“We have been taking more of a neutral stance in the past seven years, but what prompted us to increase our exposure was Abenomics,” Sugihara said in a telephone interview from Tokyo.

“The recent selloff doesn’t quite mean game over.”

Sugihara said his fund was down by “a few percent” in May based on preliminary figures.

Simplex J-Flag Absolute Return Fund began investing in smaller companies earlier last year before Abe took office and those positions boosted the fund’s performance since December, said Osezawa said, declining to name the companies.

J-Flag sold some of its positions after the selloff to increase cash positions, Osezawa said. His fund was down about 5 percent in May through May 24, he said.

“Abenomics was definitely a plus for the market,” Osezawa said in an interview from Tokyo.

“The best time to buy small caps is when they are under the radar and then once liquidity picks up, they benefit.” – Tomoko Yamazaki and Komaki Ito from Bloomberg

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