Land of the Rising Alpha: The Case for Japan Small Cap Equities

Investors are increasingly recognizing the opportunities that Japan small cap equities provide, including compelling returns and a modest risk profile. Here, we answer some frequently asked questions about the region and the asset class.

Q: Why is now a good time to consider investment allocations to Japan equities?

A: Japan equities are particularly attractive now, in our view, because the economy is on solid footing and companies are focusing more on shareholders and corporate governance. Both Japan’s economy and its equity markets have been on the mend for several years now, and we think the “lost decade” period is over.

With regard to the economy, the output gap is closing, labor markets are tightening, and companies are increasingly adopting automation to address labor shortages. This should start a virtuous cycle that gives companies more pricing power and helps them maintain profitability, which is likely to lead to capacity expansion to service both local and global demand.

From an equity market perspective, this will benefit companies and boost their earnings. Unlike former Japanese market rallies, such as those in 1999 or 2003-2005, fundamentals (earnings growth) rather than multiple expansions have been driving the ongoing rally that began in 2012.

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