Another year of poor performance has encouraged Baillie Gifford Shin Nippon (BGS ) to offer investors a 15% exit if returns from the Japanese smaller companies fund do not beat its benchmark over three years.

Annual results this week showed the £374m trust suffered a 14.9% drop in net asset value (NAV) in the 12 months to 31 January, with shareholder returns tumbling 20% versus a 6.3% rise in the MSCI Japan Small Cap benchmark.

This leaves the fund’s NAV down 6.8% over five years with shareholders 26% worse off against a 24.1% rise in the index.

The investment company, which is run by Praveen Kumar, was hit by the rotation into lower growth, large-cap stocks and companies with exposure to troubled China.

In a bid to protect investor returns should the underperformance continue, the board is ‘committing to a one-off performance-triggered tender offer for up to 15% of the company’s issued share capital if the company’s NAV per share total return underperforms the [benchmark] total return over the three years to 31 January 2027’.

As is conventional, the tender offer would be priced at a 2% discount to NAV less costs.

Trust chair Jamie Skinner said that although the board was ‘cognisant of the drivers of performance’ and remained supportive of the manager, a one-off tender would be ‘in the best interests of the company’.

Skinner said the ‘past couple of years have been very challenging for high-growth investing’ and the macro and geopolitical headwinds persist. However, he said US inflation was slowing, leading to expectations of interest rate cuts, and Japanese corporate earnings and profits ‘remain resilient’.

‘The board and managers are confident that the current portfolio can generate superior growth relative to the comparative index,’ he said.

‘Considering the current low valuation and a mid-teens discount, we think the company should be top of mind for investors looking for Japanese equity exposure.’

Kumar said it was ‘extremely disappointing’ to report another year of underperformance, which he said was ‘frustrating and possibly puzzling’ for shareholders given large-cap Japanese indices, the Topix and Nikkei 225, are near all-time highs.

However, he said the performance has been driven by value stocks from traditional sectors with ‘cash-rich balance sheets’ that the Tokyo Stock Exchange has demanded improve their payouts, under threat of delisting. This has led to a wave of dividend increases and buybacks which have ‘attracted considerable investor interest’ and boosted share prices.

It has also boosted the performance of activist rivals AVI Japan Opportunity (AJOT ) and Nippon Active Value Fund (NAVF ) which push cash-rich smaller companies to improve shareholder returns.

‘While this is very positive for the overall health of corporate Japan, this, unfortunately, has also resulted in a significant flight of shareholder capital from young, disruptive, and fast-growing companies into traditional, old economy businesses,’ said Kumar.

‘Given these developments, it is unsurprising that Japanese small-caps as an asset class remain completely out of favour, in particular the pool of growth names in which we invest.’

Not all growth stocks were out of favour over the year, with the top contributor being Megachips, the largest supplier of custom-made chips for Nintendo’s gaming consoles. It has benefited from the success of Nintendo’s Switch console and is using the profits it has made to expand into new areas.

Kumar said most of the worst performers also had the added problem of exposure to China and suffered from the sharp fall in demand from the weakening Chinese economy.

‘Premium motorcycle helmet manufacturer Shoei was among the largest negative contributors to performance,’ he said.

‘Along with weak consumer demand, it is also facing regulatory change in China which has forced it to modify the specification of its helmets to comply with the new rules. This has resulted in additional costs which have squeezed profit margins in the short term.’

Kumar purchased five new stocks over the year, but said that as the market dynamics around small-caps had changed ‘our approach towards idea generation has therefore adapted too’ but without compromising the style.

He is focused on identifying stocks with ‘different drivers of growth’, including in sectors to which the fund has not traditionally been exposed. This includes SWCC, which operates in the ‘terribly unattractive sector’ of supplying cables and wires to electric utilities.

Kumar said management has ‘successfully reoriented the business to growth areas’ and developed ‘new high-value-added and high-margin products that make its client operations more efficient’.

He acknowledged the frustration of shareholders and said that ‘while it may seem like an uphill task to turn performance around… it might be worth remembering that we have been here before’.

The stocks driving the market at the moment have a ‘time-bound investment appeal’ and once shareholder returns play out ‘there is little else to get excited about’ and attention will once again switch to small-caps.