Japanese small-cap investment trusts are enjoying mixed fortunes as activist AVI Japan Opportunity (AJOT ) unlocks value while struggling Baillie Gifford Shin Nippon (BGS ) rejigs its strategy and brings in manager reinforcements.

Annual results from the pair have seen them cement their statuses as the respective best- and worst-performing trusts in the Japan smaller companies sector over the past year.

Investors in AJOT can cheer the outperformance of almost 15% of the benchmark MSCI Japan Small Cap index in 2024, with net asset value (NAV) total returns of 32.4% in yen terms against a 16.4% rise in the benchmark. However, the growing weakness of Japan’s currency crimped returns for UK investors, with the underlying portfolio making a lower 20.9% return in sterling

Manager of the £216m portfolio Joe Bauernfreund said the results confirmed his prediction that 2024 would see ‘potential for alpha generation that has never been higher’, with strong returns for both the portfolio companies and Japanese equities more generally, although investors are still typically favouring larger companies.

Government and stock market reform also helped boost the market, with officials proposing to double the amount of tax-free investment that can be made into the NISA – the Japanese equivalent of an ISA – as the government tries to encourage households to switch cash for securities.

At the Tokyo Stock Exchange, Bauernfreund said relatively new chief executive Hiromi Yamaji was implementing ‘truly ground-breaking reforms for listed companies’, including a ‘name and shame’ list of corporates who are, or are not, taking measures to improve their share price.

‘That list was refined to scrutinise the quality of disclosures and improve accountability of companies who say they will implement measures, even listing examples of company “bad practices”,’ he said.

The poor practices of the trust’s own holdings continued to be tackled by activist AJOT, and shareholder proposals were filed with several companies over the year. This included SK Kaken, where proposals were filed for the fourth consecutive year. AVI has accused the manufacturer of insulation materials of ‘hoarding earnings on its balance sheet’.

The top performer over the year was Beenos, which was only added to the portfolio in January 2024 but has already become the largest position, making up 10.6% of the fund. The group’s e-commerce platforms allow overseas buyers to purchase items from sites in Japan and it saw strong performance as a weakening yen encouraged consumers to buy.

However, Bauernfreund noted that a ‘reversal of this trend could harm the company’s profits’.

Beenos was one of 13 new names that entered the portfolio as ‘turnover was an elevated 68% due to four portfolio companies receiving tender offer bids’.

Bauernfreund added that ‘rising pressure from regulators and activists in 2024 presents a compelling opportunity to unlock substantial value in small to mid-cap Japanese companies in 2025 and beyond’.

AJOT has not only been an activist with the companies in its own portfolio. 

While not referenced in the results released today, its board went public with a ‘hostile’ merger approach for Fidelity Japan (FJV ) last week. Despite support from City of London, which is the top 23% shareholder in FJV and owns 17% of AJOT, the Fidelity trust’s board has so far pushed back. 

Kick in the Shin Nippon

It has been a different story for sector laggard Baillie Gifford Shin Nippon as the board scrambles to put the £322m portfolio back on course.

As reported in annual results released on Thursday, the NAV of the trust slid 5% in the 12 months to end of January, against an 8.9% rise in the MSCI Japan Small Cap index, leaving the discount standing at 14.6% – exactly where it was at the start of the year despite the trust buying back nearly 10% its shares over the year. 

To keep investors onside, the trust last year announced a one-off performance-related tender for 15% of the shares, that will come into effect if the portfolio falls short of its benchmark in the three years to 31 January 2027.

The board has now also adjusted the investment strategy slightly, removing the fixed size restriction on allowed investments.

Manager Praveen Kumar had previously only been permitted to buy new stocks with a market value or turnover of less than ¥150bn (£798m), which 10 years ago would have covered the vast majority of the benchmark.

However, chair Jamie Skinner said it now limits Kumar to just the bottom 20% of the MSCI Japan Small Cap index by size, so the trust ‘can only make new investments in the smallest of Japanese small-cap companies’.

The board has decided to loosen that restriction and instead permit companies which are below the average market cap of the benchmark index.

The index is home to 800 stocks, with 500 of them trading at or below the average market cap, making up 30% of the market by value.

The board has deemed the change to be ‘non-material’, meaning shareholders will not be required to vote on it.

With an expanded investment universe to contend with, the board has also appointed a deputy portfolio manager in the shape of Brian Lum, who is head of Baillie Gifford’s smaller companies team.

From an investment perspective, Kumar is expecting his job to get easier from here, stating that ‘we might be at an inflexion point in terms of a turnaround in investor sentiment’.

While his comments were made before Donald Trump’s trade tariffs sunk Japanese equities, Kumar said ‘global uncertainty wrought by the Trump administration in the US might perversely help sentiment improve towards the more domestic-oriented small cap businesses in Japan that remain largely immune to geopolitics as far as their operations are concerned’.

In terms of reasons for underperformance during the period, he said the Japanese market had been driven by cyclical large-cap and small-cap value stocks, rather than the high-growth companies favoured by Shin Nippon.