Japan: Why small and mid cap companies look particularly attractive

Following Donald trump's recent election victory, global markets reacted sharply, and Japan was no exception with key indices enjoying a temporary boost. However, with concerns about protectionist trade policies creating an uncertain backdrop, Nicholas Price, portfolio manager of Fidelity Japan Trust outlines why he believes domestically focused mid cap companies, which are generally well insulated from external macro pressures, and those poised to benefit from reshoring trends offer compelling opportunities.

While Donald Trump’s election victory generated a sharp market reaction, the initial uplift is fading as the reality of potential tariffs ahead sets in. The lingering uncertainty around trade policies underscores the importance of disciplined research and selective stock picking. 

In this environment, we believe domestic-focused mid cap companies are particularly attractive. These businesses are often well insulated from external shocks and are positioned to benefit from structural trends such as reshoring. At the same time, Japan-specific developments such as corporate governance improvements and reflationary policies, create a fertile hunting ground for long term investment opportunities.

Stock-specific insights

Miura is a global leader in once-through boilers - which are able to produce steam at higher pressures and temperatures than drum boilers - offering notable energy efficiency. The company has a robust business model based on the provision of contract-based maintenance services, which are conducive to recurring and stable profits. We have also been impressed with the strategic changes that the company has implemented, particularly its efforts to reduce its dependence on the Chinese market and to broaden its product lineup. 

In this vein, Miura recently acquired a major player in the US, Cleaver-Brooks, which will provide a new growth driver for the business. While the outcome of the US election has reduced a certain level of uncertainty, the issue of tariffs is likely to dominate headlines for months to come and it makes sense to hold reshoring beneficiaries such as Miura that can deliver stable earnings.

Ryohin Keikaku runs the Muji brand of general merchandise stores and is a company that we have actively engaged with for many years. Management is executing well, and the business is generating double-digit comps at home and in China, where a combination of internal initiatives and macro factors are supporting a pickup in demand. In Japan, strong sales growth, underpinned by successful new products, and price hikes are leading to lower discounts and higher profit margins. 

At the same time, the reflation story in Japan, fuelled by a shift in price and wage setting behaviour, is supporting a pickup in consumption that Ryohin Keikaku is well positioned to capture - through new store openings and popular product lines. Looking forward, we expect the company to deliver healthy profit growth over the coming years.

Sanrio sells Hello Kitty and friends merchandise and operates Hello Kitty theme parks, with around 70% of sales generated in Japan. Hello Kitty was created in 1974 and remains a popular and beloved character in Japan and globally, as evidenced by the scores of inbound tourists that visit the company’s parks. Moreover, Sanrio is ideally placed to capture the structural growth of the Japanese character intellectual property market and its character diversification strategy is helping to reduce earnings volatility. 

The company’s strategies in the licensing business are working very well in both North America and China, which are contributing to an improvement in the company’s overall profitability. Sanrio recently upgraded its full-year guidance, and we expect it to deliver good profit growth over the next two to three years.

The road ahead

Japan remains a fertile hunting ground for investors seeking under researched opportunities in the small to mid cap segment. As active managers based here on the ground, we have the opportunity not only to invest in established global leaders, but also to unearth less well -known companies, where lower levels of analyst coverage can often create some great mispriced opportunities. 

Identifying under-covered companies with idiosyncratic sources of growth represent a potential source of differentiated returns for the portfolio. With trade policy uncertainty likely to persist, the ability to identify and invest in resilient companies remains a key differentiator. We believe the companies we hold in our portfolio demonstrate the value of this approach, offering a combination of innovation and growth potential than can deliver strong long-term returns.

Ultimately, while global headlines may continue to focus on the risks posed by trade policies, Japan’s equity market offers a wealth of opportunities for disciplined, active managers. By focusing on companies with unique competitive strengths and a clear runway for growth, investors can navigate the current market uncertainty and unlock the market’s full potential.

Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Fidelity Japan Trust PLC invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid. Changes in currency exchange rates may affect the value of investments in overseas markets. The shares in the investment trust are listed on the London Stock Exchange and their price is affected by supply and demand. This investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser. Investors should note that the views expressed may no longer be current and may have already been acted upon.