In terms of three-year rolling returns since the beginning of 2000, Glover said about 75% of the time the small caps in Japan outperformed the large caps.
However, foreign holdings of Topix 100 and Topix Small indices – the index with the 100 largest Japan-listed stocks versus an index that excludes the 500 largest companies – reached 35% and 16% respectively, he said, citing data from Bloomberg.
“We think this is most likely because unfamiliarity with the asset class leads to foreign investors not being able to properly assess the risks of a potential investment,” he said in a research note to clients.
While small-cap stocks in general tend to have higher volatility than large caps, he argues that Japanese small cap stocks, which account for 85% of 3,500 stocks listed in Japan, are less volatile.
“Given the segment’s higher exposure to domestic-demand related and non-manufacturing stocks, small-cap Japan is generally less sensitive to a strengthening yen or external-demand shocks.”
The lack of analyst coverage on small caps also presents mispricing opportunities, he added.
The following chart shows the performance of the firm’s Parvest Equity Japan Small Cap Fund, versus its benchmark Russell Nomura Small Caps Index, as well as Topix and Topix Small index as reference.
Volatility of the three indices during the three-year period, in terms of standard deviation, is 15.59 for the Parvest product, followed by The Russell Nomura (15.65), the Topix 100 (16.62) and the Topix Small (16.34).