Small-caps participated in the May 12 rally facilitated by news that the U.S. and China are making progress on a trade deal. The Russell 2000 Index surged 3.52%. It sounds encouraging, and it is. But investors shouldn’t take their eyes off foreign small-caps. And that includes those from Japan.
That asset class is accessible via ETFs such as the WisdomTree Japan Small Cap Dividend Fund (DFJ ). The fund merits consideration because it dispels a widely held notion. Japan’s large-caps, which have impressed this year, are the preferred way to play stocks in that country. YTD, DFJ is up 9.5%, an advantage of 100 basis points over the large-cap MSCI Japan Index.
However, Japan’s small-caps are still flying under the radar. But those stocks, including DFJ holdings, aren’t just beating larger Japan equities. They’re trouncing U.S. small-caps, too. Add to that, DFJ is accomplishing those feats while being significantly less volatile than the MSCI Japan Index and broader gauges of domestic small-caps.
DFJ Could See More Upside Ahead
DFJ turns 19 years old next month and it has more than $280 million in assets under management. So it’s accurate to say the ETF is neither too young nor is it too small. Yet investors may be glossing over the DFJ opportunity set for a familiar reason.
As is the case in the U.S., there’s ample analyst coverage of Japan’s large-cap stocks, but smaller equities. That’s because the country isn’t as widely followed by the sell-side. And that leaves some of those stocks to toil in anonymity. That’s a scenario that can facilitate opportunity for prescient investors.
“Yet in the small-cap space, only 58% of stocks have any sell-side research, with those that do being covered by an average of just three analysts. This lack of information means small caps have been overlooked amid Japan’s rally, but markets may pay closer attention to them now large-cap share prices have risen so far,” reported Tom Aylott for Portfolio Adviser.
Data indicates that despite the recent strength in Japan’s equities, global money managers are under-allocated to stocks there. And if they’re not heavily allocated to larger equities, it’s almost certain they’re light on small-caps.
“International investors have a 36% stake in Japan’s large-cap names, but they only represent 12% of its small-cap shareholders. And even after heightened interest in recent years, global allocations to Japan are at historical lows,” according to Portfolio Adviser.
Bullish Trends for DFJ?
Another reason to consider DFJ is that like U.S. equivalents, Japan’s small-caps tilt inward. The WisdomTree ETF allocates nearly 44% of its roster to industrial and consumer cyclical stocks. So if Japanese economic data is bullish, so too could the trends be for DFJ.
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