Fund Spotlight: Unlocking Japan's overlooked small-cap opportunities

• Japan's small-cap universe offers untapped opportunities, with many niche market leaders benefiting from the AI supply chain, domestic economic recovery, and improving corporate governance.
  
  
• BNP Paribas Japan Small Cap’s "Value-to-Growth" philosophy identifies undervalued companies with improving earnings prospects, allowing investments to evolve from value opportunities into growth winners.
  
  
• Across around 140 holdings, the portfolio offers diversified exposure to Japan's two key structural growth themes: AI-related manufacturing — spanning critical semiconductor materials and specialty chemical suppliers — and the country's domestic economic recovery.
  
  
• The SGD share class has returned 45.7% over the past year, while the longer-established JPY share class has consistently outperformed its benchmark since its inception in 1996, demonstrating the strength and consistency of the investment process across market cycles.
  
  
• The fund is suitable for investors seeking to complement their large-cap Japan exposure, as well as those looking for a high-conviction, actively managed strategy that captures both Japan's AI manufacturing ecosystem and domestic economic recovery through an under-researched segment of the market with greater alpha potential.

Japan's equity rally has captured investors' attention in 2026, but much of the spotlight has remained firmly on large-cap exporters and semiconductor champions such as Kioxia, Advantest, and Tokyo Electron.

Yet beneath these household names lies a far larger investment universe that remains largely overlooked. Japan's more than 3,000 listed small-cap companies occupy specialised niches across manufacturing, technology and domestic industries that receive little attention. While many lack the visibility of their large-cap peers, they often possess market-leading technologies, durable competitive advantages, and attractive long-term earnings growth that are not fully reflected in their valuations.

This is particularly evident across Japan's semiconductor supply chain. Semiconductor fabrication, for example, depends not only on lithography machines but also on highly specialised consumables, such as wafer-dicing tape, CMP slurry and ultra-high-purity chemicals. These products require decades of qualification and extremely demanding purity standards, allowing small Japanese manufacturers to command global market shares of 50% to 90% in their respective niches despite operating well outside the spotlight.

The opportunity, however, extends well beyond AI manufacturing. Japan's domestically oriented companies are also benefiting from a steadily improving economic backdrop. Following three consecutive years of Shunto wage increases above 5%, alongside easing food inflation and government energy subsidies, real wages have returned to positive territory for the first five months of 2026. Rising household purchasing power is beginning to translate into stronger domestic consumption, supporting retailers, healthcare providers, IT services, and regional businesses.

At the same time, Japan's corporate governance reforms are broadening beyond the country's largest companies. Unlike the well-researched large-cap universe, many smaller companies still receive limited analyst coverage and institutional ownership. This creates greater pricing inefficiencies that active managers can exploit through fundamental research. 

That opportunity may become even larger as governance reforms broaden. In 2026, the Tokyo Stock Exchange (TSE) tightened listing requirements for its Growth Market by requiring newly listed companies to achieve a market capitalisation of at least JPY10 billion within five years of listing by 2030. It has also introduced new initiatives to strengthen engagement between institutional investors and smaller listed companies, helping improve transparency in a segment that has historically received limited attention.

Taken together, three structural forces are converging in Japan's small-cap market: AI-driven industrial investment, strengthening domestic demand, and ongoing governance reforms. For investors willing to look beyond the headline names, the opportunity set has arguably never been broader.

Related article: Japan Outlook 2H26: Rally isn’t over – but the winners are shifting

BNP Japan Small Cap: Three decades of specialist expertise

Capturing these opportunities, however, requires far more than simply buying a small-cap index. Japan's small-cap universe is vast, but liquidity varies considerably and financial disclosure can be uneven. Many businesses receive little or no analyst coverage, making company research and management engagement critical to separating long-term winners from value traps.

This is where the BNP Paribas Japan Small Cap strategy seeks to differentiate itself. Its edge begins with continuity. Lead Portfolio Manager Shunsuke Matsushima has specialised exclusively in Japanese small-cap investing since 1996 and has managed the strategy since 2003, giving him nearly three decades of experience navigating multiple market cycles within the same investment universe.

The team's investment philosophy, known as "Value-to-Growth", deliberately avoids choosing between deep value and high-growth investing. Instead, it focuses on identifying companies trading at attractive valuations relative to their future earnings potential. The thesis is that businesses undergoing restructuring, launching new products, or improving profitability can undergo meaningful valuation re-ratings as their earnings outlook improves. As these catalysts materialise, stocks initially identified as value opportunities can gradually evolve into growth holdings, allowing the portfolio's style exposure to shift naturally from value to growth.

This philosophy is supported by a disciplined screening process. The investment universe begins with approximately 3,700 Japanese small-cap companies, which is then progressively narrowed by liquidity, valuation, and earnings-growth filters. Companies with market capitalisations below JPY10 billion or share prices below JPY100 are excluded, while businesses trading above the market's average two-year forward P/E or expected to deliver negative earnings growth are also screened out. The process ultimately narrows the universe to roughly 300 candidates for intensive fundamental research, management meetings, and ESG assessment before constructing a portfolio of typically 90 to 160 holdings.

The result is a portfolio that is concentrated enough to reflect genuine conviction while remaining diversified enough to capture the breadth of opportunities available across Japan's under-researched small-cap market.

Balanced exposure to Japan's two key growth engines

Japan's investment story today is no longer driven by a single theme, and the fund is positioned accordingly —  capturing the country's two major structural growth drivers: export-oriented manufacturers benefiting from global AI investment, and domestically focused businesses supported by Japan's improving wage and consumption cycle.

On the export side, the portfolio maintains meaningful overweight positions in Information Technology and Materials (Figure 1), reflecting the manager's conviction in semiconductor-related manufacturers, precision equipment makers, and speciality chemical companies supplying AI infrastructure.

Figure 1: The fund overweights information technology and materials

Based on the top 10 holdings as of 30 June 2026, seven companies are directly linked to the semiconductor supply chain. Rather than concentrating exposure in a single part of the industry, the portfolio spans multiple stages of semiconductor production.

Tokuyama produces ultra-high-purity polysilicon, the essential raw material used by wafer manufacturers such as Shin-Etsu Chemical and SUMCO, before the wafers are supplied to leading chipmakers including TSMC, Samsung Electronics, and Intel. Fuso Chemical commands around 90% of the global market for ultra-high-purity colloidal silica, a key ingredient in chemical mechanical polishing (CMP) slurry used to smooth silicon wafers during fabrication. Lintec and Shikoku Kasei supply the specialised tapes and chemicals required for wafer dicing and advanced semiconductor packaging. Their products serve outsourced semiconductor assembly and testing (OSAT) providers that package chips for the world's leading semiconductor companies. Meanwhile, Yamaichi Electronics manufactures high-performance semiconductor test sockets and other value-added components used throughout the testing process, serving more than 4,000 customers across the semiconductor, automotive, data communications, and consumer electronics industries.

Together, these holdings provide diversified exposure across wafer fabrication, testing, and advanced packaging through highly specialised suppliers that remain indispensable regardless of which chip designer ultimately wins the AI race.

Table 1: Most top holdings are tied to the semiconductor supply chain

Holdings	Sector	Fund
Tokuyama Corp	Materials	2.3%
Nisshinbo Holdings Inc	Industrials	2.1%
Tsugami Corp	Industrials	2.1%
Meidensha Corp	Industrials	1.8%
Yamaichi Electronics Ltd	Information Technology	1.6%
Lintec Corp	Materials	1.6%
Fuso Chemical Ltd	Materials	1.6%
Citizen Watch Ltd	Consumer Discretionary	1.6%
Daihen Corp	Industrials	1.4%
Shikoku Kasei Holdings Corp	Materials	1.3%
Source: BNP Paribas Asset Management. Data as of 30 June 2026.

The portfolio's domestic exposure is equally important. The fund favours sectors such as retail services, IT services, healthcare, infrastructure construction, and regional banks that are positioned to benefit from Japan's improving wage-consumption cycle and reflation scenarios. These businesses may not stand out among the fund's largest holdings, but they are among the 141 companies that make up the portfolio, whose top 10 holdings account for only 17.2% of assets. As a result, much of the domestic reflation theme is expressed through numerous smaller positions rather than concentrated bets.

Strong performance across all periods

Ultimately, the investment process needs to translate into performance.

The SGD share class, launched in February 2024, has outperformed its Russell Nomura Small Cap benchmark across every reporting period since inception. Over the past year, the fund delivered a cumulative return of 45.7% compared with 26.6% for the benchmark (Table 2), while generating an annualised alpha of 5.1% — the extent to which returns exceeded the benchmark after adjusting for risk. These figures suggest the outperformance has been driven by consistent stock selection rather than simply taking higher levels of portfolio risk.

Table 2: Performance of the Fund's SGD share class since inception

	YTD	1 Year	Since Inception (Feb 2024)
Fund (Classic Cap SGD)	25.2%	45.7%	26.7%
Russell Nomura Small Caps Index	12.9%	26.6%	17.5%
Excess Return	12.4%	19.1%	9.2%
Returns in SGD terms. Source: BNP Paribas Asset Management fund factsheet. Data as of 30 June 2026.

The longer-term track record is equally compelling. The original JPY share class has consistently outperformed its benchmark over the three- and five-year periods, as well as since its inception in 1996, demonstrating the manager's ability to generate alpha across multiple market cycles.

Table 3: Performance of the Fund's JPY share class since inception

	3 Year	5 Year	Since Inception (Oct 1996)
Fund (Classic Cap JPY)	30.3%	19.5%	6.8%
Russell Nomura Small Caps (JPY) RI	23.0%	16.5%	6.7%
Excess Return	7.3%	3.0%	0.1%
Returns in JPY terms. Source: BNP Paribas Asset Management fund factsheet. Data as of 30 June 2026.

The fund has also compared favourably against its Japan small-cap peers on our platform, consistently ranking among the top performers across recent calendar years.

Figure 2: The fund has outperformed its peers over the past 5 years

Active risk management through changing market conditions

Strong returns are important, but how a manager responds during periods of market stress often reveals more about the robustness of an investment process.

That was demonstrated during the reciprocal tariff-driven market volatility in early 2025. As concerns over tariffs and temporary weakness in AI sentiment weighed on export-oriented companies, the fund underperformed its benchmark during the first quarter. Rather than maintaining existing positions, the team actively reduced exposure to companies with significant US revenue or automotive dependence, while increasing allocations to domestic-demand sectors including retail, healthcare, and IT services. At one point, roughly 70% of the portfolio was tilted towards domestically oriented businesses. That allowed the fund to recover its 1Q25 losses and gain an 11.0% return in 2Q25, outperforming the benchmark’s 7.5%. 

As market sentiment improved on the back of resilient AI demand, the manager gradually rebuilt overweight positions in AI- and semiconductor-related sectors, unwinding the earlier defensive stance. The tactical repositioning continued to bear fruit, with the fund outperforming its benchmark in both the third and fourth quarters of 2025. Holdings such as Yamaichi Electronics and Meiko Electronics were among the year's strongest contributors, benefiting from renewed investor confidence in the AI investment cycle.

Risk management is embedded throughout the investment process. Individual stock positions are capped at 5% of the portfolio, sector exposure is limited to 30%, cash holdings are capped at 7%, and derivatives are used solely for hedging purposes. Importantly, the team's discipline extended beyond stock selection. As holdings approached their internal valuation targets, positions were systematically trimmed and capital was redeployed into less crowded opportunities. This disciplined sell process helped lock in gains while refreshing the portfolio with new ideas, demonstrating an active approach to portfolio management rather than simply allowing winning positions to run indefinitely.

This disciplined framework has contributed to the fund’s slightly lower drawdowns (-32.5%) relative to the peer average (-34.8%) over the past five years while allowing the portfolio to remain fully invested in its highest-conviction ideas.

A strong complement to Japan exposure

Japan's structural investment story is entering a new phase.

While the first stage of the rally was led by globally recognised exporters and semiconductor champions, the next phase may increasingly broaden into under-researched smaller companies as governance reforms deepen, domestic demand strengthens, and AI-related investment filters through the industrial supply chain.

For investors who already own Japanese large-cap exposure through our recommended ETF, the Xtrackers Nikkei 225 UCITS ETF (LSE: XDJP), the BNP Paribas Japan Small Cap strategy offers meaningful diversification into a less efficient part of the market where active management has greater scope to generate alpha.

For those building new exposure to Japan, the fund provides balanced participation in both the country's AI manufacturing ecosystem and its domestic reflation story through a manager with nearly three decades of dedicated small-cap investing experience. At a time when market leadership is becoming broader beyond large-caps and stock selection is likely to matter more, that combination could prove increasingly valuable.

Declaration:

This research report was prepared with the assistance of artificial intelligence (AI) tools. iFAST Financial Pte Ltd does not rely exclusively on AI for content generation; the content of this report – including all investment theses, ratings, price targets and conclusions – has been independently reviewed and verified by the research analyst(s) to ensure accuracy and professional integrity.

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.