The next gold mine for the Japanese stock market? US hedge fund Verdad targets small-cap stocks in search of 'alpha'

The Zhitong Finance App learned that Boston-based hedge fund Verdad Advisers LP is planning to launch a new Japanese equity fund that will mainly invest in small businesses. This move shows that global investors are no longer limited to investing in Japanese blue-chip stocks, but are focusing on Japan's re-active stock market to reap more profits.

Daniel Rasmussen, founder of Verdad Advisers, said in an interview on September 17 that the fund is likely to launch as early as this year, and its operation will continue the investment company's strategy of two small market capitalization funds, which is to look for problems such as excessive balance sheet debt burdens or excessive cash reserves and inefficient use of capital. He also stated that the target market value of the new fund would exceed $400 million.

Rasmussen said, “If you study the thousands of small-cap stocks in depth, you'll find that the trend of these stocks is more extreme, and they contain even greater investment opportunities. Once in the field of large-cap stocks, the market is very mature, and it becomes very difficult to obtain high profits.”

As the Tokyo Stock Exchange is promoting measures to increase the profitability and shareholder value of listed companies, hedge funds holding Japanese assets are once again popular. Some hedge funds have turned to small-cap stocks that are lagging behind in improving capital efficiency and are undervalued. Aggressive Investors Asset Value Investors Ltd said earlier this month that it plans to increase its holdings in small and mid-cap stocks.

Japan's small-cap stocks showed strong performance. The index for measuring small-cap stocks performed better than the Tokyo Stock Exchange Index for large-cap stocks this year, with an increase of 19%, while the increase of the large-cap stock index was 14%. The MSCI Japan Small Cap Value Index also increased by more than 30%.

Take Verdad's two existing funds as an example. As of the end of August, these two funds had a return of 39% this year. According to Rasmussen, with such performance, the two funds have total assets under management of $300 million — about a quarter of Verdad's total assets. For the new fund, he plans to increase its asset size to more than $1 billion over the next few years.

Rasmussen said that as part of the expansion plan, Verdad plans to hire one to two Japanese analysts who specialize in quantitative and fundamental analysis. Family finance offices and institutional investors in Europe and the US are all Verdad's customer base, he said.

Despite this, small-cap strategies still face many hurdles. Limited liquidity limits the amount of shares investors can hold, and smaller companies also provide less disclosure information in English. A survey by the Tokyo Stock Exchange also confirmed this. The data shows that as of December 2024, only 37% of companies with a market capitalization of less than 25 billion yen (about $169 million) will publish announcements in English, compared to 63% of companies with a market capitalization of 100 billion yen or more.

Rasmussen said that sometimes he needed to further explain Western capital efficiency concepts to management, but by spreading his portfolio across 50 to 100 stocks, he was able to be patient enough to wait. “Companies that you thought would never change are now increasingly inclined to meet shareholders' needs,” he said.