Scoring Big with Japanese Small Caps

As fund managers go, David Scott is a rare bird. The senior portfolio manager at J.P. Morgan Fleming Asset Management (Japan) Ltd. first visited Asia as a Mormon missionary. And Scott is a linguistic ace, having mastered both Japanese and Chinese. That comes in handy during the 500 company visits he makes annually in Japan and on fund promotion trips to Taiwan for his $1 billion JF Japan Small Cap fund. That fund topped the latest BusinessWeek survey of offshore funds by delivering a smart 14.9% return for the second quarter.

Beyond that, Scott, 39, distinguishes himself by his belief that Japan--yes, basket case Japan--is chock-full of world-class small companies global investors have never bothered to check out. The small caps, he points out, are relatively cheap and often outperform the market. Nevertheless, the big research houses don't cover them. "There is a huge information gap out there," says Scott.

Exploiting that gap is how a fund manager generates decent returns in a brutal market like Japan's. Scott knows how tough the market can be. Although his fund excelled last quarter, it is down 15.6% on the year, and up only .87% for five years. Still, Scott, who earned his MBA at the University of Hawaii, thinks his "bottom-up" approach to investing will win the day in the long run. That means plenty of face time with top management and rigorous financial sleuthing.

Scott looks for companies with a market cap of $1 billion to $2 billion. Raw startups, he says, are often unproven, and trading volumes are ultrathin. Japanese blue chips are so well covered it is hard to find value.

Among small caps, Scott and his analytical team set price targets on some 300 potential investments and, when a stock looks cheap, they pounce. The fund's top performer last quarter was Goodwill Group Inc., which contracts out construction crews, security teams, and health-care workers to companies. It shot up 35% from April to June. Other picks that turned in double-digit gains were Yamato Denki Co., a popular consumer electronics chain, and Plenus Co., which owns restaurants and provides food service for schools and companies.

When it comes to the main stocks in his portfolio, Scott will routinely take profits, but he rarely cuts them loose. "I never get out of my core holdings entirely, because they are winners," he says. Scott believes he has found the Japanese market's sweet spot--and, in the last quarter, it was hard to doubt him.

By Brian Bremner in Tokyo

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