Companies exploiting changes in the way business is evolving in Japan are unleashing new competitive forces and creating plenty of opportunities that can be uncovered by research Creative destruction in the Japanese economy may not seem like a term that would have many investors jumping up and down with joy, but it can be music to the ears of fund managers. Hirohisa Koga and David Mitchinson, fund managers with JP Morgan Fleming's Japan portfolio group, believe that companies exploiting changes in the way that business is evolving in Japan are creating plenty of opportunities in new sectors. 'Good management teams are exploiting opportunities thrown up by the changing demographics, and increasing competitive forces,' said Mr Koga, a specialist in Japanese smaller companies. 'Taking into account the shape of the domestic economy most Japanese companies are small. 'Increasingly companies are making their own way - restructuring aggressively, developing new products or introducing new business models to existing markets.' He says the trend is noticeable in the real estate, internet and technology sectors, where stocks are driven more by their own story and earnings than the general market. One of the reasons Mr Koga believes small companies are particularly interesting: there are few analysts who cover them in depth. The lack of attention means they are generally off the radar of larger funds and generally unloved. The majority of funds under management is concentrated in large, globally oriented companies, which are well covered in analyst reports. 'It is difficult to add value with your own research among blue chips, but in the small-cap sector there are a huge number of under-researched companies,' Mr Koga said. 'I try to spot those companies that have a competitive technology or interesting business model but are significantly undervalued. My strategy is not to invest in markets but in the companies themselves.' Well known to invest in foot leather, Mr Koga visited more than 500 Japanese companies last year. This year he expects to make more than 650 company visits. The US$241 million Japan Smaller Companies fund is rated 'high risk' by JF Asset Management. Over a one-year basis, the fund has declined 3.1 per cent, versus an 8.5 per cent rise in the benchmark index. The fund's mandate permits gearing, using borrowed money to purchase shares, in a ratio of up to 25 per cent. The practice can be a double-edged sword, magnifying returns on the way up, but also exacerbating the downside, as was the case when the fund crashed spectacularly during the dot-com bust. Five years on, the fund is down 61 per cent. 'If we are really bullish on the market, we may use it but now is not the time,' Mr Koga said. 'This is not because we are bearish, but because we are preparing for new investments and sudden redemption. Currently we have about 5 per cent cash in the portfolio.' Mr Mitchinson believes the economic mood is now more positive, with the stock market rested for a bull run after years of disappointment. 'In 2003, the Japanese market rose 23 per cent. Last year, it rose 8.5 per cent. That's the first time in a decade that the equity market has managed to stage two consecutive rises, and this year has also started well,' he said. He favours small companies started by the new wave of entrepreneurs who have dropped out of mainstream corporate culture. Many of these visionaries are former employees of giants such as Sony, Toshiba and Mitsubishi, and have valuable management experience. He also likes companies able to drive sustainable earnings growth on unique platforms. These include Next Japan, Askul, Da Vinci and C.C.C. Companies that have undergone significant restructuring such as Haseko and J-Oil Mills are also favoured. 'While much of the Japanese economy remains dysfunctional, there is still an opportunity for managers and investors,' Mr Mitchinson said.