UniversalSelect: Sompo Asset Management

Investment process:

Could you outline your investment philosophy? How does your proprietary YES model support stock selection? 

Shigeyoshi Fujiwara: As fundamental bottom-up investors, we aim to generate alpha for our investors through stock selection. And we do this by targeting the most undervalued stocks that have a clear path to intrinsic value, measured by future dividends – focusing on the sharpest disconnects between price and potential.

We believe that over time, market prices gravitate towards their intrinsic value. While market prices can fluctuate in the short term, medium- to long-term fundamentals exhibit steady trends. 

This belief is the foundation of our investment philosophy and is reflected in our proprietary YES model – a unique four-stage dividend discount model honed over three decades that supports disciplined, forward-looking valuations across all ten of our Japanese equity strategies and captures a business’ full lifecycle. It also incorporates a company-specific business risk premium into the discount rate, factoring in elements like regulatory risk, earnings uncertainty and industry dynamics. This allows us to avoid value traps and manage downside risk.

Each equity strategy varies only by investable universe and risk controls. Our small cap strategy uses the Russell/Nomura Small Cap Index with a target tracking error of two to six percent.

Our investment process has three core steps: fundamental research, stock valuation and portfolio construction. We begin with rigorous bottom-up analysis to determine a company’s “normal profitability” – a sustainable earnings baseline that strips out short-term distortions like product cycles or macro shocks. Analysts then forecast twelve key inputs across a company’s balance sheet and income statement, which are used as inputs for the YES model.¹  

The model outputs intrinsic value based on projected dividend. We compare this value to the market price to identify stocks with high expected alpha. Finally, we build the portfolio from the bottom quintile of stocks with the highest expected alpha and most significant valuation upside. 

This provides a robust, long-term lens through which we evaluate companies. It reflects how businesses evolve over time, incorporates a wide range of risk considerations and anchors our process in intrinsic value – ultimately supporting a high-conviction, valuation-driven investment strategy. 

_{1 As of May 2025}

Beyond the YES model, what differentiates Sompo’s small cap strategy from others in the market?

Most Japanese small cap strategies are growth-focused. We are one of the few managers looking at stocks’ intrinsic value over the medium to long term. Our approach gives us access to a wide universe of undervalued and overlooked small caps not typically on the radar of growth investors.

Another differentiator is access. Small caps tend to attract less investor attention, allowing us to engage directly with management. Across the research universe of all our equity strategies we hold approximately 500 individual meetings annually. As a Japanese asset manager we have a deep understanding of Japanese corporate culture and know how to deal with management teams to achieve real improvements.

How do you engage with management teams and how does that influence your investment approach?

Access to management teams is vital to our investment process. We prioritise regular, one-on-one meetings with companies we invest in, and many management teams seek our input on improving corporate value. Through these conversations, we encourage sustainable growth and corporate value improvements, supporting long-term value creation for the companies and our investors. 

What type of investor is your small cap strategy best suited to?

As our investment process is heavily reliant on the medium- to long-term forecasts, our approach is best suited for long-term investors. Unlike some value managers who rely on short-term metrics like price-to-earning ratios or price-to-book ratios, we forecast intrinsic value over several years. Our average holding period is 1.5 to two years, but we may hold individual assets for up to five years or more if the market hasn’t recognised a company’s potential.

Why are Japanese small caps compelling for international investors right now and why hasn’t the market caught on yet?

Compared to large caps, Japanese small caps are significantly undervalued and often overlooked, despite offering greater earnings growth potential than the broader market. As capital has flowed into large caps benefitting from corporate governance reform and yen depreciation, many small caps have lagged. This has created a compelling entry point. 

Now, we’re seeing small caps follow suit, presenting a unique opportunity: over half of the Japanese small caps trade at a price-to-book ratios less than 1x, offering significant room for upside as governance reforms spread. 

From a macro perspective, the yen is deeply undervalued due to divergent global monetary policies. As Japan shifts towards monetary tightening while other economies ease, we expect yen appreciation. 

Structurally, we’re seeing early signs of manufacturing onshoring. Furthermore, Japan is experiencing rising inflation, improving wages and growing domestic demand, all of which create a supportive environment for small cap growth. We’re also seeing signs of increased M&A activity as companies reposition in response to structural economic changes, which is particularly attractive for investors.

This disconnect between improving fundamentals and limited investor attention makes Japanese small caps a compelling and underappreciated opportunity. 

The strategy looks back on a strong track record of more than 24 years. Can you share more about the strategy’s long-term performance and drivers for past and future growth?

Our Japanese small cap strategy has outperformed its benchmark since inception. This outperformance reflects both our disciplined, earnings-driven investment process and favourable structural trends within Japan’s small cap market.

Our recent performance has also benefitted from targeted overweight positions in banks and domestic demand sectors such as retail. These sectors profited from cost pass-throughs to consumers, improved earnings from rate normalisation and better consumer sentiment.

In addition, governance reforms and improving shareholder returns supported these gains. 

How do you assess risk, including macro factors, financial health and catalysts?

Risk varies by company. We conduct deep, bottom-up analysis to evaluate financial stability and use our proprietary, in-house credit ratings as part of the YES model’s discount rate, ensuring we take a conservative approach. 

We also integrate macro risks and geopolitical developments into our discount rates. When making portfolio construction decisions, we consider catalysts and catalyst timing. We ensure there is a wide range of catalysts within the portfolio – such as earnings recoveries, capital efficiency improvements, or M&A activity – to minimise exposure to macroeconomic shocks.

Rather than impose top-down controls like sector caps, we diversify bottom-up across many catalysts to maintain portfolio resilience.

How do you apply your selling discipline to manage and mitigate portfolio risk?

We’re conservative when entering and scaling positions over time, as small caps can remain mispriced for extended periods. As a stock approaches our estimated intrinsic value, we reduce or exit our position.

If the original investment thesis shifts, we reassess fundamentals and valuation to determine whether to hold, trim or exit. This disciplined, valuation-driven approach allows us to manage both upside potential and downside risk.

Looking ahead, what are the key risks and opportunities for Japanese small caps?

The primary risk is a weakening of the Japanese domestic economy. This could divert management focus away from shareholder-friendly initiatives and slow corporate reform momentum.

The opportunity is equally clear, as progress on corporate governance reform spreads across small caps and structural changes take hold. Companies with improving capital efficiency, high cash reserves  and low valuations are well positioned to outperform. We expect M&A activity to further support returns as firms reposition amid economic transformation.

 

About Sompo

Sompo Asset Management, founded in 1986, manages 28.5 billion US dollars of assets, including 6.6 billion US dollars in Japanese equities.