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The Jasdaq index of smaller shares, which has advanced 22 per cent this year, reached an all-time high last month.

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Aiming small is helping some Japanese hedge funds deliver outsize returns.

Simplex Asset Management Co.'s Japan Lower Market Strategy fund, which scours the country's three regional exchanges for small-cap stocks, returned 29 per cent in the first six months of the year. Eschewing big-name companies also helped Sparx Group Co.'s Value Impact Fund gain 19 per cent in the first half, while Strategic Capital Inc.'s activist fund added 15 per cent, according to the firms.

The gains stand out even against the backdrop of rising returns for Japan hedge funds, which were buoyed by a rebound in the country's stocks to rank as this year's third-best performers behind Pan-Asian and Latin America-focused strategies. The Eurekahedge Japan hedge fund index gained 4.9 per cent in the first six months, rebounding from its worst performance in five years in 2016.

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Gauges tracking small-company shares have trounced the broader Topix index this year as investors have flocked to companies that are less vulnerable to a fluctuating yen than large global corporations. Smaller companies have also produced faster earnings growth than bigger counterparts, adding to their appeal.

Japanese small-cap stocks have outperformed because they are "rather immune to macro or geopolitical risks," said Motoyuki Sato, a Tokyo-based strategist at Man Group Japan Ltd., the world's biggest publicly traded hedge-fund firm. "Global investors are diversifying their portfolio risks to include small to medium stocks."

The Jasdaq index of smaller shares, which has advanced 22 per cent this year, reached an all-time high last month and the Topix's Second Section Index of mostly medium-sized stocks surged to record levels Tuesday to bring its gain this year to 23 per cent. The Mothers index that tracks startup stocks has increased 19 per cent, compared with the Topix's 7.7-per-cent gain.

The Mothers index has produced median earnings per share growth of 28 per cent over the past three years, compared with the Topix's 10-per-cent increase. Even so, analyst coverage remains low for small-cap companies, with less than one-fifth of Mothers' stocks followed by analysts, compared with more than half for Topix.

In addition, a government push for Japanese companies to focus on shareholder returns is starting to pay off. Smaller companies tend to enjoy bigger gains on positive news than large companies, said Simplex Asset Management CEO Hiromasa Mizushima.

Japan's regional exchanges and other indexes contain 1,653 companies, with a combined market value of less than 4 per cent of the Topix index, according to Simplex. That presents the opportunity to find stocks overlooked by investors and analysts, said Mr. Mizushima.

"It would be hard for companies like Toyota to double their growth," he said. "Our focus is whether smaller companies have the ability to boost profit say by tenfold."

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One strong performer in Simplex's portfolio is Jasdaq-listed Optoelectronics Co. The maker of bar-code readers has gained 56 per cent this year and forecasts profit will gain 18 per cent in the fiscal year ending Nov. 30.

The Lower Market Strategy fund has about ¥10-billion ($115-million Canadian) in assets, and Mr. Mizushima is seeking to increase that to ¥30-billion by the end of the year before closing it to new investors.

Sparx's Japan Value Impact Fund, which targets underperforming companies and pushes for change to boost share prices, has benefited from its campaign to get Teikoku Sen-I Co. to reduce its shareholding in Hulic Co., which accounts for about a third of its assets. Teikoku Sen-I shares have risen 26 per cent since Sparx went public with its campaign.

Strategic Capital's holdings include pump-maker Teikoku Electric Manufacturing Co., which has gained 15 per cent this year, and Nittoc Construction Co., which is up 30 per cent. The activist firm has urged Teikoku to return excess cash to shareholders, and is betting Nittoc will increase shareholder returns because of its family connection to Finance Minister Taro Aso, who has led the government's push for improved corporate governance and shareholder returns.

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