Japan's OTC Market Hopes to Follow in the Nasdaq's Footsteps

Enthusiasts say the big gains in little companies mark just the beginning of Japan's Internet revolution.
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TOKYO -- As observers so tirelessly and tiresomely point out, Japan has a knack for turning something decent into something extraordinary.

The world poked fun at

Toyota Motor

(TM:NYSE ADR) when the firm dared to chop the size of its cars a few decades back. The laughter faded, however, when the automaker successfully marketed compacts back to the "bigger-is-better" American consumer. And in consumer electronics, Japanese manufacturers have become so dominant that you'd be hard pressed to find a U.S.-made TV down at the local shop. (Fun fact:

Zenith

just came out of Chapter 11.)

Now, Japan is looking to emulate and improve upon another American prototype: the success of the

Nasdaq

. Consider Japan's over-the-counter market, chock full of high-tech and Internet companies, which has risen more than 200% since the beginning of the year. Enthusiasts say the big gains in these little companies mark just the beginning of Japan's Internet revolution.

Naysayers will tell you that since shares had been badly beaten as Japan's lost decade threatened to spill over into the next millennium, even a tiny rise in stock prices produces a significant percentage move. That, of course, is true. And investment professionals here will quickly tell you they don't expect such explosive growth next year. But amid liberalized financial regulations, a crowd of companies seeking money and, most importantly, a slew of new mutual funds seeking to invest Japan's cash stockpiles, many think the market will continue rising like its Yankee brother has.

Last month, when stock trading commissions were liberalized, 16 new domestic mutual funds were quickly registered, five of which focus on small-cap shares. It's an area that Japan's return-starved investors, who have seen rates of as low as 0.1% on bank accounts, are expected to rush to.

The country now has about 30 OTC funds busily loading up on companies that fusty old unit trusts would rarely consider. Newly listed companies, such as cosmetic maker

Fancl

and used-car reseller

Gulliver International

, all met heavy institutional demand on their first days of trading. Gulliver's stock started trading at 2,600 yen (about $25) even though the company originally thought it would open at 700 yen. That enthusiasm isn't waning. Fancl is up nearly 650% this year; Gulliver, 444%.

Domestic funds alone aren't responsible for the run-up, although institutional investors credit them for the lion's share of the rise. More than 100 funds worldwide invest in Japan small-cap shares, according to

Morningstar Japan

, and many are looking for the same bang they saw during America's IPO frenzy over the past two years.

With the addition of two new small-cap markets next year, the number of small-cap IPOs may triple next year from the current 58 public offerings seen thus far in 1999. Small Japanese businesses have traditionally leaned on one or two banks to provide loans until companies were large enough to go public. Recession, however, has prompted banks to hold back on loans to all but the biggest, most established companies. The result: more cash-strapped little companies opting for equity financing earlier than before.

"With more small-cap firms able to find

equity funding, they should be able to have IPOs in one or two years rather than waiting five to seven years like they used to," predicts Takeshi Kuroda, fund manager at

Shin Wako Securities Investment Trust and Management

. Kuroda's

Jasdaq Open

fund rose 248% for the year ended Sept. 30, while his

OTC Open

fund pulled in a 229% return for the same period.

The best outcome from all of this is a business focus many of Japan's blue-chips have often dismissed: shareholder value. And it looks like big companies may even be learning from their smaller brethren.

"In Japan, understanding the importance of shareholder value has spread from the OTC companies to the bigger conglomerates," says

Jardine Fleming Investment Trust and Advisory

fund manager David Scott, whose

Japan OTC Open

fund has gained 301% year-to-date. Heck, maybe the heads of larger companies will even start peppering their speech with mentions of dividends and capital gains like their counterparts at smaller firms have. That might cause a little confusion among investors, Scott jokes.

"Some fund managers may need to look up the definition of return on equity."