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It may be small but its returns have been mighty; 88.9 per cent over 12 months to October 19 – almost double the sector average - and 12.5 per cent in the past three months.

While Chisako Hardie, its manager since launch, is forecasting more sustainable and milder-paced performance from next year, she says the market isn't overheating and believes Japan’s smaller companies offer investors a defensive refuge.

Japan is not known for its low volatility, and small companies almost by definition are considered to be riskier than large caps. So, Ms Hardie’s views are quite contrarian.

“The Japan small-cap sector is more defensive to global economy external movements and currencies. Also, a change in government will be good for the sector. I can see a big swing from the large-cap company mentality to consumer focused and entrepreneurial small businesses, which can create value,” she says.

In addition, she says lessons have been learnt, both by the companies and by their investors, from the 2005 Japanese small-cap bubble.

“I look for undervalued, structural-growth companies. I don’t look for extreme growth; if an owner says he wants to grow the business by 50 per cent per year, I avoid it. I never take a big bet, even if I’m really confident about a stock, I just can’t. I buy 1-1.5 per cent and when it gets bigger than 2 per cent, I start top-slicing.”

She adds: “If you are selective about your stocks and control your risk, I’m confident within their [an investor's] exposure to Japan, a small-cap portfolio can grow steadily, diversify their investment and by doing so they can expect a good return.”

Of the 3,500 stocks classified as Japanese small caps, 500 form Ms Hardie's personal investment universe. These include those currently in the portfolio that fell from favour previously, and stocks the manager is interested in but, for whatever reason, has not yet invested in.

Ms Hardie says she “invests in growth companies that are significantly undervalued; that’s my style”. But in a country that has been the most undervalued major stock market in the world, what metrics are used?

Under usual circumstances, Ms Hardie uses the Peg rate (price/earnings divided by expected growth rate) to discern stock value, with anything lower than 1.5 considered undervalued, depending on the market environment and peer group.

However, the market has been particularly dire during the past 12 months, she says, and therefore the manager has reverted to price/book (p/b) ratios to value companies.

“Because these are smaller companies, the distribution of information can be patchy,” Ms Hardie says. “Often there is no problem with the business but a very usual reason for the stock to be undervalued is that it’s not well known to the analysts.”

One sector that was regularly producing p/b readings of 0.3-0.4 – distressed levels - was property-related companies. Ms Hardie bought into storage business Area Link, which has been sold off not only because of its exposure to Japanese home movers, but because during the boom years had expanded into refurbishment or residential property.

However, following conversations with the management, Ms Hardie was convinced the company was being refocused on its core capabilities and bought in in February. By summer, when the stock has reached ‘fair value’ at a p/b of 1, and it was sold, profit was taken at 800 per cent.

“This was an unusual situation for property-related stocks and I was able to grab those opportunities,” she says.

Ms Hardie forecasts a target sell price for each stock she owns, although if a stock reacts differently or over a different time frame than expected, this can be revised.

A bottom-up investment approach in small caps tends to favour domestic businesses – rather than the large-cap exporters Japan is known for. With their heads filled with concerns about Japan as a moribund economy with an ageing, frugal population, this could sound like a huge risk. Ms Hardie only sees opportunity.

“In Japan many industries are still fragmented, so if a company is entrepreneurial and innovative they can grow steadily in a mature market. There are rarely new entrants and no competition from abroad – it’s quite protected – and they can grow through expanding market share, M&A activity, and of course some competitors will fail and exit the market,” she says.

One such “mom and pop” industry is Japanese bike shops. The fund has been invested in Asahi (1.5 per cent), the first national chain of bike shops, for two years and despite the share price tripling in that time, with the company benefiting from economies of scale compared with tiny local competitors, Ms Hardie still finds the stock undervalued.

“That’s exactly the type of story I’m looking for,” she says. “It might sound unexciting but this is one of my favourite themes.” The good news is expected to continue; as the interim reporting season continues, an increasing number of companies are revising upwards their forecasts.

However, even with all her contacts at her disposal, can Ms Hardie really scoop the inside track on Japanese smaller companies from an office based in Edinburgh? She says too many of her competitors rely on brokers whereas the time difference allows her to contact company management at 3pm local time to follow up on whatever news has broken earlier in the day.

She also says the distance gets her exclusive and preferential meetings with key corporate personnel, not least when they visit their European investors (or potential investors). Even in Tokyo, she says, similar physical barriers would exist because many smaller firms are based in cheaper, out-of-the-way locations.

“It’s about being proactive,” she says. “With larger companies, it’s impossible I know something about Toyota Motors no-one else knows. With smaller companies – under-researched, uncovered stocks - that’s happening all the time.”