(Bloomberg) -- Smaller stocks are the best way to capitalize on Japan’s continued post-Covid economic recovery, according to a fund manager that beat 88% of his peers last year.

“Japan, with a slightly delayed ending to pandemic restrictions, is well positioned this year to grow,” Richard Aston, portfolio manager at Coupland Cardiff’s CC Japan Income & Growth Trust Plc, said in an interview. “That domestic focus has led us to mid-small caps,” which generally offer better local exposure than larger stocks.

Aston’s $231 million fund posted a 3.7% return in 2022 compared with a loss of 2.9% for its benchmark Topix Net Total Return. While the fund invests in large stocks including Shin-Etsu Chemical Co. that pay high dividends, it has a “bias toward mid and small cap,” the manager said.

Smaller stocks adjusted from “very high” valuations during the pandemic, leaving them more attractive, Aston said. The Topix Small Index has rebounded to its highest level versus the Topix 500 Index since the initial pandemic shock in March 2020, but is still well below its peak five years ago.

Japan relaxed entry for foreign tourists just last October, ending almost three years of tight border controls. Aston is bullish on Japan’s economic catch-up rebound, but he acknowledges that some investors still have concerns on issues such as its declining birth rate.

“There’s a lot of fear of investing in Japan just because people think they understand the demographics,” he said. “The reality is that some of the demographic changes actually can present significant opportunities.”

Among specific stocks, Aston’s fund has invested in dip Corp. and en Japan Inc., recruiting agencies that provide services online. These companies are likely to benefit from the government’s push for “re-skilling” to support job mobility as the nation’s working population shrinks, he said.

E-commerce platform Zozo Inc. is another stock the fund bought recently after a decline made its valuations more appealing. Aston said the company has “significant potential to grow domestically” thanks to its leading position in online fashion and the relatively low penetration of e-commerce in Japan.

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