UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number: 811-9521
JAPAN SMALLER CAPITALIZATION FUND, INC.
180 Maiden Lane, New York, N.Y. 10038
Nomura Asset Management U.S.A. Inc.
180 Maiden Lane, New York, N.Y. 10038
Registrant's telephone number, including area code: (800) 833-0018
Date of fiscal year end: February 29, 2004
Date of reporting period: February 29, 2004
ITEM 1. REPORT TO SHAREHOLDERS
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JAPAN SMALLER CAPITALIZATION FUND, INC.
April 22, 2004
To Our Shareholders:
We present the Annual Report of Japan The Fund underperformed the JASDAQ
Smaller Capitalization Fund, Inc. (the Index by 38.7 percentage points and under-
"Fund") for the fiscal year ended February performed the OTC Index by 5.1 percent-
29, 2004. The Net Asset Value per share age points during the year. Disappointing
("NAV") of the Fund increased by 63.8% for performances from some of the Fund's
the year. The closing market price of the holdings in sectors such as Consumption
Fund on February 29, 2004, on the New and Information/Systems, and the underex-
York Stock Exchange was $10.79 repre- posure to major internet-related issues with
senting a premium of 14.8% to the NAV of large market capitalizations, such as Yahoo
$9.40. The net assets of the Fund amounted Japan and Rakuten, had a negative impact
to $149,011,877 on February 29, 2004. on the relative performance.
The TOPIX, consisting of all companies The NAV of the Fund increased by 8.2%
listed on the Tokyo Stock Exchange (the for the quarter ended February 29, 2004.
"TSE") First Section, increased by 43.1% During the same period, the TOPIX and the
and the Nikkei Average Index (a price Nikkei Average Index decreased by 8.5%
weighted index of 225 leading stocks on the and 9.6%, respectively, and the OTC Index
TSE) increased by 42.9%, in United States and the JASDAQ Index increased by 11.4%
("U.S.") dollar terms, for the year ended and 10.4%, respectively, in U.S. dollar
February 29, 2004. The Nikkei JASDAQ terms. For the quarter ended February 29,
Average Index (the "OTC Index"), a price- 2004, the Fund underperformed the OTC
weighted index of the quotations of the Index and the JASDAQ Index by 3.2
OTC registered stocks increased by 68.8%, percentage points and 2.3 percentage
and the Index of the Japan Securities Deal- points, respectively.
ers Association Quotation System (the
"JASDAQ Index"), a capitalization-weighted The Portfolio
index of all OTC stocks, increased by
102.5%, respectively, in U.S. dollar terms, The Fund's equity exposure rose to
during the same period. The Japanese yen 98.5% at February 29, 2004 from 96.4%
("Yen") appreciated by 7.6% against the at November 30, 2003. The Fund was
U.S. dollar during the year. diversified into 98 issues, of which 57
2
issues were OTC stocks, 25 were other The JASDAQ market saw a temporary
smaller capitalization stocks and 16 were correction in the quarter ended December
TSE First Section stocks, comprising 31, 2003. Early gains in October, when the
52.6%, 30.0% and 15.9%, respectively, of Nikkei JASDAQ Average index exceeded
net assets on February 29, 2004. the 1,500 level, were subsequently eroded
by profit taking in November. Investors who
had an early entry into this strong rally in
Market Review 2003 appeared to have chosen to lock in
some of their profits before Christmas. Sub-
The OTC Index achieved a substantial re- sequently, the release of some encouraging
turn of 56.0%, in local currency terms for macroeconomic data from Japan as well as
the year ended February 29, 2004. the U.S. contributed to strong gains toward
the end of the quarter. Overseas investors
remained active buyers of Japanese stocks.
The Japanese stock market enjoyed a
strong rebound in the quarter ended June The year 2004 began with the OTC index
30, 2003. Japanese equities including the extending its strong recovery. The market
JASDAQ market began to show signs of a found plenty of support from the favorable
nascent recovery following the announce- performances of a number of initial public
ment of a public fund injection into the ail- offering issues, which attracted the atten-
ing banking group Resona Holdings, while a tion of individual investors. The OTC index
turnaround in the U.S. stock market also again recovered the 1,500 level. After post-
helped to push Tokyo stock prices higher. ing such strong gains in January, the market
Although most Asian markets struggled became narrowly range-bound throughout
early in the quarter amid fears about the much of February. However, the weakening
economic implications of the SARS out- Yen helped the OTC index to resume its up-
break, this had little impact on Japan. The ward trend towards the month end.
OTC index recovered the 1,000 level in mid-
April.
The OTC index was able to extend its Outlook and Strategy
rally through the quarter ended September
30, 2003, driven by steady performances Following the strong surge in Japan's real
from some major JASDAQ issues including Gross Domestic Product ("GDP") figure for
Yahoo Japan and Rakuten. The massive the fourth quarter of 2003 the Fund has
price gains followed some encouraging do- raised the economic growth forecasts for
mestic macroeconomic indicators, a more fiscal 2004 to 2% from 1.8%. Nevertheless,
positive outlook for the U.S. economy, and the Fund maintains the view that the cycli-
an improving fundamental outlook for cal recovery will approach its peak around
Japanese companies. Buying activity from the summer of this year. As for the stock
overseas investors continued to support the market, Japanese stocks in aggregate
market. terms are likely to remain resilient for the
3
time being, as robust corporate earnings supply from domestic investors could start
growth continues to support stock prices in to weigh on the Tokyo market again. Cross
Japan, while ample liquidity and low interest shareholding disposals tend to intensify
rates continue to underpin the markets around the fiscal year end. In addition, there
globally. This global monetary support looks may also be some frictional selling pressure
set to continue, since benign inflation con- this year due to a change in regulations
ditions on the U.S. will tend to preclude any governing the postal savings and insurance
increase in the Federal Funds rate this year. scheme that will allow the post office to
transfer assets from trust banks to other
Strong earnings growth can be observed asset management organizations. This
mainly within the manufacturing and basic supply pressure will be limited to the
materials sectors in Japan, so the market's immediate term, however, and is not
fortunes remain sensitive to changes in expected to linger in the next fiscal year.
the Yen to one U.S. dollar exchange rate.
Recent imbalances between the amount of Stock selection remains the primary
funds used for the Bank of Japan's market focus. The Fund will continue searching for
intervention operations, the current account stocks that are relatively undervalued or
surplus, and direct investment toward Japan those where fundamental changes have not
could indicate that it was speculative pres- yet been reflected in the current share price.
sure that had pushed the Yen toward the
105-level against the U.S. dollar. Hence, the The sector allocation strategy remains un-
latest reversal that saw the Yen decline back changed for the moment, although the Fund
toward the 110 Yen to one U.S. dollar level is looking for an opportunity to reduce the
can be attributed to a short covering rally in overexposure to the Electronics sector and
the U.S. dollar, and it would be premature to shift towards more undervalued sectors.
conclude that the greenback had marked a While the Fund believes the market's current
turning point. Although the current exchange resilience will prove sustainable, supported
rate is not a threat to earnings growth, a fur- by decent corporate earnings, some
ther slide in the U.S. dollar towards the im- Electronic sector stocks in particular are
portant psychological threshold of 100 Yen approaching the over-valued range and it is
to one U.S. dollar would begin to neutralize becoming harder to justify holding them.
corporate earnings growth in the Japanese
market. Currently, the Fund maintains the We appreciate your continuing support of
view that corporate profits will grow by your Fund.
around 10% for fiscal year 2004.
Sincerely,
Recent announcements of strong GDP
and industrial production growth figures
have invoked another strong inflow of /s/
money from foreign investors. On the other Yasushi Suzuki
hand, as the fiscal year end approaches, President
4
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BYLAW AMENDMENTS
On February 18, 2004, the Fund's Board of Directors, based on the
unanimous recommendation of its independent Directors, approved amendments to
the Fund's Bylaws and certain other elective provisions of Maryland law. The
Fund is incorporated under Maryland Law. The amendments and the elections to
be subject to various provisions of the Maryland General Corporation Law
include provisions that, among other things, (i) require shareholders to
provide notice to the Fund, normally not less than 90 or more than 120 days
before the anniversary of the mailing date of the notice of the prior year's
annual meeting of shareholders, of any nomination of Directors or other
proposals intended for consideration at the next annual meeting of
shareholders, (ii) classify the Board into three classes each with three-year
terms which expire only when a successor is duly elected and qualifies, (iii)
provide that shareholder meetings can be convened at shareholder request only
upon the written request of shareholders entitled to vote a majority of the
Fund's outstanding shares and establish procedures for shareholder-requested
special meetings, and (iv) provide that a majority of the Fund's outstanding
shares entitled to vote is required to elect a Director.
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NEW DIRECTOR
Effective January 1, 2004, the Fund's Board of Directors, based on the
unanimous recommendation of its Nominating Committee, elected Dr. William K.
Grollman as a Director to fill a vacancy among the independent Directors on
the Board. Dr. Grollman is the President and co-founder of SmartPros Ltd., a
leading provider of professional education programs, and a former Partner and
National Director of BDOSeidman, LLP, an international accounting firm. He is
also a former professor at Fordham University Graduate School of Business
Administration. He received his Ph.D. degree from New York University Graduate
School of Business Administration and his M.B.A. degree in accounting from New
York University. Dr. Grollman, who is a non-interested Director (as defined in
the Investment Company Act of 1940), will serve as the Fund's Audit Committee
Financial Expert.
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NEW PORTFOLIO MANAGER
On April 1, 2004, Mr. Takeshi Ebihara became the new Portfolio Manager
for the Fund. Mr. Ebihara is a Portfolio Manager for the Japan Equity Team for
Institutional Clients at Nomura Asset Management Co., Ltd. and the Chairman of
the Japan Small-Capitalization Stock Selection Committees. He was a former
analyst in the Corporate Research Department at Nomura Asset Management Co.,
Ltd. and a former member of the Japan Stock Selection Committee.
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INTERNET WEBSITE
NAM-U.S.A. has established an Internet website which highlights history,
investment philosophy and process and products, which includes the Fund. The
Internet web address is www.nomura.com. We invite you to view the Internet
website.
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5
JAPAN SMALLER CAPITALIZATION FUND, INC.
FUND HIGHLIGHTS--FEBRUARY 29, 2004
KEY STATISTICS
Net Assets............................................... $149,011,877
Net Asset Value per Share................................ $ 9.40
Closing NYSEMarket Price................................. $10.79
Percentage Change in Net Asset Value per Share*+......... 63.8%
Percentage Change in NYSEMarket Price*+.................. 69.1%
MARKET INDICES
Percentage change in market indices:*
YEN U.S.$
--- -----
TOPIX.................................................... 32.2% 43.1%
Nikkei Average........................................... 32.0% 42.9%
JASDAQ................................................... 87.1% 102.5%
Nikkei OTCAverage........................................ 56.0% 68.8%
*From March 1, 2003 through February 29, 2004.
+Reflects the percentage change in share price.
ASSET ALLOCATION
Japanese Equities
OTCStocks............................................. 52.6%
Other Smaller Capitalization Stocks................... 30.0
TSE First Section Stocks.............................. 15.9
------
Total Investments........................................ 98.5
Other Assets Less Liabilities............................ 1.5
------
Net Assets............................................ 100.0%
======
INDUSTRY DIVERSIFICATION
% of % of
Net Assets Net Assets
---------- ----------
Miscellaneous Manufacturing...... 15.7 Food Manufacturing.................. 4.2
Retail........................... 15.7 Electric............................ 3.2
Services......................... 12.2 Real Estate and Warehouse........... 2.9
Chemicals and Pharmaceuticals.... 11.2 Machinery and Machine Tools......... 2.5
Electronics...................... 8.2 Textiles and Apparel................ 2.3
Wholesale........................ 6.6 Restaurants......................... 1.6
Automotive Equipment and Parts... 5.7 Banks and Finance................... 1.0
Information and Software......... 5.5
TEN LARGEST EQUITY HOLDINGS BY MARKET VALUE
Market % of
Security Value Net Assets
-------- ----- ----------
C. Uyemura & Co., Ltd....................................... $4,123,112 2.8
Toys R Us-Japan, Ltd........................................ 3,319,954 2.2
Nitori Co., Ltd............................................. 3,007,623 2.0
T & K Toka Co., Ltd......................................... 2,967,391 2.0
Chiyoda Co., Ltd............................................ 2,820,714 1.9
Exedy Corporation........................................... 2,665,937 1.8
Suruga Co., Ltd............................................. 2,662,654 1.8
Leopalace21 Corporation..................................... 2,605,950 1.7
Nichiha Corporation......................................... 2,595,260 1.7
United Arrows Corporation................................... 2,516,412 1.7
6
JAPAN SMALLER CAPITALIZATION FUND, INC.
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REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders
of Japan Smaller Capitalization Fund, Inc.
In our opinion, the accompanying statement of assets and liabilities,
including the schedule of investments, and the related statements of
operations and of changes in net assets and the financial highlights present
fairly, in all material respects, the financial position of the Japan Smaller
Capitalization Fund, Inc. (the "Fund") at February 29, 2004, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended and the financial highlights for
each of the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America. These financial
state- ments and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our re-
sponsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the ac- counting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of securities at February 29, 2004 by
correspondence with the custodian and brokers, provide a reasonable basis for
our opinion.
PricewaterhouseCoopers LLP
New York New York
April 21, 2004
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SCHEDULE OF INVESTMENTS*
FEBRUARY 29, 2004
% of
Market Net
Shares Cost Value Assets
------ ---- ------ ------
EQUITY SECURITIES
Automotive Equipment and Parts
Exedy Corporation ............................. 202,400 $ 1,703,184 $ 2,665,937 1.8
Automobile clutches
Musashi Seimitsu Industry Co., Ltd............. 73,000 1,358,184 2,111,487 1.4
Ball joints, camshafts and gears
Nippon Cable Systems Inc....................... 187,300 1,698,791 2,177,309 1.5
Control cables
Nissin Kogyo Co., Ltd.......................... 68,000 1,519,767 1,524,943 1.0
------------ ------------ -----
Brake systems
Total Automotive Equipment and Parts........... 6,279,926 8,479,676 5.7
------------ ------------ -----
Banks and Finance
Ricoh Leasing Co., Ltd......................... 69,000 1,473,994 1,515,789 1.0
------------ ------------ -----
Credit sales and leasing
Chemicals and Pharmaceuticals
Arisawa Manufacturing Co., Ltd................. 63,230 990,131 2,170,366 1.5
Glassfibers and insulating resins
C. Uyemura & Co., Ltd.......................... 143,000 2,365,695 4,123,112 2.8
Chemicals
See notes to financial statements
7
JAPAN SMALLER CAPITALIZATION FUND, INC.
SCHEDULE OF INVESTMENTS*--Continued
FEBRUARY 29, 2004
% of
Market Net
Shares Cost Value Assets
------ ---- ------ ------
FP Corporation............................... 100,500 $ 1,895,348 $ 1,763,465 1.2
Polystyrene and other synthetic resin
foodware
Konishi Co., Ltd............................. 103,500 1,131,121 864,000 0.6
Adhesives and construction sealants
Mandom Corporation........................... 69,000 962,431 1,386,316 0.9
Cosmetic products
Matsumoto Yushi-Seiyaku Co., Ltd............. 52,000 1,014,987 970,984 0.6
Analgesic anti-inflammatory agents
Milbon Co., Ltd.............................. 51,260 1,526,033 1,205,842 0.8
Hair-care products for beauty salons
Shizuokagas Co., Ltd.+....................... 366,000 1,024,377 1,276,394 0.8
Natural gas supplier
T & K Toka Co., Ltd.......................... 131,250 2,225,242 2,967,391 2.0
------------ ------------ -------
Ink for printing
Total Chemicals and Pharmaceuticals.......... 13,135,365 16,727,870 11.2
------------ ------------ -------
Electric
Citizen Electronics Co., Ltd................. 27,900 1,277,286 2,247,323 1.5
Electric parts
Eneserve Corporation......................... 28,000 688,269 1,166,133 0.8
Electric generation system for supermarkets
Mirai Industry Co., Ltd...................... 261,000 2,586,427 1,290,069 0.9
----------- ------------ ------
Plastic molded electric materials
Total Electric............................... 4,551,982 4,703,525 3.2
----------- ------------ ------
Electronics
Chiyoda Integre Co., Ltd..................... 82,100 913,011 2,344,641 1.6
Electronic components
Cosel Co., Ltd............................... 76,500 1,986,521 1,967,643 1.3
Electrical machinery
Dainippon Screen Mfg. Co., Ltd.+............. 287,000 1,116,079 2,007,030 1.3
Electronic components
Fuji Electric Industry Co., Ltd.............. 58,000 613,710 384,897 0.3
Electronic parts
Fukuda Denshi Co............................. 39,000 961,762 828,192 0.5
Medical electronic equipment
Kuroda Electric Co., Ltd..................... 70,700 889,579 2,485,016 1.7
Materials and components
Toshiba Tec Corp............................. 280,000 1,126,847 1,122,563 0.8
Electronic equipment manufacturing
UMCJapan +................................... 1,466 2,670,710 1,072,159 0.7
------------ ------------ ------
Semiconductor memory chips
Total Electronics............................ 10,278,219 12,212,141 8.2
------------ ------------ ------
See notes to financial statements
8
JAPAN SMALLER CAPITALIZATION FUND, INC.
SCHEDULE OF INVESTMENTS*--Continued
FEBRUARY 29, 2004
% of
Market Net
Shares Cost Value Assets
------ ---- ------ ------
Food Manufacturing
Arcs Co., Ltd.................................. 150,480 $ 1,606,660 $ 1,515,130 1.0
Supermarket chain
Ariake Japan Co., Ltd.......................... 35,530 739,366 1,086,226 0.7
Natural seasonings
Kakiyasu Honten Co., Ltd....................... 80,600 674,732 988,595 0.7
Processed meat products, fresh meats, and
side dishes
Ozeki Co., Ltd................................. 12,000 1,132,929 443,753 0.3
Supermarket chain
Plenus Co., Ltd................................ 63,360 1,468,613 1,423,788 1.0
Japanese lunch-boxes
Q'sai Co., Ltd................................. 120,000 474,013 796,339 0.5
------------ ------------ ------
Frozen and processed foods and juice drinks
Total Food Manufacturing....................... 6,096,313 6,253,831 4.2
------------ ------------ ------
Information and Software
Argo Graphics Inc.............................. 36,000 896,182 830,389 0.6
Computer aided design software
CACCorp........................................ 132,100 1,495,499 941,930 0.6
Information technology services
Index Corporation.............................. 568 395,185 2,391,579 1.6
Cellular phone, internet content
Jastec Co., Ltd................................ 47,000 631,062 687,899 0.5
Business application software
Konami Computer EntertainmentTokyo, Inc........ 82,960 871,645 1,685,777 1.1
Video games software
Trend Micro Inc.+.............................. 19,500 1,488,482 603,295 0.4
Computer software, anti-virus server
Works Applications Co., Ltd.+.................. 280 529,903 1,204,577 0.7
------------ ------------ ------
Software development
Total Information and Software ................ 6,307,958 8,345,446 5.5
------------ ------------ ------
Machinery and Machine Tools
THK Co., Ltd................................... 132,400 4,015,427 2,320,787 1.6
Linear motion systems for industrial machines
Yushin Precision Equipment Co., Ltd............ 57,800 2,342,621 1,391,432 0.9
------------ ------------ ------
Injection molding related machinery
Total Machinery and Machine Tools.............. 6,358,048 3,712,219 2.5
------------ ------------ ------
Miscellaneous Manufacturing
Central Glass Co., Ltd......................... 297,000 1,565,509 1,930,160 1.3
Glass products
Eidai Kako Co., Ltd............................ 53,000 243,478 196,476 0.1
Synthetic resin processed products
See notes to financial statements
9
JAPAN SMALLER CAPITALIZATION FUND, INC.
SCHEDULE OF INVESTMENTS*--Continued
FEBRUARY 29, 2004
% of
Market Net
Shares Cost Value Assets
------ ---- ------ ------
Fuji Seal, Inc................................. 29,550 $ 542,645 $ 1,244,210 0.8
Packing materials
Fujimi Inc..................................... 62,500 1,625,209 1,521,739 1.0
Polishing materials for silicone wafers
Hoden Seimitsu Kako Kenkyusho Co., Ltd......... 62,000 1,015,688 398,389 0.3
Aluminum extruding molds
Koito Industries Ltd........................... 136,000 442,495 471,799 0.3
Electric lighting, electrical, and traffic
signal equipment
Mani, Inc...................................... 66,200 962,882 1,363,387 0.9
Medical goods and equipment
Maruko Co., Ltd................................ 73,500 865,850 666,041 0.4
Intimate apparel
Mizuno Corporation............................. 374,000 1,279,317 1,650,050 1.1
Sporting goods
Nichiha Corporation............................ 194,600 1,739,791 2,595,260 1.7
Ceramic exterior walls and fiber boards
Nippon Kodoshi Corp............................ 188,000 2,839,396 1,608,970 1.1
Paper for electric insulation
Nippon Signal Co., Ltd......................... 234,000 1,087,517 1,163,039 0.8
Traffic signals
Onkyo Corp..................................... 115,000 1,053,288 1,115,789 0.8
Multi-media products
Riso Kagaku Corporation........................ 35,100 1,333,217 1,606,407 1.1
Printing and copying machines
Secom Techno Service Co., Ltd.................. 44,000 1,176,991 1,389,474 0.9
Security systems, provides maintenance service
Shinkawa Ltd................................... 27,900 540,404 646,105 0.4
Bonders for semiconductors
SKKaken Co., Ltd............................... 49,500 1,135,503 1,282,243 0.9
Paints
Suruga Co., Ltd................................ 141,900 2,165,222 2,662,654 1.8
------------ ------------ ------
Daily necessities, novelties and promotional
items
Total Miscellaneous Manufacturing.............. 21,614,402 23,512,192 15.7
------------ ------------ ------
Real Estate and Warehouse
Leopalace21 Corporation........................ 219,000 1,928,030 2,605,950 1.7
Builds, repairs, sells, leases and manages
real estate properties
Nippon Kanzai Co., Ltd......................... 75,580 1,103,449 1,245,946 0.8
Comprehensive building maintenance
Recrm Research Co., Ltd.+...................... 945 1,172,070 598,572 0.4
------------ ------------ ------
Building management
Total Real Estate and Warehouse................ 4,203,549 4,450,468 2.9
------------ ------------ ------
See notes to financial statements
10
JAPAN SMALLER CAPITALIZATION FUND, INC.
SCHEDULE OF INVESTMENTS*--Continued
FEBRUARY 29, 2004
% of
Market Net
Shares Cost Value Assets
------ ---- ----- ------
Restaurants
Saint Marc Co., Ltd............................ 34,700 $ 961,983 $ 1,140,256 0.9
Restaurants and bakery shop chain
Watami Food Service Co., Ltd................... 159,350 2,489,530 1,093,936 0.7
------------ ------------ ------
Restaurant chain
Total Restaurants.............................. 3,451,513 2,234,192 1.6
------------ ------------ ------
Retail
Askul Corporation.............................. 28,400 1,419,284 1,429,748 1.0
Catalog shopping
Cawachi Limited................................ 22,400 1,241,833 1,638,224 1.1
Drug store chain
Chiyoda Co., Ltd............................... 221,700 1,565,569 2,820,714 1.9
Specialty store chain
Edion Corporation.............................. 206,000 1,006,273 1,911,982 1.3
Consumer electronics
Kyoto Kimono Yuzen Co., . 491 1,664,707 1,137,053 0.8
Ltd.
Japanese traditional kimonos
Nissen Co., Ltd................................ 83,600 350,876 1,362,087 0.9
Mail-order business
Nitori Co., Ltd................................ 49,560 1,599,142 3,007,623 2.0
Home furnishings
Otsuka Kagu, Ltd............................... 55,900 2,237,581 2,015,982 1.4
Furniture
Prime Network Inc.............................. 396 930,215 384,220 0.3
TV shopping business
Toys R Us-Japan, Ltd........................... 150,500 4,069,477 3,319,954 2.2
Toy store chain
Uoriki Co., Ltd................................ 208,400 1,422,799 1,730,149 1.3
Fresh fish and sushi
stores
USS Co., Ltd................................... 31,300 703,008 2,300,586 1.5
------------ ------------ ------
Automobile auction
Total Retail................................... 18,210,764 23,058,322 15.7
------------ ------------ ------
Services
Alps Logistics Co., Ltd........................ 84,000 515,309 1,660,778 1.1
Transportation
Bellsystem 24, Inc............................. 3,100 1,015,540 620,284 0.4
Telemarketing
E-System Corporation +......................... 760 685,655 800,000 0.5
Consulting services
Fullcast Co., Ltd.............................. 594 970,096 1,973,656 1.3
Human resources
See notes to financial statements
11
JAPAN SMALLER CAPITALIZATION FUND, INC.
SCHEDULE OF INVESTMENTS*--Continued
FEBRUARY 29, 2004
% of
Market Net
Shares Cost Value Assets
------ ---- ----- ------
Leoc Japan Co., Ltd. 123,000 $ 2,593,420 $ 298,352 0.2
Nursing home caterer
Nichii Gakkan Company 32,560 1,434,734 1,540,826 1.0
Hospital administration services
Nissin Healthcare Food Service Co., Ltd. 107,400 1,976,466 2,261,053 1.5
Nursing home caterer
Pasona Inc.+ 265 704,397 1,697,941 1.1
Human resources
Sumisho Auto Leasing Corporation 6,800 182,552 225,318 0.2
Auto leasing and maintenance
Toei Animation Co., Ltd. 28,300 1,447,047 1,352,183 0.9
Animated cartoon movies production
Tohokushinsha Film Corporation 59,300 624,843 1,443,826 1.0
Produces tv programs, movies and commercial
films
Toppan Forms Co., Ltd. 105,200 1,113,807 1,198,847 0.8
Commercial printing
Tow Co., Ltd. 226,720 1,403,612 1,718,299 1.2
Entertainment
Weathernews Inc. 147,300 1,816,185 1,523,561 1.0
------------ ------------ ------
Custom weather forecasting services
Total Services 16,483,663 18,314,924 12.2
------------ ------------ ------
Textiles and Apparel
United Arrows Limited 53,800 972,762 2,516,412 1.7
Casual clothes
Workman Co., Ltd. 43,000 691,495 873,776 0.6
------------ ------------ ------
Uniforms
Total Textiles and Apparel 1,664,257 3,390,188 2.3
------------ ------------ ------
Wholesale
ArcLand Sakamoto Co., Ltd. 125,400 1,502,668 1,624,174 1.1
Home appliances
Hakuto Co., Ltd. 177,600 1,916,241 2,113,318 1.4
Electric parts
Kato Sangyo Co., Ltd. 197,000 1,393,669 2,145,812 1.4
Processed foods
Paltac Corporation 85,000 701,892 1,392,677 0.9
Cosmetics, toiletries, and other consumer
goods
Takachiho Electric Co., Ltd. 37,400 640,364 672,687 0.5
Electronics parts
See notes to financial statements
12
JAPAN SMALLER CAPITALIZATION FUND, INC.
SCHEDULE OF INVESTMENTS*--Continued
FEBRUARY 29, 2004
% of
Market Net
Shares Cost Value Assets
------ ---- ----- ------
Toba, Inc.................................... 48,000 $ 586,907 $ 667,826 0.5
Trading company for control systems
Toshin Denki Co., Ltd........................ 72,000 892,909 1,186,270 0.8
------------ ------------ ------
Lighting equipment and electrical engineering
materials
Total Wholesale.............................. 7,634,650 9,802,764 6.6
------------ ------------ ------
TOTAL INVESTMENTS IN EQUITY SECURITIES....... 127,744,603 146,713,547 98.5
------------ ------------ ------
OTHER ASSETS LESS LIABILITIES, NET........... 2,303,083 2,298,330 1.5
------------ ------------ ------
NET ASSETS................................... $130,047,686 $149,011,877 100.0
============ ============ ======
* The description following each investment is unaudited and not covered by
the Report of Independent Auditors.
+ Non-income producing security.
Portfolio securities and foreign currency holdings were translated
at the following exchange rate as of February 29, 2004.
Japanese Yen JPY(Y) 109.25 = $1.00
See notes to financial statements
13
JAPAN SMALLER CAPITALIZATION FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
FEBRUARY 29, 2004
ASSETS:
Investments in securities, at market value (cost--$127,744,603)........ $146,713,547
Receivable for investments sold........................................ 474,000
Receivable for dividends and interest, net of withholding taxes........ 245,878
Cash or cash equivalent................................................ 2,105,310
------------
Total Assets........................................................... 149,538,735
------------
LIABILITIES:
Payable for investments purchased...................................... 248,666
Accrued management fee................................................. 111,377
Other accrued expenses................................................. 166,815
------------
Total Liabilities...................................................... 526,858
------------
NET ASSETS:
Capital stock (par value of 15,846,384 shares of capital stock
outstanding, authorized
100,000,000, par value $0.10 each)..................................... 1,584,638
Paid-in capital........................................................ 167,057,114
Accumulated net realized loss on investments and foreign currency (38,594,066)
transactions...........................................................
Unrealized net appreciation on investments and foreign exchange........ 18,964,191
------------
Net Assets............................................................. $149,011,877
------------
Net asset value per share.............................................. $9.40
============
See notes to financial statements
14
JAPAN SMALLER CAPITALIZATION FUND, INC.
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED FEBRUARY 29, 2004
INCOME:
Dividend income (less $127,359 withholding taxes)................ $1,280,313
----------
Interest income.................................................. 7,514
----------
Total Income............................................... $ 1,287,827
-----------
EXPENSES:
Management fee................................................... 1,233,249
Legal fees....................................................... 174,453
Custodian fees................................................... 139,500
Auditing and tax reporting fees.................................. 64,606
Shareholder reports.............................................. 45,018
Directors' fees and expenses..................................... 35,090
Registration fees................................................ 29,206
Annual meeting expenses.......................................... 26,058
Transfer agency fees............................................. 24,130
Miscellaneous.................................................... 9,882
Insurance........................................................ 5,856
----------
Total Expenses............................................. 1,787,048
------------
INVESTMENT LOSS--NET............................................. (499,221)
------------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS AND FOREIGN CURRENCY:
Realized loss on investments and foreign currency transactions:
Net realized loss on investments................................. (5,808,231)
Net realized loss on foreign exchange............................ (1,558,350)
Net realized loss on investments and foreign exchange............ (7,366,581)
Change in net unrealized appreciation on translation of foreign
currency and other assets and liabilities denominated in foreign
currency...................................................... 11,507,568
Change in net unrealized appreciation on investments............. 54,440,512
------------
Net realized and unrealized gain on investments and foreign
exchange...................................................... 58,581,499
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS............. $58,082,278
============
See notes to financial statements
15
JAPAN SMALLER CAPITALIZATION FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS
For the Year Ended
February 29, 2004 February 28, 2003
----------------- -----------------
FROM INVESTMENT ACTIVITIES:
Net investment loss.................................. ($499,221) ($772,617)
Net realized loss on investments..................... (5,808,231) (5,991,125)
Net realized gain/(loss) on foreign exchange......... (1,558,350) 18,060
Change in net unrealized appreciation/(depreciation)
on investments and foreign exchange................ 65,948,080 4,859,812
------------ ------------
Increase/(decrease) in net assets derived from
investment activities.............................. 58,082,278 (1,885,870)
------------ ------------
NETASSETS:
Beginning of year.................................... 90,929,599 92,815,469
------------ ------------
End of year ......................................... $149,011,877 $ 90,929,599
============ ============
See notes to financial statements
16
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies cost if their original maturity at the date of purchase
was 60 days or less, or by amortizing their value on
Japan Smaller Capitalization Fund, Inc. (the the 61st day prior to maturity if their term to maturity
"Fund") is registered under the Investment Company at the date of purchase exceeded 60 days. Securi-
Act of 1940 as a non-diversified, closed-end man- ties and other assets for which market quotations
agement investment company. The Fund was incor- are not readily available are valued at fair value as
porated in Maryland on January 25, 1990 and in- determined in good faith by or under the direction of
vestment operations commenced on March 21, the Board of Directors of the Fund.
1990. The Fund issued to its shareholders of record
as of the close of business on October 25, 1999 non- (b) Foreign Currency Transactions -- Transactions
transferable Rights to subscribe for up to an aggre- denominated in Japanese Yen are recorded in the
gate of 3,804,940 shares of Common Stock of the Fund's records at the current prevailing rate at the
Fund at a rate of one share of Common Stock for time of the transaction. Asset and liability accounts
three Rights held ("Primary Subscription"). The Fund that are denominated in Yen are adjusted to reflect
had the ability to increase the number of shares sub- the current exchange rate at the end of the year.
scribed for in this offering by up to 25% of the Pri- Transaction gains or losses resulting from changes in
mary Subscription, or an additional 951,235 shares, the exchange rate during the reporting period or
to honor record date shareholder requests to pur- upon settlement of foreign currency transactions are
chase more shares. During November 1999, the included in operations for the current period.
Fund issued a total of 4,458,565 shares of Common
Stock on exercise of such Rights at the subscription The net assets of the Fund are presented at the
price of $11.99 per share, compared to a net asset exchange rate and market values at the end of the
value per share of $16.20 and a market value per year. The Fund does not isolate that portion of the
share of $12.6875. Additionally, a sales load of change in unrealized appreciation (depreciation)
3.75% was charged to each share issued. Right of- included in the statement of operations arising as a
fering costs of approximately $546,000 and the sales result of changes in Japanese Yen rates at February
load were charged directly against the proceeds of 29, 2004 on investments and other assets and
the Rights Offering. The following is a summary of liabilities. Net realized foreign exchange gains or
significant accounting policies followed by the Fund. losses includes gains or losses arising from sales of
portfolio securities, sales and maturities of short-
term securities, currency gains or losses realized be-
(a) Valuation of Securities--Investments traded in tween the trade and settlement dates on securities
the over-the-counter market are valued at the last re- transactions, the difference between the amounts of
ported sales price as of the close of business on the dividends, interest, and foreign withholding taxes
day the securities are being valued or, if none is recorded on the Fund's books, and the U.S. dollar
available, at the mean of the bid and offer price at the equivalent of the amounts actually received or paid.
close of business on such day or, if none is available,
the last reported sales price. Portfolio securities (c) Security Transactions, Investment Income and
which are traded on stock exchanges are valued at Distributions to Shareholders--Security transactions
the last sales price on the principal market on which are accounted for on the trade date. Dividend in-
securities are traded or lacking any sales, at the last come and distributions are recorded on the ex-
available bid price. Short-term debt securities which dividend date and interest income is recorded on the
mature in 60 days or less are valued at amortized accrual basis. Realized gains and losses on the sale
17
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS--Continued
of investments are calculated on the identified cost (f) Use of Estimates in Financial Statement Prepa-
basis. ration -- The preparation of financial statements in
accordance with generally accepted accounting
Distributions from net investment income and net principles requires management to make estimates
realized gains are determined in accordance with and assumptions that affect the reported amounts
Federal income tax regulations, which may differ and disclosures in the financial statements. Actual
from generally accepted accounting principles. To results could differ from these estimates.
the extent these "book/tax" differences are perma-
nent in nature (i.e., that they result from other than (g) Concentration of Risk -- A significant portion of
timing of recognition--"temporary"), such accounts the Fund's net assets consists of Japanese securi-
are reclassified within the capital accounts based on ties which involve certain considerations and risks
their Federal tax-basis treatment; temporary differ- not typically associated with investments in the
ences do not require reclassification. Dividends and United States. In addition to the smaller size, and
distributions which exceed net realized gains for fi- greater volatility, there is often substantially less
nancial reporting purposes, but not for tax purposes, publicly available information about Japanese issuers
are reported as distributions in excess of net realized than there is about U.S. issuers. Future economic
gains. and political developments in Japan could adversely
affect the value of securities in which the Fund is
(d) Income Taxes -- A provision for United States invested. Further, the Fund may be exposed to
income taxes has not been made since it is the in- currency devaluation and other exchange rate fluc-
tention of the Fund to qualify as a regulated invest- tuations.
ment company under the Internal Revenue Code and
to distribute within the allowable time limit all taxable (h) Indemnifications--Under the Fund's organiza-
income to its shareholders. tional documents its officers and directors are
indemnified against certain liabilities arising from the
Under Japanese tax laws, a withholding tax is im- performance of their duties to the Fund. Additionally,
posed on dividends at a rate of 7% (7% effective in the normal course of business, the Fund enters
1/1/04 to 3/31/08; 10% effective 4/1/03 to 12/31/03; into contracts that contain a variety of representa-
15% effective prior to 4/1/03) and on interest at a tions which provide general indemnifications. The
rate of 10% and such withholding taxes are reflected Fund's maximum exposure under these agreements
as a reduction of the related revenue. There is no is unknown as this would involve future claims
withholding tax on realized gains. that may be made against the Fund that have not yet
occurred. However, based on experience, the Fund
(e) Capital Account Reclassification -- For the year expects the risk of loss to be remote.
ended February 29, 2004, the Fund's accumulated
net realized loss was increased by $853 and paid in 2. Management Agreement and
capital was decreased by $498,368, with an offset- Transactions With Affiliated Persons
ting decrease in accumulated net investment loss of
$499,221. This adjustment was primarily the result of Nomura Asset Management U.S.A. Inc. (the "Man-
the reclassification of foreign currency gains and the ager") acts as the manager of the Fund pursuant to
net operating loss. a management agreement. Under the agreement,
the Manager provides all office space, facilities and
18
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS--Continued
personnel necessary to perform its duties. Pursuant attended, together with such Director's actual
to such management agreement, the Manager has expenses related to attendance at meetings. Such
retained its parent company, Nomura Asset Manage- fees and expenses for unaffiliated Directors aggre-
ment Co., Ltd. (the "Investment Adviser"), to act as gated $35,090, for the year ended February 29,
investment adviser for the Fund. 2004.
As compensation for its services to the Fund, the
Manager receives a monthly fee at the annual rate of
1.10% of the value of the Fund's average weekly net 3. Purchases and Sales of Investments
assets not in excess of $50 million, 1.00% of the
Fund's average weekly net assets in excess of $50 Purchases and sales of investments, exclusive of
million but not exceeding $100 million, .90% of the investments in foreign currencies and short-term se-
Fund's average weekly net assets in excess of $100 curities, for the year ended February 29, 2004 were
million but not exceeding $175 million, and .80% of $33,189,487 and $35,178,815, respectively.
the Fund's average weekly net assets in excess of
$175 million. For services performed under the In- As of February 29, 2004, net unrealized apprecia-
vestment Advisory Agreement, the Investment Ad- tion on investments exclusive of investments in for-
viser receives a monthly fee from the Manager at the eign currency and short-term securities for Federal
annual rate of .50% of the Fund's average weekly net income tax purposes was $18,968,944 of which
assets not in excess of $50 million, .45% of the $37,278,186 related to appreciated securities and
Fund's average weekly net assets in excess of $50 $18,309,242 related to depreciated securities. The
million but not in excess of $100 million, .40% of the aggregate cost of investments, exclusive of invest-
Fund's average weekly net assets in excess of $100 ments in foreign currencies of $0, at February 29,
million but not exceeding $175 million, and .35% of 2004 for Federal income tax purposes was
the Fund's average weekly net assets in excess of $127,744,603. The Fund has a capital loss carryfor-
$175 million. Under the Management Agreement, the ward as of February 29, 2004 of approximately
Fund accrued fees to the Manager of $1,233,249 for $38,594,066 of which $22,683,799 expires February
the year ended February 29, 2004. Under the Invest- 28, 2010, $6,143,866 which expires February 28,
ment Advisory Agreement, the Manager informed 2011 and $9,766,401 which expires February 29,
the Fund that the Investment Adviser earned fees of 2012.
$556,341 for the year ended February 29, 2004. At
February 29, 2004, the fee payable to the Manager,
by the Fund, was $111,377.
Certain officers and/or directors of the Fund
are officers and/or directors of the Manager.
Affiliates of Nomura Holdings, Inc. (the Manager's
indirect parent) earned $448 in commissions on the
execution of portfolio security transactions for the
year ended February 29, 2004. The Fund pays
each Director not affiliated with the Manager
an annual fee of $5,000 plus $500 per meeting
19
JAPAN SMALLER CAPITALIZATION FUND, INC.
FINANCIAL HIGHLIGHTS
Selected per share data and ratios for a share of common stock outstanding
throughout the year.
For the Year Ended
-----------------------------------------------------------
February 29, February 28, February 29,
------------ ------------ ------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Net asset value, beginning of year.. $5.74 $5.86 $7.59 $16.39 $5.86
----- ----- ----- ------ ------
Rights offering costs*.............. -- -- -- -- (0.16)
----- ----- ----- ------ ------
Net investment loss @............. (0.03) (0.05) (0.06) (0.09) (0.11)
Net realized and unrealized gain
(loss) on investments and
foreign currency................ 3.69 (0.07) (1.59) (7.89) 11.99
----- ----- ----- ------ -----
Total from investment operations.. 3.66 (0.12) (1.65) (7.98) 11.88
Distributions to shareholders from:
Net realized capital gains........ -- -- (0.08) (0.82) --
Net investment income............. -- -- -- -- --
----- ----- ----- ------ -----
Total distributions................. 0.00 (0.00) (0.08) (0.82) 0.00
Decrease in net asset value due to
shares issued through rights
offering*......................... -- -- -- -- (1.19)
----- ----- ----- ----- ------
Net asset value, end of year........ $9.40 $5.74 $5.86 $7.59 $16.39
===== ===== ===== ===== ======
Market value, end of year........... $10.79 $6.38 $5.53 $6.89 $11.00
Total investment return+............ 69.1% 15.4% (18.6%) (31.1%) 76.0%
Ratio to average net
assets/supplemental data:
Net assets, end of period (in 000) $149,012 $90,930 $92,815 $120,275 $259,766
Operating expenses................ 1.47% 1.63% 1.58% 1.33% 1.33%
Net investment loss............... (0.41%) (0.75%) (0.84%) (0.76%) (0.88%)
Portfolio turnover.................. 28% 28% 38% 78% 50%
+ Based on market value per share, adjusted for reinvestment of income
dividends and long term capital gain distributions, and capital share
transactions. Total return does not reflect sales commissions.
* Decrease is due to rights offering (see note 1).
@ Based on average shares outstanding.
20
JAPAN SMALLER CAPITALIZATION FUND, INC.
Supplemental Shareholder Information (Unaudited)
The 2003 Annual Meeting of the Shareholders of the Fund was held at the
Fund's offices, 180 Maiden Lane, New York, New York on November 12, 2003. The
purpose of the meeting was to elect five Directors to serve for the ensuing
year; and to transact such other business as may properly come before the
Meeting or any adjournment thereof.
At the Meeting, the following persons were elected by the shareholders to
serve as Directors of the Fund: William G. Barker, Jr., Yasushi Suzuki, Chor
Weng Tan, Arthur R. Taylor, and John F. Wallace. No other business was
transacted at the meeting.
The results of the voting at the Annual Meeting are as follows:
1. To elect the Fund's Board of Directors:
% of Shares Voted % of
Shares Voted outstanding Withhold outstanding
For Shares Authority Shares
------------ ----------- -------- -----------
William G. Barker, Jr............ 12,622,007 79.6 111,515 0.7
Yasushi Suzuki................... 12,632,857 79.7 100,665 0.6
Chor Weng Tan.................... 12,644,585 79.8 88,937 0.5
Arthur R. Taylor................. 12,623,115 79.6 110,407 0.7
John F. Wallace.................. 12,626,072 79.7 107,450 0.6
21
JAPAN SMALLER CAPITALIZATION FUND, INC.
INFORMATION PERTAINING TO BOARD OF DIRECTORS
Certain biographical and other information relating to each Director who is an
"interested person," as defined in the Investment Company Act of 1940
("Investment Company Act"), of the Fund is set forth below:
Other
Term of Number of Public
Position(s) Office and Funds in the Directorships
Name, Address and Age Held with the Length of Principal Occupation(s) Fund Complex Held by the
of Director Fund Time Served During Past Five Years Overseen* Director
--------------------- ------------- --------------- ------------------------------------ ---------------- --------------
Yasushi Suzuki (49)** President President President of the Fund since May 2 registered None
180 Maiden Lane and Director and Director 2003; President and Director of investment
New York, New York since May Nomura Asset Management U.S.A. companies
10038 2003 Inc. ("NAM-U.S.A.") since May consisting of
2003; Management Executive of 2 portfolios
Nomura Asset Management Co.,
Ltd. ("NAM") from 1998 to April
2003.
John F. Wallace (75)*** Director Director Vice President of the Fund from 2 registered None
17 Rhoda Street since 1993 1997 to 2000 and Secretary and investment
West Hempstead, Treasurer of the Fund from 1990 companies
New York 11552 to 1997; Senior Vice President of consisting of
NAM-U.S.A. from 1981 to 2000, 2
portfolios Secretary from 1976 to
2000, Treasurer from 1984 to 2000
and Director from 1986 to 2000.
------------------
* In addition to the Fund, the "Fund Complex" includes Korea Equity Fund,
Inc.
** Mr. Suzuki is a director and President of Korea Equity Fund, Inc. for which
NAM-U.S.A. acts as manager and for which NAM acts as investment adviser.
Mr. Suzuki is an "interested person," as defined in the Investment Company
Act, of the Fund based on his positions as President of the Fund, and as
President and Director of NAM-U.S.A. and former Management Executive,
Senior Officer and Director of NAM. Effective May 8, 2003, Mr. Kazuhiko
Hama resigned as President and Director of the Fund and Mr. Yasushi Suzuki
was elected as President and Director of the Fund.
*** Mr. Wallace is a director of Korea Equity Fund, Inc. for which NAM-U.S.A.
acts as manager and for which NAM acts as investment adviser. Mr. Wallace
is an "interested person," as defined in the Investment Company Act, of
the Fund based on the positions he has previously held with the Fund and
NAM-U.S.A.
22
JAPAN SMALLER CAPITALIZATION FUND, INC.
Certain biographical and other information relating to the Directors who are
not "interested persons," as de- fined in the Investment Company Act of 1940,
of the Fund is set forth below:
Other
Term of Number of Public
Position(s) Office and Funds in the Directorships
Name, Address and Age Held with the Length of Principal Occupation(s) Fund Complex Held by the
of Director Fund Time Served During Past Five Years Overseen* Director
--------------------- ------------- --------------- ----------------------------------- ---------------- -------------
William G. Barker, Jr. (71) Director Director Consultant to the television 2 registered None
111 Parsonage Road since 1993 industry since 1991. investment
Greenwich, Connecticut companies
06830 consisting of
2 portfolios
Chor Weng Tan (68) Director Director Managing Director for Education, 2 registered None
3 Park Avenue since 1993 The American Society of Mechan- investment
New York, New York ical Engineers since 1991; Direc- companies
10016 tor, U.S.-China Education Foun- consisting of
dation since 1992. 2 portfolios
Arthur R. Taylor (68) Director Director President of Muhlenberg College 2 registered None
339 North Leh Street since 1993 from 1992 to 2002. investment
Allentown, Pennsylvania companies
18104 consisting of
2 portfolios
* Each director is a director of Korea Equity Fund, Inc. for which
NAM-U.S.A. acts as manager and NAM acts as invest- ment adviser, and each
is a member of the Audit and Nominating Committees of Korea Equity Fund,
Inc. and a mem- ber of the Audit and Nominating Committees of the Fund.
23
JAPAN SMALLER CAPITALIZATION FUND, INC.
INFORMATION PERTAINING TO THE OFFICERS OF THE FUND
Certain biographical and other information relating to the officers of the
Fund is set forth below:
Name, Address* and Position(s) Held with Term of Office** and Principal Occupation(s)
Age of Officers the Fund Length of Time Served During Past Five Years
--------------- --------------------- --------------------- ---------------------------------------------
Yasushi Suzuki (49) President and President since 2003 President and Director of NAM-U.S.A. since
Director May 2003; Management Executive of NAM
from 1998 to April 2003.
Keisuke Haruguchi (53) Vice President Vice President since Senior Vice President and Director of NAM-
1999 U.S.A. since 1999; Senior Manager of NAM
from 1997 to 1998.
Kenneth L. Munt (57) Vice President Vice President since Senior Vice President and Secretary of NAM-
2001 U.S.A. since 1999; Senior Vice President of Hu-
man Resources for Middlesex Mutual Assur-
ance Company from 1996 to 1999.
Rita Chopra-Brathwaite Treasurer Treasurer since 2002 Vice President of NAM-U.S.A. since 2001: As-
(35) sistant Vice President of NAM-U.S.A. from 1999
to 2000. Senior Accounting Manager from 1997
to 1998.
Neil Daniele (43) Secretary Secretary since 2002 Senior Vice President of NAM U.S.A. Inc. since
2002; Vice President and Compliance Officer of
Munich Re Capital Management Corp. from
2001 to 2002; Vice President of AIGGlobal
Investment Group, Inc. from 2000 to 2001;
Compliance Officer from 1996 to 2000.
--------------------
* The address of each officer listed above is 180 Maiden Lane, New York, New York 10038.
** Elected by and serves at the pleasure of the Board of
Directors.
*** Effective May 8, 2003, Mr. Kazuhiko Hama resigned as President and
Director of the Fund and Mr. Yasushi Suzuki was elected as President
and Director of the Fund.
24
JAPAN SMALLER CAPITALIZATION FUND, INC.
REVIEW OF THE FUND'S MARKET PRICE COMPARED TO NET ASSET VALUE
Shares of closed-end investment companies, including funds focusing on a
single country, have at various times traded at both premiums and discounts
to their net asset value ("NAV"). Although the shares of the Fund have
traded at such a premium, they also have traded at a discount from NAV.
Since the Fund was established, the Board of Directors on a quarterly
basis has reviewed the trading price of the Fund's shares. The purpose of such
review has been to determine whether a discount exists and, if so, whether it
would be in shareholders' overall best interests for the Fund to conduct share
repurchases, make an issuer tender offer for shares or consider another means
of possibly reducing the discount. For example, the Board of Directors has
also considered whether it would be in the best interests of the Fund to
convert to an open-end fund or to an interval fund, which is a form of
investment company that makes periodic share repurchases at prices based on
NAV.
To date, the Board of Directors has not authorized open-market share
repurchases or a tender offer for shares of the Fund. The Board of Directors
also has not felt that it would be in the best interests of the Fund or its
shareholders to convert to an open-end fund or an interval fund. As a "country
fund", emphasizing a smaller capitalization segment of the market, the Fund's
NAV is more volatile than might be the case for a fund with a broader
investment focus. The Board of Directors believe that converting the Fund to
either an open-end or interval fund would subject the Fund to redemptions or
repurchases at times when liquidation of portfolio securities could
disadvantage remaining shareholders, and they believe that the recent
volatility of the financial markets in Japan supports their view.
Additionally, since an open-end fund has a limited ability to invest in
illiquid securities, such a conversion could hinder the Fund's ability to
pursue its investment objectives. The Board of Directors intend to continue to
review, on a quarterly basis, the trading market for the Fund's shares.
25
JAPAN SMALLER CAPITALIZATION FUND, INC.
DIVIDEND REINVESTMENT PLAN
The Dividend Reinvestment Plan (the "Plan") by dividing such amount, less brokerage com-
is available automatically for any holder of Com- mission, by the per share market price.
mon Stock with shares registered in his/her own
name who wishes to purchase additional shares Purchases will be made by the Plan Agent
with income dividends or capital gains distribu- from time to time on the New York Stock Ex-
tions received on shares owned, unless such change (the "Exchange") or elsewhere to satisfy
shareholder elects to receive all dividends and dividend and distribution investment require-
capital gain distributions in cash, paid by check ments under the Plan. Purchases will be sus-
and mailed to the shareholder. If a shareholder pended on any day when the closing price (or the
holds shares in his/her own name, communica- mean between the closing bid and ask prices if
tions regarding the Plan should be addressed to there were no sales) of the shares on the Ex-
the Plan Agent, Equiserve Trust Company, N.A., change on the preceding trading day was higher
150 Royall Street, Canton, Massachusetts than the net asset value per share. If on the divi-
02021. Under the Plan, shareholders appoint the dend payable date, purchases by the Fund are
Plan Agent to reinvest dividends and distribu- insufficient to satisfy dividend or distribution
tions in shares of the Fund. Such shares will be investments and on the last trading day immedi-
acquired by the Plan Agent for shareholders ei- ately preceding the dividend payable date the
ther through open market purchases if the Fund closing price or the mean between the closing
is trading at a discount or through the issuance of bid and ask prices of the shares is lower than or
authorized but unissued shares if the Fund is the same as the net asset value per share, the
trading at net asset value or a premium. If the Plan Agent will continue to purchase shares until
market price of a share on the payable date of a all investments by shareholders have been com-
dividend or distribution is at or above the Fund's pleted or the closing price or the mean between
net asset value per share on such date, the num- the bid and ask prices of the shares becomes
ber of shares to be issued by the Fund to each higher than the net asset value, in which case the
shareholder receiving shares in lieu of cash divi- Fund will issue the necessary additional shares
dends or distributions will be determined by di- from authorized but unissued shares. If on the
viding the amount of the cash dividends or distri- last trading day immediately preceding the divi-
butions to which such shareholder would be dend payable date, the closing price or the mean
entitled by the greater of the net asset value per between the bid and ask prices of the shares is
share on such date or 95% of the market price of higher than the net asset value per share and if
a share on such date. If the market price of a the number of shares previously purchased on
share on such distribution date is below the net the Exchange or elsewhere is insufficient to sat-
asset value per share, the number of shares to be isfy dividend investments, the Fund will issue the
issued to such shareholders will be determined necessary additional shares from authorized but
26
unissued shares. There will be no brokerage name of a broker or other nominee, such person
charges with respect to shares issued directly by should be contacted regarding changes in partic-
the Fund to satisfy the dividend investment re- ipation in the Plan. Upon withdrawal from the
quirements. However, each participant will pay a Plan, the Plan Agent will deliver to the share-
pro rata share of brokerage commissions in- holder a certificate or certificates for the appro-
curred with respect to the Fund's open market priate number of full shares and a cash payment
purchases of shares. In each case, the cost per for any fractional shares. In lieu of receiving a
share of shares purchased for each shareholder's certificate, the shareholder may request the Plan
account will be the average cost, including bro- Agent to sell part or all of the shareholder's
kerage commissions, of any shares purchased in shares at the market price and remit the pro-
the open market plus the cost of any shares is- ceeds to the shareholder, net of any brokerage
sued by the Fund. For the fiscal year ended Feb- commissions. A $2.50 fee will be charged by the
ruary 29, 2004, the Fund did not issue any new Plan Agent upon any cash withdrawal or termi-
shares for dividend reinvestment purposes. nation. An election to withdraw from the Plan will,
until such election is changed, be deemed to be
Shareholders who elect to hold their shares an election by a shareholder to take all subse-
in the name of a broker or other nominee should quent distributions in cash. An election will be
contact such broker or other nominee to deter- effective only for a dividend or distribution if it
mine whether they may participate in the Plan. To is received by the Plan Agent not less than 10 days
the extent such participation is permitted, the prior to such record date.
Plan Agent will administer the Plan on the basis
of the number of shares certified from time to The Plan Agent will maintain all sharehold-
time by the broker as representing the total ers' accounts in the Plan, and furnish written
amount registered in the shareholder's name and confirmation of all transactions in such account,
held for the account of beneficial owners who are including information needed by shareholders for
participating in such Plan. Shareholders that par- tax records. Shares in the account of each Plan
ticipate in the Plan holding shares in a brokerage participant may be held by the Plan Agent in non-
account may not be able to transfer the shares to certificated form in the name of the participant,
another broker and continue to participate in the and each shareholder's proxy will include those
Plan. Shareholders who are participating in the shares purchased or received pursuant to the
Plan may withdraw from the Plan at any time. Plan.
There will be no penalty for withdrawal from the
Plan, and shareholders who have previously The automatic reinvestment of dividends
withdrawn from the Plan may rejoin it at any time. will not relieve participants of any income taxes
Changes in participation in the Plan should be that may be payable (or required to be withheld)
made by contacting the Plan Agent if the shares on such dividends. Shareholders receiving divi-
are held in the shareholder's own name and must dends or distributions in the form of additional
be in writing and should include the share- shares pursuant to the Plan should be treated for
holder's name and address as they appear on the Federal income tax purposes as receiving a dis-
account registration. If the shares are held in the tribution in an amount equal to the amount of
27
money that the shareholders receiving cash divi- the record date for such dividend. There is no
dends or distributions will receive and should service charge to participants in the Plan; how-
have a cost basis in the shares received equal to ever, the Fund reserves the right to amend the
such amount. Plan to include a service charge payable by the
participants. All correspondence concerning the
The Fund reserves the right to amend or ter- Plan, including requests for additional informa-
minate the Plan as applied to any dividend paid tion about the Plan, should be directed to the
subsequent to written notice of the change sent Plan Agent.
to participants in the Plan at least 90 days before
SHAREHOLDERS ACCOUNT INFORMATION
------------------------------------------------------------------------------
Shareholders whose accounts are held in their own name may contact the Fund's
transfer agent,Equiserve Trust Company, N.A. at (800) 426-5523 for information
concerning their accounts.
------------------------------------------------------------------------------
28
===========================
===========================
BOARD OF DIRECTORS
William G. Barker, Jr.
William K. Grollman
Yasushi Suzuki
Chor Weng Tan
Arthur R. Taylor
John F. Wallace
OFFICERS
Yasushi Suzuki, President
Keisuke Haruguchi, Vice President
Kenneth L. Munt, Vice President
Rita Chopra-Brathwaite, Treasurer
Neil A. Daniele, Secretary
MANAGER
Nomura Asset Management U.S.A. Inc.
180 Maiden Lane
New York, New York 10038-4936
Internet Address
www.nomura.com
JAPAN
INVESTMENT ADVISOR Smaller Capitalization
Nomura Asset Management Co., Ltd. Fund, Inc.
1-12-1-Chome Nihonbashi, Chuo-ku,
Tokyo 103-8260, Japan
DIVIDEND PAYING AGENT, TRANSFER AGENT AND REGISTRAR
Equiserve Trust Company, N.A.
P.O. Box 43011
Providence, RI 02940-3011
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109
COUNSEL
Sidley Austin Brown & Wood LLP
787 Seventh Avenue
New York, New York 10019
ANNUAL REPORT
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP FEBRUARY 29, 2004
1177 Avenue of the Americas
New York, New York 10036-2798
JAPAN SMALLER CAPITALIZATION FUND, INC.
180 MAIDEN LANE
NEW YORK, NEW YORK 10038-4936
-----------------------------------------------
This Report, including the Financial Statements,
is transmitted to the Shareholders of Japan
Smaller Capitalization Fund, Inc. for their
information. This is not a prospectus, circular
or representation intended for use in the
purchase of shares of the Fund or any securities
mentioned in the Report. ===========================
===========================
29
ITEM 2. CODE OF ETHICS
------------------------------------------------------------------------------
(a) As of February 29, 2004, the Registrant had adopted a code of ethics that
applies to the Registrant's Principal Executive Officer, Principal
Financial Officer, Principal Accounting Officer or Controller, or persons
performing similar functions, regardless of whether these individuals are
employed by the Registrant or a third party.
(c) There were no amendments during the fiscal year ended February 29, 2004
to a provision of the code of ethics that applies to the Registrant's
Principal Executive Officer, Principal Financial Officer, Principal
Accounting Officer, or persons performing similar functions, and that
relates to any element of the code of ethics definition enumerated in
paragraph (b) of Item 2 of Form N-CSR.
(d) Not applicable.
(e) Not applicable.
(f) A copy of the Registrant's code of ethics is attached as an exhibit.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT
______________________________________________________________________________
The Registrant's Board of Directors has determined that William K. Grollman, a
member of the Registrant's Audit Committee, is an "audit committee financial
expert" and "independent," as such terms are defined in this Item. This
designation will not increase the designee's duties, obligations or liability
as compared to his duties, obligations and liability as a member of the Audit
Committee and of the Board; nor will it reduce the responsibility of the other
Audit Committee members. The Board believes each member of the Audit Committee
contributes significantly to the effective oversight of the Registrant's
financial statements and condition.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES
------------------------------------------------------------------------------
(a) Audit Fees for the Registrant were $49,000 and $47,000 for the fiscal years
ended 2/29/04 and 2/28/03, respectively.
(b) Audit-Related Fees for the Registrant were $9,000 and $9,000 for the
fiscal years ended 2/29/04 and 2/28/03, respectively. These amounts represent
procedures performed in connection with the review of the Registrant's semi-
annual reports.
In addition, there were no Audit-Related Fees billed in the fiscal years ended
2/29/04 and 2/28/03 for assurance and related services by the Accountant to
the Registrant's investment adviser (not including any sub-adviser whose role
is primarily portfolio management and is subcontracted with or overseen by
another investment adviser), and any entity controlling, controlled by or
under common control with the investment adviser that provides ongoing
services to the Registrant ("service affiliates"), that were reasonably
related to the performance of the annual audit of the service affiliates.
Accordingly, there were no such fees that required pre-approval by the Audit
Committee for the fiscal years ended 2/29/04 and 2/28/03, respectively.
(c) Tax Fees for the Registrant were $7,500 and $7,500 for the fiscal years
ended 2/29/04 and 2/28/03, respectively. These amounts represent aggregate
fees paid for tax compliance, tax advice and tax planning services, which
include (the filing and amendment of federal, state and local income tax
returns, timely RIC qualification review and tax distribution and analysis
planning) rendered by the Accountant to the Registrant.
There were no fees billed for tax services by the Accountants to service
affiliates for the fiscal years ended 2/29/04 and 2/28/03, respectively.
(d) There were no All Other Fees for the Registrant for the fiscal years ended
2/29/04 and 2/28/03, respectively.
There were no other fees billed for services rendered by the
Accountant to service affiliates for the fiscal years ended 2/29/04 and
2/28/03, respectively,
30
by the Audit Committee.
(e) (1) The Charter for the Audit Committee of the Registrant requires the
Audit Committee (a) to preapprove all auditing services to be provided to the
Registrant by the Registrant's independent accountants; (b) to preapprove all
non-audit services, including tax services, to be provided to the Registrant
by the Registrant's independent accountants in accordance with the Securities
Exchange Act of 1934, as amended (the "1934 Act"); provided, however, that the
preapproval requirement with respect to the provision of non-audit services to
the Registrant by the Registrant's independent accountants may be waived by
the Audit Committee under the circumstances described in the 1934 Act; and (c)
to preapprove non-audit services to be provided to the Registrant's investment
adviser (and any entity controlling, controlled by or under common control
with the investment adviser that provides ongoing services to the Registrant)
if the engagement relates directly to the operations and financial reporting
of the Registrant.
(f) N/A
(g) Non-audit fees billed by the Accountant for services rendered to the
Registrant and NAM-USA and any entity controlling, controlled by, or under
common control with NAM-USA that provides ongoing services to the Registrant
were $259,700 and $363,375 for the fiscal years ended 3/31/04 and 3/31/03,
respectively. These amounts represent aggregate fees paid for tax compliance,
tax advice and tax planning services and non-audit related services rendered
by the Accountant to service affiliates.
(h) Yes. The Registrant's Audit Committee has considered whether the provision
of non-audit services that were rendered to Service Affiliates which were not
pre-approved (not requiring pre-approval) is compatible with maintaining the
Auditor's independence. All services provided by the Accountant to the
Registrant or to Service Affiliates which were required to be pre-approved
were pre-approved as required.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS
------------------------------------------------------------------------------
(a) The Registrant's Board of Directors has a standing Audit Committee, which
consists of the Directors who are not "interested persons" of the
Registrant within the meaning of the Investment Company Act of 1940, as
amended. Currently, Messrs. William G. Barker, William K. Grollman, Chor
Weng Tan and Arthur R. Taylor are members of the Audit Committee.
(b) Not applicable.
ITEM 6. SCHEDULE OF INVESTMENTS
------------------------------------------------------------------------------
Form N-CSR disclosure requirement not yet effective with respect to the
Registrant.
31
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES
------------------------------------------------------------------------------
The Registrant has delegated proxy voting responsibilities to its investment
adviser, subject to the Board of Directors' general oversight. The investment
adviser has adopted its own Policy and Process on Corporate Governance and
Proxy Voting for this purpose. The Policy and Process is set forth below.
Policy and Process on Corporate Governance and Proxy Voting
NOMURA ASSET MANAGEMENT
NOMURA ASSET MANAGEMENT CO., LTD.
NOMURA ASSET MANAGEMENT U.S.A. INC.
NOMURA ASSET MANAGEMENT U.K. LIMITED
NOMURA ASSET MANAGEMENT SINGAPORE LIMITED
NOMURA ASSET MANAGEMENT HONG KONG LIMITED
August 2003
I. Basic Policy for Proxy Voting
---------------------------------
This policy regarding proxy voting has been adopted by Nomura Asset Management
Co., Ltd. ("NAM") and its investment advisory subsidiaries (listed on Schedule
1). These companies are hereinafter collectively referred to as "Nomura Asset
Management". The overall objective of Nomura Asset Management is to increase
the value of its clients' investments. We recognize that the power to
influence management through voting rights is an effective way to achieve such
an objective. Nomura Asset Management believes the right to vote proxies is an
important financial asset that must be managed with the same care and
diligence as any other client asset. We exercise proxy voting decisions solely
in the best interests of our clients and will acquire a company's equity
securities only because we believe it is good investment. We will not acquire
equity securities to obtain control of an issuer.
II. Organizational Structure for Proxy Voting Process
------------------------------------------------------
The Proxy Voting Committee is primarily responsible for making final
determinations on proxy voting for Nomura Asset Management. The day-to-day
operational activities relating to proxy voting are performed at each of the
departments within Nomura Asset Management.
Notwithstanding the foregoing, proxy voting shall be instructed through NAM's
overseas affiliates which owe a primary responsibility for proxy voting under
the investment advisory agreements entered into with their clients.
1. Proxy Voting Committee
32
The Proxy Voting Committee develops the firm's positions on specific voting
issues, creates proxy voting guidelines (the "Proxy Voting Guidelines"), and
has oversight responsibility over the proxy voting process. From time to time,
it shall have direct decision-making input on a company's specific proxy
voting matters, as more fully described in Section V of this Policy. NAM's
Board of Directors appoints the Chairman of the Proxy Voting Committee, who,
in turn, appoints the other members of the Committee. The Proxy Voting
Committee may be held whenever necessary.
2. Fund Administration Division (Fund Operation Department and Fund Accounting
Department)
For accounts for which NAM serves as manager, its Fund Administration Division
has the primary responsibility for handling proxy voting instructions. The
Division also provides necessary supports to NAM's overseas affiliates with
respect to their accounts.
For a Japanese issuer, Fund Administration Division classifies the proxy
materials received from the custodian depending upon whether (i) it is a
company on the Watch List (as defined in Section VI below), (ii) its proxy
agenda includes any extraordinary items (defined as an item not considered as
"routine agenda". See III.) and (iii) its audit opinion attached to the
company's financial statement is qualified. If a company meets one or more of
the foregoing conditions, the company's proxy materials shall be forwarded to
NAM's Corporate Research Department for its review. If none of the conditions
apply to a company, Fund Administration Division shall instruct the custodian
to vote for the agenda. For the agendas that have been forwarded to Corporate
Research Department, Fund Administration Division shall instruct the custodian
to vote in accordance with the determinations made by Corporate Research
Department, or when necessary, the Proxy Voting Committee.
For a non-Japanese issuer, Fund Administration Division, after receiving the
proxy materials from the custodian, shall forward such materials to either
Corporate Research Department (for Japanese investment trusts) or Equity
Investment Department (for NAM's institutional clients). If proxy materials
are available through other information sources, Corporate Research Department
or Equity Investment Department may rely upon the information from such
sources. Fund Administration Division shall instruct the custodian to vote in
accordance with the determinations made by Corporate Research Department or
Equity Investment Department based on the recommendations made by the overseas
affiliates, or when necessary, the determinations made by the Proxy Voting
Committee. Records of the proxy voting instructed shall be maintained.
3. Operations Department at Overseas Affiliate
The operations department of each overseas affiliate ("Overseas Operations
Department") generally handles proxy voting instructions in accordance with
the investment advisory agreements entered into with its client. The Overseas
Operations Department shall also provide necessary supports to NAM or other
overseas affiliates with respect the accounts of NAM or other overseas
affiliates.
33
The Overseas Operations Department, after receiving the proxy materials from
the custodian, shall forward, if necessary, such materials to NAM or other
relevant overseas affiliates. If proxy materials are available through other
information sources, NAM or other relevant overseas affiliates may rely upon
the information from such sources. After having the agenda reviewed by NAM or
other relevant overseas affiliates, the Overseas Operations Department shall
instruct the custodian to vote. Records of the proxy voting instructed shall
be maintained.
4. Corporate Research Department
NAM's Corporate Research Department, through the support it provides to the
Proxy Voting Committee, plays an important role in the review of proxy
materials.
For Japanese issuers, Corporate Research Department is responsible for
preparing, reviewing and maintaining the Watch List. Corporate Research
Department reviews the proxy materials received from Fund Administration
Division and informs of their determinations on proxy voting. When Corporate
Research Department believes that further review is necessary, Corporate
Research Department requests the Proxy Voting Committee to deliberate on a
specific agenda in question. Corporate Research Department shall inform Fund
Administration Department of the Proxy Voting Committee's determinations in a
timely manner. Corporate Research Department shall keep the minutes of the
Proxy Voting Committee meeting.
Corporate Research Department also reviews the proxy materials received from
NAM's overseas affiliates. Corporate Research Department shall provide its
determinations on proxy voting through the process described above to the
relevant overseas affiliate.
For non-Japanese issuers whose equity securities are held in Japanese
investment trust portfolios, Corporate Research Department, after receiving
the proxy materials from Fund Administration Division, shall forward such
materials to the relevant overseas affiliates. The recommendations of the
overseas affiliates are delivered to Corporate Research Department. General
Manager of Corporate Research Department is responsible for the final
determinations on proxy voting, or when necessary, may refer a specific agenda
to the Proxy Voting Committee.
5. Equity Investment Department
NAM's Equity Investment Department plays an important role in handling proxy
voting for non-Japanese issuers whose equity securities are held in NAM's
institutional accounts. Equity Investment Department, after receiving the
proxy materials received from Fund Administration Division, shall forward such
materials to the relevant overseas affiliates. The recommendations of the
overseas affiliates are delivered to Equity Investment Department. General
Manager of Equity Investment Department is responsible for the final
determinations on proxy voting, or when necessary, may refer a specific agenda
to the Proxy Voting Committee.
Equity Investment Department also provides its determinations on proxy voting
to the overseas affiliates managing Japanese equity accounts. When Equity
Investment Department finds that (i) a company is on the Watch List, (ii) its
proxy agenda includes any extraordinary items, or (iii) its audit opinion
attached to the company's financial statement is qualified, the company's
proxy
34
materials shall be forwarded to Corporate Research Department, and otherwise,
Equity Investment Department shall recommend the overseas affiliate to vote
for the agenda.
6. Investment Department at Overseas Affiliate
The investment department of each overseas affiliate ("Overseas Investment
Department") handles proxy voting for non-Japanese issuers whose equity
securities are held in NAM's Japanese investment trust portfolios and
institutional accounts. The Overseas Investment Department is responsible for
providing recommendations for proxy voting for the issuers in its region,
i.e., Nomura Asset Management U.S.A. Inc. is responsible for North American
equity proxy voting recommendations, Nomura Asset Management U.K. Limited is
responsible for European equity proxy voting recommendations, and Nomura Asset
Management Singapore Limited is responsible for Asian equity recommendations.
When necessary, other Overseas Investment Departments may provide to the
relevant Overseas Investment Department their recommendations about a certain
issuer even if the issuer is not in its region. In addition, the Overseas
Investment Department may utilize third party proxy voting service providers
(e.g., Institutional Shareholder Services (ISS)) to formulate their
recommendations. These recommendations are delivered to NAM's Corporate
Research Department or Equity Investment Department.
The Overseas Investment Departments also provide proxy voting recommendations
to other overseas affiliates managing non-Japanese equity accounts. For such
accounts, the Overseas Operations Department sends voting information to the
relevant overseas affiliate and instructs the custodian as recommended. The
relevant overseas affiliate shall make the determinations on proxy voting
through the process described above.
III. Proxy Voting Process for Japanese Equities
------------------------------------------------
Nomura Asset Management carries out the following proxy voting process for
Japanese equities:
1. Corporate Research Department prepares, reviews and maintains the Watch
List.
2. Fund Administration Division classifies the proxy materials received from
the custodian into companies: 1) which are on the Watch List, 2) their
proxy agenda includes any extraordinary items (defined as an item not
considered as "routine agenda." See III.), and 3) their audit opinion
attached to their financial statement is qualified.
3. If none of the conditions stated above applies to a company, Fund
Administration Division then instructs the custodian to vote for the
agenda.
4. When Fund Administration Division finds that (i) the company is on the
Watch List, (ii) the proxy agenda includes any extraordinary item, or
(iii) its audit opinion attached to the company's financial statement is
qualified, the proxy material is then forwarded to Corporate Research
Department for its review.
5. Corporate Research Department reviews the agenda and when they find that
the agenda has any problem, details are sent to the Proxy Voting
Committee for its deliberation. When Corporate Research Department
determines that there is no problem involved, Corporate Research
Department informs Fund Administration Division of its determinations on
proxy voting.
35
6. The Proxy Voting Committee closely reviews the agenda in accordance with
the Proxy Voting Guidelines. When the Proxy Voting Committee finds a
specific agenda would not be in the clients' best interests, the Proxy
Voting Committee shall determine whether to abstain from or vote against,
such specific agenda. The Proxy Voting Committee's determinations shall
be informed to Fund Administration Division.
7. The agendas reviewed by the Proxy Voting Committee shall be reported to
the NAM's Management Committee or Board of Directors.
8. For Japanese issuers whose equity securities are held in the overseas
affiliates' accounts, the Overseas Operations Department receives the
proxy materials from the custodian, and instructs the custodian in
accordance with the determinations on proxy voting made by the NAM's
Equity Investment Department. When the Equity Investment Department finds
that (i) a company is on the Watch List, (ii) its proxy agenda includes
any extraordinary item, or (iii) its audit opinion attached to the
company's financial statement is qualified, the company's proxy materials
shall be forwarded to Corporate Research Department for its review, and
otherwise, Equity Investment Department shall recommend Overseas
Operations Department to vote for the agenda. Corporate Research
Department shall provide its determinations through the process described
above.
Note 1. "Routine agendas" are as follows:
1. Appropriation of profit
2. Election of directors (uncontested elections only)
3. Election of statutory auditors
4. Payment of lump sum bonus to retiring directors
5. Payment of lump sum bonus to retiring statutory auditors
6. Amendment to compensation table for directors or statutory auditors
7. Notwithstanding foregoing, any shareholder proposal is not considered
as routine proposals.
IV. Proxy Voting Process for Non-Japanese Equities
---------------------------------------------------
Nomura Asset Management carries out the following proxy voting process for
non-Japanese equities:
1. For institutional client accounts, cash flow of which is infrequent,
Nomura Asset Management shall instruct, in principal, proxy voting with
respect to each issuer of equity securities held in its institutional
accounts; provided the Company is authorised to do so by the client.
2. For Japanese investment trusts or other open-ended investment vehicles,
cash-flow of which is frequent, Nomura Asset Management and its overseas
affiliates shall instruct proxy voting on each proxy voting matter;
provided, however, that a proxy voting shall not be instructed if the
exercise of proxy imposes any restriction on disposal of the securities.
Nomura Asset Management, in instructing proxy voting, considers costs and
benefits associated therewith.
3. NAM's Corporate Research Department or Equity Investment Department, in
accordance with the Proxy Voting Guidelines, prepares, reviews and
maintains the Watch List or list of companies that potentially have
problems in terms of clients' best interests.
36
4. NAM's Fund Administration Division, after receiving the proxy materials
from the custodian, shall forward such materials to Corporate Research
Department or Equity Investment Department. If proxy material are
available through other information sources, they may rely upon the
information from such sources.
5. If the custodian has not sent a proxy material, Corporate Research
Department or Equity Investment Department may seek information through
other informational sources such as third party information venders.
6. Corporate Research Department or Equity Investment Department shall
forward the proxy materials to the relevant overseas affiliates. The
proxy materials that are available through other information sources may
be used in lieu of their hardcopies.
7. Each overseas affiliate sends its proxy voting recommendations to
Corporate Research Department or Equity Investment Department. The
overseas affiliates may utilize third party proxy voting service
providers to formulate their recommendations.
8. Corporate Research Department or Equity Investment Department, after
reviewing the proxy voting recommendations from the overseas affiliates,
shall inform Fund Administration Division of its determinations. Fund
Administration Division shall instruct the custodian to vote in
accordance therewith. When necessary, General Manager of Corporate
Research Department or Equity Investment Department may refer a specific
agenda to the Proxy Voting Committee for its review. The Proxy Voting
Committee closely reviews the agenda in accordance with the Proxy Voting
Guidelines. If the Proxy Voting Committee believes the agenda referred to
is not in our clients' best interests, it shall determine either to
abstain from or vote against, such agenda. The determinations of the
Proxy Voting Committee shall be informed to Fund Administration Division.
The agendas reviewed by the Proxy Voting Committee shall be reported to
NAM's Management Committee or Board of Directors.
9. Corporate Research Department and Equity Investment Department shall
maintain records of the proxy voting recommendations.
10. Fund Administration Division shall maintain records of the proxy voting
instructed.
11. For non-Japanese issuers whose equity securities are held in the overseas
affiliate's accounts, the Overseas Operations Department receives the
proxy materials from the custodian, and instructs the custodian in
accordance with the proxy voting recommendations made by the Overseas
Investment Department of other relevant overseas affiliate. The Overseas
Investment Department shall provide its recommendations through the
process described above.
V. Proxy Voting Guidelines
---------------------------
The Proxy Voting Committee closely examines company voting agendas under the
cases listed below. If it believes that a specific agenda is not in our
clients' best interests, the Proxy Voting Committee shall decide either to
abstain from or vote against, such agenda.
1) If it is publicly announced that the issuer violated the law or otherwise
its conduct severely harms social interests. In such cases, Nomura Asset
Management would vote for shareholder social or political proposals only
if it enhances investment value.
2) If the issuer's audit opinion is qualified (for Japanese equity
securities).
3) If the issuer's disclosure is inadequate and deemed to be considerably
harmful to the investor interest.
37
4) If the issuer continuously reports poor business results and its
management's efforts for improvement are found to be inadequate.
5) If the issuer plans a substantial change in its financial or business
strategy and such plan has the potential to severely harm the shareholder
interest or the issuer's long-term business development. Notwithstanding
the foregoing, Nomura Asset Management may vote for such a plan in
consideration of the reasonable business judgment.
6) If the issuer's board of directors or statutory auditors do not provide
an adequate level of internal control and is likely to harm shareholder
interest.
7) If an extraordinary agenda such as amendment to articles of incorporation
is proposed which is likely to harm shareholder value.
8) For a shareholder proposal, the Proxy Voting Committee makes the final
determination based upon whether the proposal would contribute to higher
shareholder value.
VI. The Watch List
-------------------7
Instructing exercise of proxy voting appropriately and effectively is often
made difficult by the large number of proxies and information to be processed.
In order to facilitate the proxy voting process, Nomura Asset Management shall
screen its investments based on certain predetermined criteria to create a
list of the problematic companies that requires increased review (the "Watch
List"). A separate Watch List is created for Japanese and non-Japanese
issuers.
1. Watch List Criteria for Japanese Companies: A Japanese company shall be
placed on the Watch List if:
a. it is publicly announced that the company violated the law and/or if
it was determined that the company's conduct severely harms social
interests;
b. the company's disclosure is determined to be inadequate, or its
financial strategy and/or business operations are deemed to pose a
severe threat to shareholders' interests and to the company's future
business developments, or it is deemed that its internal control
program is inadequate and is likely to harm shareholder interests;
c. it meets one or more of the following conditions:
i. the company has an accumulated deficit in the most recent
accounting period;
ii. the company has reported losses or has paid no dividend for the
past three accounting periods;
iii. the company has reported losses or has paid no dividend for the
past five accounting periods, and has an accumulated deficit in
the most recent accounting period.
d. it meets one or more of the following conditions:
i. the company's net financial assets exceed its the total
market capitalization;
ii. the company's net financial assets exceed 50 percent of its total
sales;
iii. the company's net financial assets exceed 50 percent of its total
assets;
iv. the company's ROE is below 5 percent.
(The term "net financial asset" shall equal current assets less
current liabilities)
e. it meets one or more of the following conditions:
38
i. For a company listed on the First Section of either of Tokyo,
Osaka, or Nagoya Stock Exchanges, its annual investment return
has belonged to the worst quartile of its TSE 33 industry sector
during the past three years.
ii For a company listed on the Second Section of either of Tokyo,
Osaka, or Nagoya Stock Exchanges, its annual investment return
has belonged to the worst quartile of its TSE 33 industry sector
during the past three years.
iii For a company traded on an OTC market, its annual investment
return has belonged to the worst quartile of the entire OTC
stocks during the past three years.
2. Watch List Criteria for non-Japanese Issuers: A non-Japanese company shall
be placed on the Watch List if:
a. if it meets one or more of the following conditions:
i. its investment return has been below the sector index return
(i.e., an index based upon the MSCI's 10 sectors) by 40 percent
for the past three years, and if the company has reported
losses (computed on earnings per share basis) for the past three
accounting periods. If sector classification information is not
available for a certain company, the company is compared to the
MSCI country index to which the issuer belong;
ii. its investment return has been below the sector return index
(i.e., an index based upon the MSCI's 10 sectors) by 70 percent
for the past three years. If sector classification information is
not available with respect for a certain company, the company is
compared within the MSCI country index to which the issuer
belongs;
iii. when Nomura Asset Management holds more than 1 percent of all the
outstanding shares of a certain issuer.
b. Corporate Research Department or Equity Investment Department shall
produce and send the Watch List to the overseas affiliates and other
relevant departments. Each overseas affiliate reviews the company on
the Watch List, in accordance with the Proxy Voting Guidelines, and
may remove a company from the Watch List if it reasonably believes
that its inclusion on the list is not warranted. The overseas
affiliate, when necessary, may add a company to the Watch List;
c. General Manager of Research Department or Equity Investment Department
are responsible for making the final determinations regarding the
deletion or addition of certain companies to and from the Watch List.
Corporate Research Department or Equity Investment Department shall
maintain records of their determinations;
d. The Watch List generally shall be up-dated on semi-annual basis.
Screening criteria shall be reviewed when necessary, and any change to
the criteria must be approved by the Proxy Voting Committee.
VII. Conflicts of Interest
---------------------------
Due to the nature of Nomura Asset Management's business and its large size, it
is possible that material conflicts of interest will arise in voting of
proxies of public companies (for example,
39
Nomura Asset Management may have a business relationship with an issuer whose
securities are held in client portfolios).
When such a material conflict arises, Nomura Asset Management shall vote in
accordance with recommendations made by a third party proxy voting service
venders (e.g., ISS). A material conflict of interest will occur if Nomura
Asset Management is to vote on behalf of its client for a certain issuer with
a close business relationship generating revenue of more than 1 percent of the
total revenue of Nomura Asset Management and such proxy voting is for the
purpose of providing an unjust enrichment to the director, officer, or other
affiliate of this issuer. If the revenue from a business relationship with
this issuer is more than 0.5 percent of the total revenue of Nomura Asset
Management, Nomura Asset Management shall closely examine the agenda to see
whether there is any potential conflict of interest.
VIII. Positions on Special Matters
----------------------------------
Corporate Governance
--------------------
o Election of Directors
Nomura Asset Management votes for the management's proposed directors in
uncontested elections. For contested elections, we vote for candidates
that best serve our clients' best interests. Nomura Asset Management
votes, in principal, for proposals calling for a board consisting of
directors who are independent of the company, subject to the skills and
experience of the candidates. We vote against proposals that stagger the
board, if it does material harm to the shareholder's interest.
o Mergers, Acquisitions and Other Corporate Restructurings
Nomura Asset Management views all proposals on a case-by-case basis by
looking at the financial impact on our clients.
o Anti-takeover Measures
Nomura Asset Management will vote, in principal, against proposals that
make it more difficult for a company to be acquired by another company. We
believe that anti-takeover measures may depress the company's market
value.
Shareholder Rights Protection Plans (Poison Pills): Shareholder rights
plans, typically known as poison pills, often involve issuing stock
purchase rights or warrants to shareholders. These rights or warrants are
usually not exercisable unless a hostile takeover offer is tendered or a
potential acquirer of the company purchases a specific percentage of the
shares. Typically, the plan will allow the rights holders to purchase
shares from, or sell shares to, the company at very favorable prices. This
increases the costs to the potential acquirer, thus making the takeover
less attractive.
Nomura Asset Management recognizes that there are arguments in favor and
against shareholder rights plans (i.e., "Poison Pills"). Therefore, we
support, in principal, proposals that ask that shareholders to approve
such plans. Nomura Asset Management will assess shareholder rights plans
on a case-by-case basis, generally supporting plans designed to protect
shareholder value rather than to insulating the board and management.
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Supermajority Provisions: Supermajority voting requires the vote of more
than a simple majority (typically 66.7% to 80% of the vote) to approve a
decision or transaction. Supermajority voting can limit the ability of
shareholders to effect change by essentially giving veto power to a large
minority shareholder or group of minority shareholders. As a result,
Nomura Asset Management will vote against proposals to impose
supermajority requirements, while vote for proposals that remove
supermajority voting requirements.
Capital Structure Changes
-------------------------
o Increased Authorized Common Stocks
Companies may request increases in authorized stocks for a variety of
legitimate business purposes. For example, the additional shares may be
used to raise new investment capital for acquisitions, stock splits,
recapitalizations or debt restructurings. Nomura Asset Management votes
for these proposals in the absence of unusual circumstances. Otherwise,
proposals will be voted on a case-by-case basis.
o "Blank Check" Preferred Stocks
Nomura Asset Management will highly scrutinize proposals to authorize
preferred stocks whose voting, conversion, dividend and distribution, and
other rights are determined by the company's board of directors when the
stocks are issued ("Blank Check Preferred Stock"). We recognize that Blank
Check Preferred Stocks can be used for legitimate financing purposes, but
also could be used to thwart hostile but desirable takeovers without
shareholder approval. To protect our clients, but still give financial
flexibility to management, Nomura Asset Management will vote for the
authorization of, or an increase in, Blank Check Preferred Stock in cases
where the company expressly states that the stock will not be used as an
anti-takeover defense or carry superior voting rights. All other Blank
Check Preferred Stock proposals will be handled on a case-by-case basis.
Management Compensation
-----------------------
Nomura Asset Management votes for reasonable compensation of executives,
particularly equity-based compensation plans that are linked to the interests
of the company's long-term shareholders. We vote against plans that are
inconsistent or inequitable with the company's overall financial condition or
that would substantially dilute the interests of our clients.
Corporate and Social Responsibility
-----------------------------------
NOMURA ASSET MANAGEMENT BELIEVES IT IS MANAGEMENT'S RESPONSIBILITY TO HANDLE
ORDINARY BUSINESS MATTERS. RATHER THAN ARBITRARILY IMPOSE A JUDGMENT ON SUCH
MATTERS, WE WILL TYPICALLY ABSTAIN FROM VOTING ON PROPOSALS CONCERNING
CORPORATE AND SOCIAL POLICY ISSUES. HOWEVER, NOMURA ASSET MANAGEMENT MAY
DECIDE TO VOTE ON SUCH ISSUES ON A CASE-BY-CASE BASIS RECOGNIZING THAT
CORPORATE AND SOCIAL RESPONSIBILITY ISSUES SOMETIMES DO IMPACT THE
RISK-ADJUSTED FINANCIAL RETURN OF OUR INVESTMENTS.
Nomura Asset Management
Policy and Process on Corporate Governance and Proxy Voting
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Schedule 1
Nomura Asset Management Co., Ltd.
Nomura Asset Management Hong Kong Limited
Nomura Asset Management Singapore Limited
Nomura Asset Management U.K. Limited
Nomura Asset Management U.S.A. Inc.
ITEM 8. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS
------------------------------------------------------------------------------
Form N-CSR disclosure requirement not yet effective with respect to the
Registrant.
ITEM 9. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
------------------------------------------------------------------------------
The principal purpose of the Registrant's Nominating Committee is to
select and nominate the Directors of the Registrant. It evaluates candidates'
qualifications for Board membership and, with respect to nominees for
positions as independent directors, their independence from the Registrant's
manager and its affiliates and other principal service providers.
The Nominating Committee will consider potential director candidates
recommended by Registrant shareholders provided that the proposed candidates
satisfy the director qualification requirements provided in the Nominating
Committee's Charter; are not "interested persons" of the Registrant or the
Registrant's investment adviser within the meaning of the Investment Company
Act; and are "independent" as defined in the New York Stock Exchange listing
standards. The Committee has determined that potential director candidates
recommended by Registrant shareholders must satisfy the Securities and
Exchange Commission's ("SEC") nominee requirements found in Regulation 14A of
the Securities and Exchange Act of 1934, as amended ("1934 Act"). Shareholders
recommending potential director candidates must substantiate compliance with
certain requirements at the time of submitting their proposed director
candidate to the attention of the Registrant's Secretary.
The Nominating Committee identifies prospective candidates from any
reasonable source and has the ability to engage third-party services for the
identification and evaluation of potential nominees. The Committee meets
annually to identify and evaluate nominees for Director and makes its
recommendations to the Board. In identifying and evaluating a potential
nominee to serve as an independent Director of the Registrant, the Nominating
Committee will consider, among other factors: (i) whether the individual has
any material relationships that could create any appearance of impropriety
with respect to or a lack of independence from NAM-U.S.A. or any of its
affiliates; (ii) whether the individual has the integrity, independence of
mind and personal qualities to fulfill the fiduciary duties of an independent
Director of the Registrant and to protect the interests of Registrant
shareholders; (iii) the individual's corporate or other business experience in
significant positions which demonstrate sound business judgment; (iv) whether
the individual has financial and accounting experience; (v) the individual's
ability to and attend at least four regular meetings a year and (vi) whether
the individual can add to the balance of experience of the present independent
Directors. The standard of the Nominating Committee is to treat all equally
qualified nominees in the same manner.
ITEM 10. CONTROLS AND PROCEDURES
------------------------------------------------------------------------------
The Registrant's Principal Executive Officer and Principal Financial Officer
have evaluated the Registrant's disclosure controls and procedures within 90
days of the filing of this report and have concluded that they are effective
in providing reasonable assurance that the information required to be
disclosed by the Registrant in its reports or statements filed under the 1934
Act is recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange Commission.
There were no changes in the Registrant's internal control over financial
reporting that occurred during the Registrant's last fiscal half-year (the
Registrant's second fiscal half-year in the case of an annual report) that
have materially affected, or are reasonably likely to materially affect, the
Registrant's internal control over financial reporting.
ITEM 11. EXHIBITS
------------------------------------------------------------------------------
99(a)(1) Code of Ethics.
99(a)(2) Certifications of Principal Executive Officer and Principal Financial
Officer pursuant to Rule 30a-2 under the Investment Company Act of
1940 are attached hereto as an exhibit.
99(a)(3) Not applicable.
42
99.(b)(1) Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 are furnished herewith as an exhibit.
43
SIGNATURES
------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Japan Smaller Capitalization Fund, Inc.
By: /s/ Yasushi Suzuki
-------------------------------------
Yasushi Suzuki, President
(Principal Executive Officer)
Date: May 12, 2004
-------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
By: /s/ Rita Chopra-Brathwaite
-------------------------------------
Rita Chopra-Brathwaite, Treasurer
(Principal Financial Officer)
Date: May 12, 2004
-------------------------------------
44