Mark Headley, who manages the second-best-performing U.S. mutual fund focused on Japan, is buying shares of financial services companies in anticipation of higher industry profits as consumer lending and investment climb.

"When I first went to Japan 11 years ago, you couldn't use a credit card outside Tokyo," Headley said in an interview from his office at Matthews International Capital Management LLC in San Francisco. "Now we have Internet brokerages."

The $195 million Matthews Japan Fund rose 27.5 percent in the past 12 months, outperforming the 8 percent gain in dollar terms of the Nikkei 225 Stock Average and 12 of 13 competing Japanese funds tracked by Bloomberg. Only the Fidelity Japan Smaller Companies Fund, run by Kenichi Mizushita, did better, gaining 37.4 percent.

Headley's biggest holding as of July 31 was Monex Beans Holdings Inc., Japan's largest online brokerage. The Tokyo-based company's earnings surged 35-fold in the three months ended June, as average daily trading volume more than doubled. Headley also added to his stake in Sumitomo Trust & Banking Co. this year, buoyed by optimism about potential bank mergers.

"We've really had a home run with the financials," the 45-year-old Headley said.

The one-time competitive fencer, who tried out for the 1988 and '92 U.S. Olympic teams, invests in about 45 companies. About 21 percent of the fund's assets were in financial companies at the end of July, compared with an industry average of about 14 percent.

Headley also has stakes in consumer companies such as Ito En Ltd., producer of Japan's top-selling brand of canned and bottled green tea, and Seven-Eleven Japan Co. of Tokyo, the nation's largest chain of convenience stores, as well as flat-panel television makers Matsushita Electric Industrial Co. and Sharp Corp.

Japan's economy, the world's second-largest after that of the United States, is forecast by the government to grow 3.5 percent in the fiscal year ending March 31, the most in eight years.

Consumer lending is also increasing. At Mitsubishi Tokyo Financial Group Inc., Japan's second-largest bank, consumer lending rose 8.6 percent to 8.1 trillion yen ($74 billion) in the fiscal year ended March 31. Sumitomo Mitsui Financial Group Inc.'s consumer finance business gained 1.5 percent, to 13.9 trillion yen.

This year has been a watershed for Japanese banking, Headley said. Sumitomo Mitsui Financial, which is separate from Sumitomo Trust in Osaka, is in a takeover battle with Mitsubishi Tokyo Financial for control of UFJ Holdings Inc., the country's No. 4 lender. A merger would create the world's biggest bank, eclipsing Citigroup Inc.

UFJ Holdings of Osaka is seeking a merger partner to help reduce its 4.62 trillion yen in bad loans to meet a government deadline. Japanese Prime Minister Junichiro Koizumi wants to slash bad loans that are curbing economic growth. In 2002, regulators unveiled a plan to cut bad loans in half at the country's largest banks by March 2005.

Regardless of which bank buys UFJ, the nation's economic recovery will boost investor confidence and demand for Sumitomo Trust's mutual fund and asset-management services, said Headley, who has degrees in economics and politics from the University of California at Santa Cruz.

"You are seeing improved loan books in Japan and much-improved balanced sheets," said Samarjit Shankar, director of global strategy at Mellon Financial Corp.'s foreign-exchange group in Boston. Institutional investors in the United States started taking larger stakes in Japanese financial stocks during the fourth quarter, according to data compiled by Mellon Financial.

The Topix Banks Index is up 29 percent in dollar terms in the past 12 months, outperforming the 12 percent advance of the broader Topix Index.

The value of financial assets held by Japanese households rose in the second quarter to the highest in three years as stock markets gained, according to a report from Bank of Japan. Financial assets rose for the fourth consecutive quarter and were the highest since June 2001.

Japanese consumers, bolstered by better returns and economic conditions, may start spending more on everything from flat-panel TVs to green tea, Headley said. That view is what led him to stocks including Tokyo-based Ito En and Matsushita Electric.

Headley expects demand for high-tech televisions to rise as prices fall and the popularity of cable programming increases in Japan. "Flat-panel TVs are going to be ubiquitous," he said.

Headley hasn't eliminated any stock holdings this year, restraining his fund's returns. Shares of NTT DoCoMo Inc. are down 29 percent during the past 12 months. Tokyo-based NTT DoCoMo, the world's No. 2 mobile-phone company, was the fund's second-biggest holding at the end of last year.

"NTT DoCoMo hasn't been a great investment," Headley said. The stock is trading slightly under the middle of its 52-week range on the New York Stock Exchange and closed Friday at $18.80 per share.

Headley said he helped start the Newport Tiger Fund in 1989, the first U.S.-based mutual fund to invest exclusively in Asian companies outside Japan. Fifteen years later, Headley said, he continues to search for companies that will be industry leaders.

"Some of these companies are going to be giants," he said.