Market Commentary and Fund Performance

Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Performance data current to the most recent month end, and standardized performance can be obtained by viewing the fact sheet or by clicking here.

Fund Performance Review

In January 2025, the TOPIX, which is a leading index of the Japanese stock market, rose by 1.63% compared to the end of the previous month.

In the first half of the month, the stock market declined amid rising long-term interest rates in both Japan and the U.S., following the dampening of expectations for a U.S. rate cut. This shift was driven by stronger-than-anticipated U.S. business sentiment and employment data, as well as reports that the Biden administration planned to tighten export controls on semiconductors for artificial intelligence (AI). The subsequent official announcement of these controls further weighed on sentiment. Midway through the month, remarks by the Bank of Japan’s (BOJ) Governor and Deputy Governor at the Monetary Policy Meeting signaled that a rate hike would be a topic of discussion and decision-making, increasing speculation of imminent policy tightening. This triggered yen appreciation, placing additional pressure on the stock market. However, as equities approached a key technical support level that had served as a floor since last fall, selling pressure subsided, leading to a sharp rebound.

In the latter half of the month, the Japanese stock market remained resilient, buoyed by U.S. President Trump’s decision to defer the immediate imposition of tariffs on China, a key campaign pledge, and an announcement from SoftBank Group, OpenAI (U.S.), Oracle (U.S.), and others regarding plans to invest up to $500 billion in U.S. artificial intelligence (AI) development over the next four years. These developments provided a strong tailwind for AI and semiconductor-related stocks. However, towards month-end, sentiment was dampened after Chinese AI developer DeepSeek revealed that it had developed a large-scale language model, surpassing U.S. counterparts at a lower cost. This raised concerns about the future competitive positioning of U.S. semiconductor firms, prompting a sharp sell-off in AI and semiconductor stocks in both Japan and the U.S., exerting downward pressure on the broader market. Nevertheless, equities staged a recovery towards the end of the month, closing at levels roughly unchanged from the previous month. Overall, the market continued to fluctuate within a well-established trading range. Although the BOJ raised its policy rate by 0.25% during the month, its impact was limited, as the move had been largely priced in following prior statements from the central bank’s leadership and widespread reports anticipating the hike.

This month, the Fund returned -0.16% (HJPIX), underperforming its benchmark, the Russell/Nomura Total Market™ Index, which returned 2.31%.

The month’s positive performers among the Global Industry Classification Standard (GICS) sectors included shares of Information Technology, Consumer Discretionary, and Financials while Materials, Consumer Staples, and Health Care detracted from the Fund’s performance.

Among the best performers were our investments in Mitsubishi UFJ Financial Group, Inc., one of Japan’s largest financial groups, Tokyo Electron Limited, one of the world’s largest manufacturer of semiconductor production equipment and SOMPO Holdings, Inc., one of the three largest general insurance company in Japan.

As for the laggards, Tokio Marine Holdings, Inc., Japan’s largest general insurance company with arguably the best underwriting track record and successful overseas expansion, Shin-Etsu Chemical Co., Ltd., Japan’s largest chemical company, and MS&AD Insurance Group Holdings, one of the leading non-life insurance company in Japan.

Recruit Holdings Co., Ltd.

Shares of Recruit Holdings Co., Ltd., which have been held in our Strategy since 2016, have seen a significant surge in 2024 soaring to all-time highs. Recruit is one of the “pure” growth stocks that we decided to keep during the major reshuffling of the holdings back in 2022.

As a platformer, it operates various online media, with Indeed, the world’s largest recruitment platform, at its core. Indeed has been rapidly rolling out new services to enhance the efficiency and automation of corporate recruitment activities in recent years.  As a result, the company’s already formidable moats are being further strengthened.

Recruit’s competitive strength

Recruit is Japan’s unique print/online media giant targeting job advertisement as well as other domestic industries such as property, travel, and restaurants. It also operates staffing agencies. The firm’s history dates back to the 1960s when the founder Hiromasa Ezoe, who was an undergraduate college student, started an on-campus classified print ad business to connect job-seeking students with hiring companies, both of whom lacked an effective means of approaching each other.

Achieving quick success, Mr. Ezoe formed a company around it. Subsequently, he branched into different industries where the service providers remained fragmented and did not have an effective reach to attract prospective consumers. Since its inception more than 60 years ago, the company has thrived to become one of the largest privately held companies in Japan with household media names like “Rikunabi” (classified ad), “Suumo” (property), “Jalan” (domestic travel), “AB-Road” (overseas travel¹), “Zexy” (wedding hall), “Car Sensor” (used car dealers), “Hot Pepper” (restaurants). Over the years, it has successfully evolved to embrace digital technology to keep pace with changing media industry landscape.

Recruit is a vertically integrated company that controls the entire process from dealing directly with advertisers to producing proprietary media platforms and attracting individual customers and job seekers through them. This comprehensive approach creates significant barriers to entry for new competitors. After being a private company for half a century, Recruit went public in late 2014 with a market cap of 2tn yen ($13.4bn), and today its market cap exceeds 15tn yen ($100.7bn), making it one of the five largest companies in Japan.

The company’s business philosophy is centred around charging enterprises only for the value-additive services it provides, rather than charging individuals. Recruit also aims to shift its revenue model towards performance-based fees, as demonstrated by Indeed’s recent development, rather than the traditional “pay-per-click” basis. This approach differentiates the company from competitors like LinkedIn, ZipRecruiter, and Monster.com.

Indeed

Recruit is essentially an online media conglomerate with a focus on recruitment services. Under its umbrella, it owns Indeed Inc. (acquired in 2012) and Glassdoor (acquired in 2018) along with many other proprietary online media.

Indeed is the world’s largest online job search/recruitment platform. According to its website, the platform boosts:

•    580 million job seeker profiles

•    295 million resumes

•    1 billion reviews

•    3.5 million+ employers using the service

•    60+ countries (28 languages) in which it operates

As a media business, Indeed’s competitive barriers are characterized by its network effects, in which its media platforms attract many advertisers, drawing in prospective individual customers, which in turn brings in more advertisers whereby creating virtuous cycles.

Before its 2004 inception in the U.S., online job ads were primarily created in HTML format, which was ideal for displaying web pages but limited in its ability to structure and exchange data. This made it time-consuming for job seekers to search for employment opportunities across various websites.

Indeed’s early success was largely attributed to the internet technology transition from HTML to XML format, which enabled the crawling of job listing data from various websites and allowed for a wider range of job opportunities to be aggregated and searched on its platform. The first-mover advantage put Indeed in a prime position to dominate the human resources (HR) technology market.

With its comprehensive coverage, Indeed has become a go-to platform for job seekers, providing a user-friendly interface to search for job openings. Companies that post job listings on Indeed can reach a vast pool of potential candidates, making it the most attractive option for hiring. The use of XML in this context enables the standardization of job information data, facilitating the process of data exchange and making it easier for job seekers to access information on job openings. In contrast, HTML is not specialized in data structuring and exchange, making XML a more suitable choice for handling job listing data.

High returns on capital, high operating leverage, high growth rate

We typically use the “seven key investment criteria” to determine the attractiveness of the business for investment. However, when considering a potential opportunity for exponential growth, we find it more useful to focus on the following criteria:

•    High returns on capital (ROC)

•    High operating leverage

•    A long-term secular high growth rate with a large addressable market

Interestingly, these three dimensions don’t always coexist, even in well-established, high-quality businesses. For instance, Costco, the well-known U.S. big box retailer, boasts high ROC, but operating leverage is relatively low, resulting in a quite linear profit growth trajectory due to large variable costs as a percentage of revenue. In some cases, high ROC and high operating leverage may be present simultaneously, but the expected growth rate can be low. A dominant yet mature software company is a good example, such as Microsoft during the 2000s.

On the other hand, internet companies often possess all three criteria, making them an important sector for growth managers.

A high entry barrier business is attractive, a growing barrier is better

A business with a high return on equity (ROE) indicates that it can generate excess returns compared to the cost of capital, making it attractive to new entrants. However, this also means that the business needs to have a strong defence against potential threats in the form of entry barriers.

We consider entry barriers to be ‘dynamic’ and not static. That is, even if the barrier is high if it becomes gradually weakened by competition, it does not qualify as a good investment. On the other hand, a company that can maintain its entry barriers, and better yet, continue to raise them is a wonderful business to own. Currently, Recruit appears to be in such a phase through launching multiple new services to widen its lead over its competitors.

Recent examples of new services

Indeed Hiring Platform: (Introduced in March 2021) Indeed Hiring Platform is a platform that enables employers to directly manage the hiring process on Indeed, from job posting to conducting interviews, without the need for additional software.

Indeed Apply: (Introduced in June 2021) Previously, the job seeker had to navigate an external company website to apply for the job after finding it through a search on Indeed. Job seekers can now search for jobs and submit applications directly without leaving the Indeed platform. The application process is quick and efficient by registering their resume on Indeed.

PPSA (Pay-Per-Started-Application): (Introduced in April 2023) A departure from its original pay-per-click model to a pay-for-performance model. The fee is only charged when an interested job seeker clicks to see the job listing and submits his application.

Indeed PLUS: (Introduced in January 2024) A proprietary job listing distribution platform. Depending on the type of the job (position for new graduate, part-timer, or mid-career professional), the platform can post it on the most suitable website/job board in its ecosystem, within which they are connected through API, allowing for more efficient matching of job seekers and jobs.

Indeed Smart Sourcing: (Introduced in April 2024) Smart Sourcing enables the employer to search for qualified candidates from a pool of resumes registered on Indeed. The service also leverages AI tools to make recommendations for candidates to the employer. The resume search was previously done by the hiring company manually, but Smart Sourcing can facilitate this process. The employer can approach the candidate through personalized emails.

We view these initiatives as efforts to further strengthen the company’s already high entry barrier (aka the moat). The platform’s users, whether it is job seekers or employers, will be drawn in by its utility, leading to increased user stickiness. As a result, the business would have a greater ability for fee hikes, which should translate into higher returns on capital.

According to the company’s Investor Day held in March 2024, the current take rate, which is the fee received by the company for successful job placement as a percentage of the placed candidate’s first-year salary, is less than 1%. This is significantly lower than the industry average of around 20% charged by general recruiting agents and up to 40% for executive search firms.

However, management believes there is significant upside potential for the take rate, considering the current low rate and the relative affordability of the service. The company can potentially double or triple its fees and still offer a significantly lower cost per hire compared to other rival services.

One of the missions set by management, “Simplify Hiring,” is worth mentioning. The company aims to facilitate hiring and automate the applying process and hiring process, which is becoming increasingly crucial. Indeed strives to improve matching accuracy through large troves of data collected on its platform.

At the FY2020 full-year results meeting, Hisayuki Idekoba, the CEO who spearheaded the acquisition of Indeed, shared his grand vision where “people who want a job can change jobs in one second” or “people can find a new job with the push of a button” by fully utilizing AI and machine learning. It will be interesting to see how new services will develop from within Recruit in this endeavour.

Valuations

Internet growth stocks are hard to value with a definitive margin of safety. This is because it is difficult to find quantitatively undervalued indicators such as price to book ratio (P/B) less than 1x, high dividend yields, or price to earnings ratio (P/E) that are significantly below the market average to argue for limiting the downside risk.

In many cases, because the company appears to be overvalued compared to other industries, no matter how much its intrinsic value exceeds its current market cap, the stock market tends to be sensitive to temporary negative news, and stock price volatility tends to be severe. Recruit is no exception.

However, Internet companies characterized by high operating leverage often announce earnings results that far exceed market expectations. For this reason, we believe that stock prices that may seem overvalued at first glance are acceptable to some extent. We also believe it is a sensible decision to hold such names in the strategy, so long as the position is appropriately sized. We maintain that the strategy successfully combines a focused approach with a diverse range of elements, or as we have said previously “concentrated yet diversified.”

Click here for a full listing of Holdings.