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.

Market Commentary and Fund Performance for March 2024

In March 2024, the Japanese stock market’s representative index, the TOPIX, gained 4.44% month over month, while the Nikkei Stock Average climbed by 3.07%. The Japanese stock market had a solid first half of the month, with the Nikkei 225 reaching JPY 40,000 ($259) for the first time in its history, driven by the ongoing rise in semiconductor-related stocks. However, the market took a downturn toward the middle of the month. Factors contributing to this downturn included the impact of the fall in U.S. semiconductor-related stocks, reports suggesting the Bank of Japan’s (BoJ) lifting of its negative interest rate policy, and rising expectations for high wage increases during the spring labor-management wage negotiations (Shunto), leading to speculation about the BoJ normalizing its monetary policy and the yen’s appreciation. Toward the end of the month, share prices rose as the yen weakened, reflecting the BoJ’s stance to maintain the accommodative financial conditions for the foreseeable future, as well as its decision at its monetary policy meeting to lift its negative interest rate policy, eliminating its long- and short-term interest rate controls, and ending purchases of exchange-traded funds (ETFs). As a result, the Tokyo Stock Price Index rose by 3.28% month-over-month, while the benchmark for the Fund, the Russell/Nomura Small Cap™ Index, returned 2.85%. The Fund’s performance returned 3.19% (HJPIX), outperforming its benchmark.

This month, the Fund saw gains from Daihen Corporation, a manufacturer of power supplies for semiconductor production equipment; and Tosei Corporation, whose mainstay is real estate revitalization in Tokyo Metropolitan area office buildings and rental housing. On the other hand, losses came from a biopharmaceutical firm PeptiDream Inc., and a medical equipment manufacturer Nihon Kohden Corporation.

Daihen Corporation’s share price rallied on rising expectations for expanded business opportunities among its client SPE manufacturers. Tosei rose alongside real estate stocks due to bullishness on a continued accommodative monetary policy despite the BoJ’s announcement of a policy rate hike. PeptiDream’s stock lost value due to concerns about deteriorating short-term performance after the company had no announcement about new licensing income. Nihon Kohden was not mentioned in any notable news, but its share price fell amid concerns about deteriorating earnings due to increased upfront costs and other factors.

We continued to increase the Fund’s holdings in its portfolio companies while selling stocks with rising share prices that no longer seemed undervalued. We also sold stocks that have fundamentally diverged from our initial investment hypotheses. We made two new investments including a service operator.

Outlook for April 2024

Immediate concerns include the Middle East and Ukraine conflicts, the geopolitical uncertainty smoldering ahead of various elections, and the impact of the slowdown in the Chinese economy. However, a gradual recovery in the global economy is expected due to rising expectations that the U.S. would relax its monetary policy. In the Japanese market, the BoJ has raised its policy interest rate as the first step in normalizing its monetary policy. That indicates a virtuous cycle of wages and prices in the Japanese economy should be generated, creating an environment that is conducive to expectations of improved earnings for domestic demand-related stocks. We believe that prospects of earnings recovery for the small and mid-caps with a high proportion of domestic demand are promising. As a result, they would offer much room for revaluations due to their undervalued share price performance.

The average wage increase rate for the Shunto negotiations in 2024 was significantly higher than the previous year. The Fund sees notable investment opportunities in consumer discretionary stocks, which will likely benefit from the boost in domestic consumption brought about by higher wages.

In this report, we would like to introduce a newly invested company, a karaoke box operator. Karaoke was one of the sectors most severely impacted by the COVID-19 pandemic in 2020. The industry faced closures and shortened business hours due to state-of-emergency declarations, and users were reluctant to use karaoke establishments due to concern about the “Three Cs” and the ease of infection through droplets. The result was a long-standing lack of recovery in occupancy rates. That led to deteriorating earnings across the entire industry, and many businesses—especially small and medium-sized enterprises lacking resilience—withdrew from the market.

In the meantime, however, the firm boldly continued to open new stores with an eye on the post-COVID world. In contrast to its struggling competitors, it significantly increased its market share. It has also tried reducing new store costs by using as much existing equipment and fixtures as possible. Its operations policy has been to maximize store sales by focusing on the morning hours when occupancy rates tend to be low. The company’s strength lies in its ability to offer attractive pricing to consumers and high profitability in light of these initiatives. The recent recovery in karaoke demand has reversed the aforementioned conditions that caused earnings struggles, and the firm is maintaining robust performance. Moreover, its increased consumer name recognition due to ongoing new store openings will likely have helped it attract more customers. The new stores opened in recent years have tended to be in urban areas and larger in size. The company expects revenue growth and better profit margins as a result of opening more large, multi-room karaoke parlors, which have relatively high operational efficiency. The market regards the mature karaoke industry as one that cannot expect high growth against a declining domestic population. However, as mentioned above, if it can continue to open large-format stores, we expect the firm to achieve earnings growth and improved profit margins.

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