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 December 2024

In December 2024, Japan’s stock market saw the TOPIX decrease 0.60% from the end of the previous month. On an annual basis, the TOPIX posted an increase for the second consecutive year.

In the first half of the month, several factors drove the market higher: the Ministry of Health, Labour and Welfare announced plans to raise the return targets for assets managed by the Government Pension Investment Fund (GPIF), fueling speculation of an increased allocation to Japanese equities. Additionally, robust performance in U.S. tech stocks supported by a resilient U.S. equity market, as well as yen depreciation stemming from concerns over slower U.S. rate cuts, contributed to the positive momentum.

In the latter half of the month, the Federal Reserve’s Federal Open Market Committee (FOMC) met on December 18 and announced a widely anticipated policy rate cut. However, the Fed indicated plans for only two additional rate cuts in 2025. This led to an uptick in U.S. long-term bond yields, triggering a correction in the U.S. stock market, which also pressured Japanese equities.

On December 19, the Bank of Japan (BOJ) held its monetary policy meeting, deciding to maintain interest rates at current levels. BOJ Governor Kazuo Ueda later made dovish remarks in a press conference, leading to further yen depreciation against the dollar. Following this, a strong rebound in U.S. semiconductor stocks and continued yen weakening buoyed the Japanese market. By December 27, the Nikkei 225 broke through the 40,000 yen mark, underscoring the renewed bullish sentiment.

This month the Fund returned 0.19% (HJSIX), outperforming its benchmark, the Russell/Nomura Small Cap™ Index, which returned -1.88%.

The stocks that contributed positively to the Fund’s performance this month included J. Front Retailing Co., Ltd. and Musashi Seimitsu Industry Co., Ltd. J. Front’s business results of Q3 FY2/2025 were strong, and the stock’s price increase was also boosted by the government’s relaxation of visa requirements for Chinese tourists. Musashi Seimitsu Industry benefitted from the Company’s hosting of special events related to hybrid super capacitors which, as in the prior month, highlighted the business’s growth potential. Brokers’ initiation of coverage also gained positive reaction.

Meanwhile, stocks that had negatively contributed to performance was Cosmos Pharmaceutical Corporation. Cosmos Pharmaceutical faced negative sentiment when in its monthly earnings preliminary report November same-store sales posted a 3.0% year-over-year (YoY) decline, down for the third consecutive month.

From an investment activity perspective, there were no new investments made during the month.

This month, we would like to reflect on 2024 and share our outlook for 2025. In 2024, the Japanese economy experienced a sense of stagnation due to factors such as automotive factory shutdowns, natural disasters, and a decline in real wages. The yen’s depreciation, driven by differences in central bank monetary policies, persisted throughout the year, further dampening consumer sentiment.

Turning to the Japanese stock market, corporate governance reforms and the yen’s depreciation drew considerable attention to Japanese equities through the summer. However, in August, the unwinding of the yen carry trade led to a significant correction. From autumn onward, uncertainty surrounding policies under the newly formed Ishiba administration contributed to continued market volatility. As a result, investors appear to be adopting a more cautious stance toward Japanese equities. Turning to the Japanese stock market, corporate governance reforms and the yen’s depreciation drew considerable attention to Japanese equities through the summer. However, in August, the unwinding of the yen carry trade led to a significant correction. From autumn onward, uncertainty surrounding policies under the newly formed Ishiba administration contributed to continued market volatility. As a result, investors appear to be adopting a more cautious stance toward Japanese equities.

The market in 2024 was once again led predominantly by large-cap stocks. Factors such as the yen’s continued depreciation and sluggish domestic consumption contributed to the relative advantage of large-cap stocks with high exposure to external demand. As a result, it appears that it will take more time for investment capital to flow into the small- and mid-cap segments of the market.

Turning to the performance of the Fund, not only did stock price gains driven by corporate earnings growth contribute positively, but changes in shareholder return policies and corporate actions such as de-listings also played a significant role. Observing recent corporate activities, we are increasingly recognizing that corporate governance reforms in Japan are gradually extending beyond large-cap companies to also influence small- and mid-cap companies. The Corporate Governance Code, established in 2015, initially lacked effectiveness and did not lead to noticeable changes in corporate behavior. However, following the requests made by the Tokyo Stock Exchange in 2023, concrete guidelines and objectives have been introduced, prompting a shift in the management approach of Japanese companies. While much attention has been given to improvement measures for listed companies with a price to book ratio (P/B) below 1x, the more significant development is that Japanese companies have reached the turning point. After decades of prioritizing financial soundness in the wake of the asset bubble collapse, they are now transitioning to a management focus that emphasizes capital efficiency.

Corporate actions such as the divestment of cross-shareholdings and the restructuring or downsizing of unprofitable businesses are on the rise, particularly among large-cap companies. These measures have contributed to stock price increases for firms holding significant amounts of cross-shareholdings.

Broadening our perspective to the Japanese equity market as a whole, there remain many companies with excessive equity capital (such as large cash reserves), indicating substantial potential for improvements in capital efficiency. We believe that such management transformations could lead to a significant unlocking of value in undervalued companies. Furthermore, delisting remains a viable option for companies seeking to implement fundamental business restructuring or overhaul their shareholder composition. This is particularly relevant in the small- and mid-cap segment, where many owner-managed companies face skewed shareholder structures. As these companies approach generational transitions in leadership, structural reforms appear inevitable for securing a sustainable future.

Looking ahead to 2025, geopolitical risks and economic slowdowns in China and Europe are likely to remain key concerns. However, turning our attention to the Japanese economy, sustained wage growth is expected to improve income conditions, raising hopes for a recovery in long-stagnant consumer spending. At the same time, companies are likely to continue investing in labor-saving technologies and implementing efficiency measures to balance profitability with wage increases. We believe that the progress of this virtuous economic cycle is poised to become a tailwind for corporate earnings, accelerating growth for highly competitive companies through the survival of the fittest. We remain committed to a bottom-up approach, striving to uncover overlooked investment opportunities in the market.

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