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 May 2024

In May 2024, the Japanese and U.S. stock markets started on an uptick due to lower-than-expected U.S. employment figures for April and increased speculation of a U.S. interest rate cut. However, the price ceiling was restrained by speculation on the Bank of Japan’s (BoJ) monetary policy normalization and other factors. Mid-month brought the release of the U.S. Consumer Price Index, U.S. Retail Sales, and other indicators that fell below expectations. As a result, the three major U.S. stock indexes reached new all-time highs as concerns over prolonged monetary tightening receded. The market was also underpinned by an across-the-board rise in semiconductor stocks based on solid earnings from U.S.-based NVIDIA. Approaching month-end, concerns about the trend of interest rate cuts vis-à-vis a rebounding U.S. economy and the BoJ governor’s speech suggesting additional monetary tightening again drew attention, joining the rise in long-term interest rates in Japan and the U.S. to fuel a downturn in stock prices. However, signs that the interest rate hike had temporarily paused eventually led to renewed buying. As a result, the benchmark for the Fund, the Russell/Nomura Small Cap™ Index returned -0.13%, while the Fund’s performance returned 0.55%(HJSIX), outperforming its benchmark.

This month’s positive contributors to the Fund’s performance included Towa Corporation and Relo Group, Inc. The results of their earnings calls fueled share price increases for both firms. Towa revealed its outlook for continued active investment related to generative artificial intelligence (AI) and in-house semiconductor production in China. Relo Group announced the impairment loss figures for SIRVA-BGRS—an equity-method affiliate in North America that had drawn concerns about the impairment loss risk—reinforcing the view that the bad news had run its course. Additionally, for the fiscal year (FY) ending March 2025, the company expects revenue to increase and plans to achieve its highest net profit, setting a new record.

Conversely, the stocks negatively impacting the Fund’s performance included Penta-Ocean Construction Co., Ltd. and NEC Networks & System Integration Corporation. Their share prices fell due to their earnings calls. Penta-Ocean Construction failed to meet market expectations for performance and projections. NESIC seemed all the good news had already been factored in.

Japanese stocks continue to fluctuate. Corporate earnings calls in May indicated a trend of conservative corporate projections. The Fund’s portfolio companies also suffered falling share prices as expectations declined regarding their short-term performance growth. However, our research has confirmed that business conditions are favorable, so we see no need for pessimism. As we have been reporting for some time, the revaluation of stock prices should progress if solid corporate performance is confirmed against robust domestic demand, including a wage-hike-driven recovery in consumption and an increase in capital investment.

Demand for medical and nursing care is increasing in Japan due to the aging population, while the shortage of medical and nursing care workers is becoming more severe, emerging as a significant social issue. According to a Ministry of Health, Labour and Welfare estimate, a shortage of approximately one million medical and welfare workers will occur by 2040. We have been focusing on companies that can help promote work style reforms for medical and nursing care workers through their businesses. In that vein, we recently opened a new position in a related company.

It started as a medical bed manufacturer but has since expanded into the nursing bed market, where it boasts a high market share. Its service business has also been growing in recent years. It provides services to medical institutions facing severe labor shortages by stationing group company staff to help with miscellaneous tasks such as equipment maintenance and bed cleaning. It also rents assisted living equipment—primarily nursing care beds—to long term care-related businesses. We are particularly interested in how these services are not one-off sales but are provided as a recurring business with sales recorded on an ongoing basis. The firm has set increasing recurring sales as a key indicator in its medium-term management plan. We appreciate this change, as the increase in the recurring component of sales has made its performance more stable than in the past, when the one-off sale of beds accounted for a significant portion of its revenue.

Meanwhile, its share price has stagnated as short-term performance fell short of market expectations due to rising costs and struggling overseas operations. Nevertheless, its primary domestic recurring business is showing steady growth, and the overseas business aims for sufficient growth over the medium to long term due to ongoing efforts. Thus, we believe its current share price is undervalued relative to its corporate value. Moreover, we see plenty of room for improvement in the company’s return on capital. It has no significant debt, a very high equity ratio, and no return on equity (ROE) target in its medium-term management plan, indicating a low awareness of return on capital (ROC). We appreciate that it significantly raised its ROE and dividend payout ratio—indicating a higher awareness of ROC than before—in its earnings call for FY3/2024. However, it still has much room for improvement. We intend to engage further on its capital structure and other issues to maximize its corporate value.

One potential risk is the outlook of the nursing bed rental business, where profitability is declining due to delays in price pass-through. This price pass-through is already underway, but it is difficult to expect a short-term resolution despite its progress with medical bed pricing. We believe that the profitability of the nursing bed business will gradually improve with the introduction of new models.

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