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 April 2024

In April 2024, the Japanese stock market started with restraint by profit-taking and concerns over rising U.S. long-term interest rates following the indication by The Federal Reserve official to postpone a rate cut by the end of the year, which led to a decline in the U.S. stock market. In the middle of the month, the market declined due to a higher-than-expected rise in the U.S. consumer price index (CPI), a sharp decline in semiconductor-related companies, and the deteriorating situation in the Middle East. In late month, the market slightly recovered as the situation in the Middle East eased and stocks were seen on the rebound as investors showed relief. The Bank of Japan’s Monetary Policy Meeting held through April 26 decided to maintain an accommodative monetary policy. On April 29, which was a public holiday in Japan, the dollar-yen exchange rate temporarily surged above the JPY 160 ($1.03) level, reaching a 34-year high. However, the yen reversed course and appreciated sharply to around JPY 154 ($0.99), leading to widespread speculation that the government had intervened in the exchange rate. As a result, the benchmark for the Fund, the Russell/Nomura Small Cap™ Index returned -4.64%, while the Fund’s performance returned -3.15% (HJSIX), outperforming its benchmark.

This month, the main contributors to Fund performance were PeptiDream Inc. and Relo Group, Inc. Meanwhile, losses came from J. Front Retailing Co., Ltd. and Towa Corporation.

PeptiDream saw rising expectations for performance growth after it announced a development partnership with Novartis for peptide drug discovery. Relo Group’s share price climbed on the back of a corporation disclosing its significant shareholding in the firm for investment purposes.

J. Front Retailing’s share price declined after its earnings call, which included its plans to reduce the profit targets for the current fiscal year. Towa’s share price fell in tandem with corrections in the semiconductor sector. In terms of investment activities, we newly invested in a service provider that will likely see future earnings growth due to improved order profitability despite seemingly stagnant short-term performance caused by upfront investments and increased labor costs.

Rising U.S. interest rates due to receding expectations for monetary easing in the U.S. and increasing geopolitical risks in the Middle East are causing investor sentiment to deteriorate. Most Japanese companies will soon hold their earnings calls. If they announce conservative company guidance in response to the yen’s ongoing depreciation, there is concern that earnings growth expectations may decline in the short term. Uncertainty remains in the stock market, but we see no need to change our view that the Japanese economy is on a growth trajectory due to the structural expansion of capital investment demand and improved consumption triggered by wage hikes. We will strive to improve the Fund’s performance by identifying companies with unique growth factors.

This month, we would like to discuss a food manufacturer in the portfolio. We believe that the firm is in a period of structural reform to prepare for future growth and that its short-term performance downturn provides an investment opportunity. Its business is ready-made meals, manufacturing and selling boxed lunches, rice balls, deli sides, and more to a top retail chain. These sales account for about 80% of total sales. This chain has built an unshakeable position in the industry on the strength of the high quality of its original products, which were developed in partnership with various manufacturers, including our portfolio company.

As one of these manufacturers, the firm produces an average of approximately three million meals per day in Japan, becoming an indispensable presence as one of the three leading vendors that provide products to the retail chain. The company once pursued growth through scale, building new production sites throughout Japan, which coincided with the rapid expansion of its client retail chain. However, since the late 2010s, its sales growth has plateaued due to this top chain’s slowdown in new store openings in Japan and intensified competition among vendors. In response, the company has since shifted its growth strategy to improving profit margins in its Japanese business and growing its North American business. It has been improving profitability in its Japanese business by consolidating its domestic factories. Recent improvements in food manufacturing technology have led to an increase in the ratio of chilled boxed lunches. Their extended product shelf life has made transporting products over long distances possible, enabling plant consolidation. It has also scheduled the construction of a massive plant, with plans to further increase efficiency through manufacturing site consolidation and division of labor. We believe this initiative should improve the Japanese business’s profit margins by reducing fixed costs and increasing capacity utilization.

The top chain mentioned above is working to expand its overseas business, focusing on bolstering its original product lineup as part of its product strategy in North America. As part of this North American business growth, the firm is playing a central role in developing fresh food, with a new plant underway in 2023 and a new plant in another region scheduled to start operations in 2025. It can expect sales growth to continue through increased volume and diversification of the product lineup offered. The North American business expansion should contribute significantly to the company’s profit growth, as it is easier to secure higher profit margins in North America than in Japan due to the ease of price pass-through.

Meanwhile, its share price has been undergoing corrections following its recent earnings call, in which it forecast a decrease in profits. However, we do not see a need to be overly pessimistic, as the short-term earnings slowdown indicates a willingness to move toward medium- to long-term earnings growth. The risk is that prolonged sluggishness in domestic consumer confidence will lead to a contraction in demand for ready-made meals. Nevertheless, the firm has been steadily implementing measures to improve profitability, including moving ahead with structural reforms. It is focusing its earnings growth on larger overseas markets, which should influence the market’s evaluation of the company.

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