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 August 2024

In August 2024, the TOPIX, a representative index of the Japanese stock market, returned 0.34% from the end of the previous month, while the Nikkei Stock Average (Nikkei 225) fell 1.16% from the end of the previous month. The Japanese stock market experienced historic volatility during the month, with the Nikkei 225 monthly price range reaching an all-time high, surpassing the period during the collapse of the bubble economy. The additional interest rate hike at the Bank of Japan’s (BOJ) monetary policy meeting on July 31 spurred the yen to rise, and the weaker-than-expected July ISM Manufacturing Index in the U.S. raised concerns about a slowdown in the U.S. economy, which further strengthened the yen. This caused the Japanese stock market to plunge in the first half of the month as risk aversion intensified. On August 5, the yen appreciated significantly due to factors such as caution over the slowdown in the U.S. economy and employment, and in the afternoon a circuit breaker was triggered twice in a single day for the first time in 13 years in Nikkei 225 futures, causing the Nikkei 225 to drop 4,451 yen ($31.65) from the previous day, its largest price decline in history. However, the following day, the Japanese stock market had calmed once the foreign exchange market settled down, and the TOPIX and Nikkei 225 posted the largest gains in their respective histories. In addition, the dovish comments of BOJ Deputy Governor Uchida on the following day, the 7th, reassured investors, and the Japanese stock market rebounded sharply toward the middle of the month. In the second half of the month, caution about the U.S. economic outlook eased and the Japanese stock market recovered at a moderate pace, recovering most of the sharp declines seen in the first half of the month to close the month.

As a result, the benchmark for the Fund, the Russell/Nomura Small CapTM Index returned 1.52%, while the Fund’s performance returned -1.64% (HJSIX), underperforming its benchmark.

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

The companies that contributed positively to the Fund’s performance included TRE Holdings Corporation and Relo Group, Inc. TRE Holdings’ stock rose after its Q1 FY3/2025 earnings report, which showed positive growth due to increased profits from price adjustments in its waste management business and higher transaction volumes in its resource recycling operations. Relo Group benefitted from its strong Q1 FY3/2025 performance across all business segments, along with the announcement of a share buyback, which was well received by investors.

Meanwhile, stocks that contributed negatively to the Fund’s performance Included J. Front Retailing Co., Ltd., Nihon Kohden Corporation, and Nishi-Nippon Financial Holdings, Inc. J. Front Retailing faced concerns over declining inbound consumption due to the rapid appreciation of the yen. Nihon Kohden reported its first quarter results, with a decline in both revenue and profits due to a reactionary decline in Information Technology (IT) systems in Japan, which were performing well in the same period last year, and a decline in investment overseas, particularly in China and other Asian markets. Nishi-Nippon Financial Holdings fell as bank stocks saw a sell-off, with the BOJ’s interest rate hike already priced in.

No new investments were made in August.

The market was extremely volatile in August. Early on, concerns about the U.S. economic recession and hawkish comments by the BOJ’s governor caused the yen to appreciate, and Japanese stocks temporarily plunged, but subsequently quickly recovered in response to U.S. economic indicators and comments by the BOJ Deputy Governor.

During the month, concerns about a decline in inbound consumption due to the strengthening of the yen led to a decline in related stocks, resulting in inferior short-term performance. However, at the current exchange rate level, the impact on the business environment should be limited and there is no need to revise our view toward a virtuous cycle in the Japanese economy. We will continue to seek out attractive investment opportunities through discussions with individual companies.

Previously, we mentioned that we are focusing on industries that may make progress in passing on delayed price adjustments against the backdrop of the normalization of inflation. This time, we would like to focus our comments on the construction-related services business as a specific example.

The construction industry has a very broad base, ranging from the five major super general contractors to general contractors, specialty contractors specializing in electrical and HVAC work, and medium-sized or smaller construction firms. The construction-related service industry, which is the focus of this report, is engaged in the business of renting construction equipment and peripheral equipment to construction companies. Construction companies are increasingly choosing to rent such machines because they do not need to own them outright, which reduces maintenance costs, and the market itself continues to grow at a moderate pace. In addition, there has been a gradual increase in the presence of construction equipment rental companies in recent years compared to the past, with employees of construction equipment rental companies being dispatched to construction companies for large-scale construction projects, where they are stationed at construction sites to provide a variety of advice.

Meanwhile, construction costs have continued to increase in recent years against a backdrop of soaring material costs and a worsening labor shortage. Some construction companies are experiencing a downturn in business performance due to the deteriorating profitability of projects for which they received orders prior to cost increases, such as projects with long construction periods. The construction equipment rental companies discussed in this report are also experiencing difficulties in passing on costs to customers. The fact that many companies in the construction equipment rental industry are trying to secure profitability by increasing utilization rates instead of being able to pass on prices is thought to have contributed to the difficulty in raising rental prices. However, in response to the recent changes in the business environment, where the cost of purchasing new construction equipment and the cost of labor continues to rise, the trend of passing on prices has begun to become more prevalent in the construction equipment rental industry since last summer, and the business environment has begun to receive a tailwind. The construction industry as a whole is also experiencing increasing opportunities to pass on prices to customers, and the profitability of the entire industry is improving as projects that had been unprofitable are now being completed.

In addition, we recently visited the company’s facilities and observed that the construction equipment rental company is helping to improve productivity in the construction industry by offering a variety of new services. It is worth noting that the company is expanding its lineup of products, such as remote-controlled solutions for construction equipment and self-developed equipment, which contribute to improving on-site productivity as well as the company’s profitability. Given the ongoing labor shortage in the construction industry, we expect demand for their products to continue rising.

We believe that demand for civil engineering and construction will remain robust, supported by factors such as rising demand for capital investment by the manufacturing industry focused on semiconductors, active urban redevelopment in various regions, and demand for replacement of aging infrastructure facilities. In addition, the delayed price passing-thorough will not only penetrate the market, but also provide more opportunities for new value-added offerings, which should create more business opportunities for the company moving forward.

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