Compelling Japanese Opportunities Amid Attractive Valuations

Key Takeaways

» The new Prime Minister in Japan may seek to balance growth initiatives with financial stability, minimizing the risk of market disruption.

» The Fund was largely unaffected by the tariff decision as it focuses on companies that are service-based, operate high-margin manufacturing, or have onshore U.S. production facilities.

» By investing in firms with global footprints and diversified revenue streams, the Fund seeks to mitigate risks associated with currency volatility.

» The Fund holds Japanese homebuilders Sekisui House, Sumitomo Forestry, and Daiwa House with varying U.S. market exposure, providing a well-diversified play on the U.S. housing market.

» Valuations look reasonable relative to both global peers and Japan’s own history.

How could a new Prime Minister influence fiscal and monetary policy?

In the Liberal Democratic Party (LDP) leadership election, former Economic Security Minister Sanae Takaichi was chosen. Takaichi inherits the economic policy framework of former Prime Minister Shinzo Abe’s “Abenomics,” centered on bold monetary easing and flexible fiscal policy. Compared with Shigeru Ishiba, who emphasized fiscal reconstruction, this marks a shift toward more growth-oriented economic policies.

For investors, this leadership change may initially be viewed positively, as expectations for pro-growth stimulus could support equity markets and corporate earnings sentiment. However, a relaxation of fiscal discipline might heighten concerns about Japan’s already large sovereign debt burden and long-term fiscal sustainability. Nonetheless, Japan’s strong institutional frameworks, disciplined fiscal track record, and the capacity to implement gradual structural reforms suggest it can balance growth initiatives with financial stability, minimizing the risk of market disruption.

How were the Fund’s holdings affected by the final trade agreement between the U.S. and Japan?

The Fund’s holdings were unevenly affected by trade-related risks. The portfolio was generally insulated in 3 ways from the impacts of tariffs through the selection of:

1. service-based companies

2. high margin manufacturing

3. onshore U.S. production facilities

Sectors with high export exposure are likely more vulnerable, while domestic economy-oriented sectors like financials, real estate, and construction have been less affected and benefited from domestic recovery. Theme-driven stocks in artificial intelligence (AI), defense, and activist-related areas, along with mid- and small-cap stocks, showed resilience and limited sensitivity to external trade dynamics.

How does currency volatility factor into the Fund’s risk management and stock selection?

Currency volatility is a key consideration in the Fund’s risk management process. While the Japanese Yen has experienced moderate appreciation against the U.S. dollar this year, it has depreciated against other major currencies like the Euro and the British Pound. Despite these fluctuations, the Yen remains the only major currency with a negative real interest rate, which generally puts downward pressure on its value.

By investing in firms with global footprints and diversified revenue streams, the Fund seeks to mitigate risks associated with currency volatility. Companies that produce goods locally in key markets (such as the U.S.) reduce their exposure to currency risk and tariff impacts.

In addition, the Fund recognizes that the interest rate differential between Japan and the U.S. can influence short-term currency movements. The current divergent rate cycles between the U.S. and Japan can cause short-term noise. These potential fluctuations are factored into the Fund’s overall risk management framework, which includes maintaining a diversified portfolio to manage exposure across sectors and currencies.

What holdings are expected to benefit from the use of AI in their business?

We believe the following holdings could benefit from the use of AI:

• SoftBank Group is a pure beneficiary, markedly through its ownership in OpenAI, and secondary effect from its ownership in Arm Holdings, a leading computer platform company.

• Tokyo Electron could benefit from memory chip shortage on the back of increasing usage of AI inferencing.

• Hitachi is leveraging AI to streamline operations, notably partnering with Nvidia to provide cutting-edge railway system maintenance solutions.

Would you please comment on the Fund’s homebuilder holdings and their potential benefits from growing U.S. market share and lower interest rates?

The Fund holds three major Japanese homebuilders—Sekisui House, Sumitomo Forestry, and Daiwa House—with varying U.S. market exposure (10% to 80%), providing a well-diversified play on the U.S. housing market. Despite near-term challenges from high mortgage rates and rising construction costs, these conditions present a timely buying opportunity:

• Sekisui House has expanded its U.S. presence significantly through acquisition, focusing on mid- to high-end homes, with a strong balance of domestic and overseas profits. The company is poised to benefit as the U.S. housing market recovers.

• Sumitomo Forestry has the longest U.S. presence, a strong acquisition track record, and a leading market share in Australia. Overseas profits dominate its portfolio, with continued growth expected.

• Daiwa House is diversified across housing and commercial properties, showing resilience amid the market downturn and targeting substantial overseas profit growth.

A common theme across all three companies is their focus on capturing growth opportunities by deepening their U.S. housing market presence. Given their increasing reliance on U.S. operations, improving capital efficiency is critical. If Japanese firms can emulate NVR’s asset-light model and efficient working capital management, they could unlock similar valuation premiums.

On the policy front, bipartisan U.S. housing initiatives aim to tackle chronic supply shortages, while potential Federal Reserve and government-backed entity actions could reduce mortgage rates from current highs. Lower interest rates would improve affordability, stimulate demand, and support these homebuilders’ efforts to increase U.S. market share and profitability over time.

What changes were made to the portfolio in 3Q?

In the third quarter, the portfolio saw a significant increase in the SoftBank Group position, building on initial re-entry in summer 2024 and intermittent increases thereafter. This larger allocation was made during the second quarter and carried forward into the early part of the third quarter, allowing the Fund to benefit from a subsequent share price rally. Additionally, SoftBank Group’s major investment in OpenAI, completed in April (Q2), marked a key portfolio development, adding a new core holding.

How do valuations in Japan compare to the U.S. and Europe? How do they compare to historical Japanese valuations?

Despite ongoing tariff concerns, Japanese equities have seen a notable re-rating. TOPIX is currently trading at around 17x forward earnings, with large caps in the low 16s, mid caps in the high 17s, and small caps around 15x—now roughly on par with the broader market as of the end of the third quarter. Over the same period, the average price-to-book ratio stands at 1.6x, implying a return on equity (ROE) of about 9%, which remains low by global standards but shows continued room for improvement.

Compared to Japan’s historical valuations—especially during the late-1980s bubble—current levels are more grounded and supported by stronger fundamentals and governance improvements. Select sectors such as retail, heavy industry, and gaming are trading at elevated multiples (25–40x), while tariff-impacted sectors remain depressed, highlighting a polarized market. Overall, valuations look reasonable relative to both global peers and Japan’s own history.

Where do you see the most compelling opportunities as we close out 2025 and enter 2026?

We still find Seven & i Holdings compelling due to its strong position in the global convenience store market and attractive valuation—trading at about 13x true cash earnings with a 9% free cash flow yield. We believe that the recent withdrawal of the merger offer actually opens up greater long-term growth potential, especially in fragmented markets like the U.S. Management is under pressure and actively returning capital through buybacks, which supports upside with good margin of safety.

Homebuilders also look attractive. As discussed above, the U.S. housing market, unlike Japan’s, represents a long-term growth market, characterized by chronic undersupply and insufficient housing stock. This makes the sector particularly attractive for homebuilders.

SoftBank Group stands out as a critical player in the AI mega trend. Its aggressive investments in AI-driven companies and technology innovation position it well capitalized on the rapid adoption of AI across industries. Its scale and focus on emerging technologies make it a compelling long-term growth stock as AI becomes increasingly central to business transformation.