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 Highlights

In July 2025, Japan’s major stock indices were primarily flat, with the TOPIX falling 1%.

During the first half of the month, profit-taking following the previous month’s sharp rally, coupled with uncertainty over U.S. reciprocal tariffs and expectations of a challenging Upper House election for the ruling party, limited market movements. Additional uncertainty arose from reports of NVIDIA resuming artificial intelligence (AI) chip exports to China and speculation regarding the possible dismissal of U.S. Federal Reserve Chair Powell, resulting in a lack of clear market direction and sideways trading.

In the latter half of the month, the Upper House election on July 20 resulted in the ruling party failing to secure a majority even when including non-contested seats; however, as this outcome was widely anticipated, the market reaction when trading resumed on July 22 was limited. Stock prices surged following reports of a Japan-U.S. trade agreement on July 23, with the TOPIX reaching a record high and the Nikkei 225 climbing sharply on July 24. Following a brief correction due to overheating concerns, the market rebounded toward the end of the month, supported by strong earnings from U.S. tech stocks.

The Fund’s Performance

This month, the Fund returned -3.52% (HJPIX), underperforming its benchmark, the Russell/Nomura Total Market™ Index, which returned -0.48%.

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

Among the best performers were our investments in Hitachi, Ltd., one of Japan’s oldest electric equipment & heavy industrial machinery manufacturers and SoftBank Group Corp., the telecom and Internet conglomerate.

As for the laggards, Seven & i Holdings Co., Ltd., a Japanese diversified retail group and operator of Seven-Eleven convenience stores and Shin-Etsu Chemical Co., Ltd., Japan’s largest chemical company.

July Commentary

Portfolio Differentiation

In our September 2021 commentary, we discussed the importance of having a differentiated portfolio. The ideal "differentiated portfolio" to us is one that not only stands apart from the broader stock market (i.e., the index) but also differs from the portfolios managed by other active investment firms. By definition, a portfolio deviating from the overall stock market (the index) is a necessary condition for generating returns that outperform the market average. To this end, it is crucial to hold a minority opinion about your investments, differing from the broader market consensus.

For the stock to rise faster than the broader market, the minority opinion would have to be proven correct over time, such that other market participants belatedly bid the share price higher by coming around to your view. Portfolio differentiation can be achieved by investing in stocks that others do not own or, in cases where a stock is widely held by market participants, by taking a substantially larger position than other managers. Our strategy, being large-cap focused, tends to be the latter case. However, in the same commentary, we also pointed out that even with a differentiated portfolio, outperforming the index is by no means an easy task (though we are of the view that Japanese stock markets are generally still inefficient relative to the U.S.).

The stock market represents a form of "collective wisdom." Price movements reflect predictions and, more often than not, these predictions are proven correct. It is well-documented that stock markets tend to rise in anticipation of economic recovery and decline ahead of economic downturns. As a result, when selecting individual stocks with a perspective that differs from the broader market, it is not uncommon for the market's view to prevail, and one's projections turn out to be off the mark. Making the wrong stock selections may invite criticism, and even holding stocks that cause others to raise their eyebrows can be an uncomfortable experience, regardless of whether those choices ultimately turn out to be right or wrong. You need to be comfortable in the uncomfortable. Counterintuitively, such feelings should also be regarded as a recipe for the future outperformance of your investment.

Margin of Safety to Help You Maintain Outsized High-Conviction Positions

When taking the courageous step of investing in individual stocks with a minority opinion, it is important to ensure that even if your projections turn out to be wrong, the resulting losses (if any) remain manageable. This is where the concept of the "Margin of Safety" comes into play. The term was originally introduced by Benjamin Graham, widely regarded as the father of value investing, in his seminal book The Intelligent Investor (published in 1949). The concept refers to the idea of investing in stocks that are sufficiently undervalued relative to their intrinsic value. In The Intelligent Investor, Graham emphasises that even the most thorough analysis cannot eliminate uncertainty. He writes: “The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.”

According to Graham, the gap between intrinsic value and the current stock price acts as a buffer. For instance, if a company’s intrinsic value is calculated to be $10 per share, and its stock is trading at $6, there is a $4 margin of safety (ideally, for us, that $10 intrinsic value should grow over time). The wider this margin, the more cushion investors have against price volatility or potential misjudgements in their forecasts. It reduces the likelihood of significant losses in the event of temporary market downturns or valuation errors. Graham advocated that investments should only be made when the stock price is two-thirds or less of the company’s net current asset value as calculated from its balance sheet. His stringent approach was arguably shaped by the prevailing difficult market conditions at the time the book was written, during the 1930s and 1940s, in the wake of Black Monday.

Today, we take a somewhat broader interpretation of this concept. For example, we consider cases where a stock's valuation, measured by price to earnings ratio (P/E) or price to book ratio (P/B), is significantly below the market average despite having strong long-term growth prospects. Similarly, high dividend yields or strong total shareholder returns (dividends plus buybacks) are also viewed as part of the margin of safety. At times, we incorporate qualitative factors into this assessment as well. Now and then, we come across a situation with a compelling potential return that we firmly believe in, combined with a robust margin of safety. That’s when we take a substantial position. Without both conviction and safety, the position won’t warrant significant sizing. There have been times in our Fund's history when a single stock accounted for close to 10% of the portfolio. In other instances, we concentrated the Fund’s investments in just 20+ stocks. This concentrated approach is one of the defining characteristics of our investment strategy. By acting differently, it is inevitable that the Fund underperforms the index at times, as it has done so in the past. However, we believe that such differentiation is a necessity for superior performance over time. We will aim to continue to manage the Fund in a manner that maximizes the expected return for our investors.

Investment Cases from the Past

Hitachi

Hitachi is a case in point. It’s a stock we began investing in during the summer of 2021 and continue to hold as a key position today. At the time, the company’s Lumada business had not yet begun to significantly contribute to its overall performance. In our July 2021 commentary, we highlighted the following points:

•    Hitachi had already achieved a double-digit return on equity (ROE).

•    Free cash flow (FCF) was consistently positive.

•    The company demonstrated financial stability with a 30% equity ratio and a debt-to-equity (D/E) ratio of 0.54x.

Despite these strengths, the stock was trading at a valuation of only 10.5x P/E. In our commentary, we emphasised how such a combination of strong fundamentals and low valuation offered an attractive investment opportunity:

“If our investment view is correct, we expect both earnings growth and multiple expansion to drive up the share price…… On the other hand, if we are proven wrong, Hitachi will just remain as a cheap manufacturing stock with not much downside risk.”

Keyence

Another example is Keyence, a stock included in our portfolio for more than 15 years. At that time, the company boasted strong profitability, with a peak net income of approximately 60bn yen ($406mn) before the 2008 Global Financial Crisis, against a market capitalization of about 1,100bn yen ($7.4bn). Its robust business model led us to believe that once the crisis subsided, the company would return to its growth trajectory. Keyence had accumulated substantial FCF, from its core operations, resulting in surplus cash & cash equivalents of roughly 500bn yen ($3.4bn) (45% of market cap). With such financial strength, we judged that the possibility of bankruptcy was virtually non-existent.

From the perspective of margin of safety, the "adjusted" market cap was effectively 600bn yen ($4.1bn) – versus the quoted market cap of 1,100bn yen ($7.4bn) if we subtracted these surplus funds from the market capitalization. We thought that the company's abundant net cash position could be treated as potentially attributable to its shareholders. On this basis, the implied P/E was just 10x, assuming a return to peak net income of 60bn yen ($7.4bn), conservatively estimated. At such a low multiple, even if the global economic recovery took longer than expected, we believed the stock had a significant margin of safety, implying minimal downside risk. For these reasons, Keyence was the single largest holding in our portfolio from 2009 to 2014, ranging from 13–23% of the Fund’s net assets. It became a ten-bagger during the Fund’s ownership to date.

Current Portfolio

Today, our current portfolio is heavily weighted in Seven & i Holdings and ORIX Corporation. As explained in previous commentaries, both stocks exhibit significant undervaluation based on their margin of safety, even without factoring in future growth.

Seven & i Holdings

For Seven & i, while the company’s forward P/E based on FY25 statutory earnings per share (EPS) estimates does not appear particularly undervalued, we focus on pre-goodwill EPS, which excludes non-cash goodwill amortization to better reflect operational earnings. Using this measure (145.33yen per share ($0.98), based on the Q1FY25 results presentation), the forward P/E comes out significantly lower. Looking at the company’s core convenience store business and its FCF, the numbers are even more compelling. Over the past three years, the average annual FCF has been approximately 400bn yen ($2.7bn), translating into an FCF multiple of 13x, significantly lower than the broader market’s P/E (or an FCF yield of 8%, which compares very favorably to current risk-free interest rates).

The company is increasingly concentrating their management and financial resources in the convenience store operations, aiming to expand its global footprint of 7-Eleven stores, and revitalize sluggish same-store sales performance in Japan and the U.S. However, even if the company’s growth from these initiatives falls short of our expectations, the stock would remain undervalued. As such, we believe the risk of significant investment losses should be low. From a shareholder returns perspective, the company is executing a massive 600bn yen ($4.1bn) share buyback program this fiscal year (part of a broader 2,000bn yen ($13.5bn) plan through FY2030).

Based on our analysis, the company has ample resources to facilitate this. These buybacks represent a substantial percentage of the company’s market capitalization and provide strong support for the stock price. A qualitative margin of safety lies in Seven & i's sustained appeal as a potential takeover candidate even after Couche Tard withdrew its acquisition proposal, which was announced on July 17th.¹ Last year in August, we wrote in our letter: "Even if Couche-Tard is unsuccessful, there will be someone else who would be interested." At the current valuation, new potential buyers could emerge (financial buyers or strategic buyers, including hostile bidders). That should put a solid floor on the share price, serving as a margin of safety as well (sure enough, the share price fell following the news, but the size of the correction was nothing out of the ordinary, in our view). Now that no deal has materialized for Seven & i, management will be held accountable.

Whatever actions it takes moving forward will be subject to close public scrutiny. It is not difficult to imagine that there is huge pressure to speed up the ongoing strategic initiatives to grow the intrinsic value of the business fast, a sharp contrast to the previously non-existent sense of urgency. From our Fund’s perspective, allowing the company to remain independent and improve its management approach could potentially generate far greater long-term returns compared to crystallizing short-term gains through an acquisition. This view is grounded in the inherent strength of the convenience store business, which is a capital-efficient retail model that generates robust cash flows.

The long-term earnings growth and stock price performance of competitors such as Couche-Tard, Casey’s General Stores, and Murphy USA in the U.S. further validate this perspective. The company’s growth runway in the U.S. is far longer than that of the Japanese domestic market. In addition to the vast, still-fragmented U.S. market, there are significant untapped opportunities across Europe, the Middle East, Asia, and Oceania. Needless to say, these opportunities were not at all reflected in the valuations proposed by Couche Tard. Therefore, the withdrawal of the offer should be a blessing in disguise for the Fund’s investors.

ORIX Corporation

ORIX has been operating under a principal investment model, holding investment assets on its balance sheet. Going forward, the firm will focus on generating returns by recycling assets rather than increasing them, as well as pushing for an "asset management shift" toward a structure that generates fee income by utilising external investors' funds. This should fundamentally change the source and quality of the company’s earnings, which will increasingly be driven by management fees rather than investment gains, implying the valuation framework will also gradually evolve. In theory, ORIX should transition from being valued based on P/B to being assessed on P/E. This is key to our expectations of significant upside in the company’s valuation. Even if this shift does not materialize, the current valuation is highly attractive, with both P/E and P/B below 10x and 1x, respectively. Furthermore, when accounting for unrealised gains on investment assets not reflected on the balance sheet, the P/B (i.e. net asset value (NAV) approach) effectively falls well below 1x. Shareholder returns are also a key highlight. The company’s shares offered a total capital return yield of 6.2% as of 7/31/25, well above the market average. We believe its progressive dividend policy should serve as an additional buffer against downside risk.

Click here for a full listing of Holdings.