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

Japanese equities delivered mixed performance in July 2026. The TOPIX rose 2.30% during the month.

During the first half of the month, the market entered a correction phase as concerns grew over elevated valuations in artificial intelligence (AI) and semiconductor-related stocks, which had risen sharply in prior months. A sharp decline in the U.S. semiconductor index served as the catalyst for the pullback. Investor sentiment deteriorated following declines in U.S. technology stocks and the Korean KOSPI index, leading to significant weakness in Japanese AI and semiconductor-related names as well. Renewed tensions in the Middle East also weighed on Japanese equities. On the other hand, bank stocks and domestic-demand-oriented sectors continued to attract investor interest, supported by expectations of higher interest rates.

In the second half of the month, concerns intensified regarding the semiconductor industry’s outlook and competitive dynamics as recent developments highlighted the rapid progress of Chinese AI developers and chip-related companies. Semiconductor-related stocks declined further alongside weakness in Korean equities and U.S. semiconductor stocks, pushing the Nikkei 225 to its lowest level in approximately two months. While semiconductor stocks underwent a significant correction, investors also rotated into defensive sectors as downside risks to corporate earnings eased following a decline in oil prices after the United States refrained from conducting a large-scale attack on Iran.

As a result, the Nikkei 225 remained under pressure throughout the month and ended July substantially lower than at the end of June. In contrast, the TOPIX traded in a relatively narrow range and ultimately finished the month higher.

The Fund’s Performance

In July, the Fund (HJPIX) returned 1.52%, outperforming its benchmark, the Russell/Nomura Total Market™ Index, which returned (0.04%).

The month's positive performer among the Global Industry Classification Standard (GICS) sectors included shares of Financials, Industrials, and Consumer Discretionary while Information Technology, Materials, and Communication Services 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, Mitsubishi UFJ Financial Group, Inc., one of the three largest Japan’s banking groups, and Sony Corporation, global technology and entertainment company operating businesses in gaming, music, film, consumer electronics, and semiconductor imaging solutions.

As for the laggards, Tokyo Electron Limited, one of the world's largest manufacturer of semiconductor production equipment, Shin-Etsu Chemical Co., Ltd., Japan’s largest chemical company, and SoftBank Group Corp., the telecom and Internet conglomerate.

July Commentary

The AI Market Correction and Our Fund's Positioning

In the first half of this year, the Japanese equity market was driven primarily by AI-related stocks, particularly in the semiconductor sector. Our Fund also benefited from strong gains in holdings such as Tokyo Electron and Renesas Electronics, which boosted our year-to-date performance.

Since peaking in late June, the AI rally appears to have entered a correction phase. While numerous AI-related names have emerged as key market themes, the Fund's exposure is strictly limited to companies that had been included in our portfolio before AI became a major market focus. In other words, we have refrained from chasing the rally this year, avoiding high-flying AI stocks. Consequently, the Fund has averted the risk of buying at the peak and subsequently incurring losses. This disciplined approach is one of the reasons why the Fund's performance has remained resilient relative to the benchmark index over the past few months.

The Pitfalls of High-Growth, High-Multiple Stocks and the Margin of Safety

Our cautious stance is not unique to the current AI boom. The Fund has always maintained a prudent approach toward high-growth, high-multiple stocks. The rationale is simple: if the assumption of high earnings growth is disrupted for any reason, the premium valuation multiple can contract sharply and rapidly, leading to a steep decline in the share price. Since a stock’s price is the product of earnings per share (EPS) and the price to earnings (P/E) multiple, a simultaneous decline in both can trigger a severe sell-off.

A recent case in point occurred during the recent full-year earnings season in May. An optical fiber and optical components manufacturer, highly popular as an AI play, released full-year forecasts that fell far short of market expectations. Its stock price halved within a week. Investors lured by the prior momentum who bought leading up to the peak would have suffered major immediate losses. This serves as a powerful lesson. When investing in equities, we believe it is important to remain humble and recognize that no one can predict the future. For that reason, we seek to invest only at price levels that provide an ample margin of safety against unforeseen events.

Opportunities Arise in Pessimism: Semiconductor Investments in 2022–2023

Whenever evaluating a new investment, we always ask ourselves: "Is the stock price trading at a clear discount to its intrinsic value?" We would never buy a stock simply because its price is rising and the stock is "hot."

Sometimes it requires going against the market consensus, even if it means hurting short-term returns. For instance, while Tokyo Electron is now well appreciated as a prime beneficiary of the AI boom, we initiated our position in the autumn of 2022—long before the AI craze took off. At the time, global semiconductor stocks were reeling from the U.S. Government's announcement of export controls on semiconductors and manufacturing equipment to China.

Until then, the Fund had no significant exposure to the semiconductor sector. However, we had long admired that many Japanese companies hold dominant positions in the global semiconductor supply chain, backed by their superior manufacturing excellence. Although the industry's cyclicality (the "Silicon Cycle") was a concern, we viewed the extreme pessimism surrounding the U.S.-China trade tensions as a rare opportunity to acquire high-quality assets at highly attractive valuations.

This contrarian approach paid off. The Fund maintained the position even when the stock plunged nearly 20% following a downgrade to full-year guidance in August last year. Riding the subsequent AI tailwinds, Tokyo Electron has now become one of our core holdings. Together with Shin-Etsu Chemical, Renesas, and SoftBank Group—which we added in 2023 and 2024—our semiconductor and AI-related exposure forms a key pillar of our portfolio, alongside other core pillars such as the three major non-life insurers.

Staying One Step Ahead: AI Supply Chain Bottlenecks and Accumulating Shin-Etsu Chemical

Earlier this spring, we increased our stake in Shin-Etsu Chemical, the world's leading manufacturer of silicon wafers, and established a new position in SUMCO. While the explosive expansion of global AI infrastructure has fuelled the market rally for GPUs, memory chips, and fiber-optic cables, we anticipate that the recovery in wafer demand will follow these segments.

Looking back at the AI value chain, the cycle began with tight supply for Nvidia's GPUs. This was followed by severe shortages in memory chips (DRAM and NAND), hard disk drives, and more recently, CPUs. These supply constraints represent the bottlenecks in rapid AI infrastructure expansion. Backed by massive capital, U.S. hyperscalers have been aggressively securing these components, driving unprecedented price hikes and delivering record earnings for suppliers.

Through the first half of 2026, shares of these "bottleneck" companies surged. The logical next step is for semiconductor manufacturers to invest in expanding capacity to resolve these bottlenecks, which in turn benefits semiconductor equipment makers. This dynamic explains the recent surge in stocks like Tokyo Electron.

Looking further ahead, as ordered equipment is delivered and actual production ramps up, the volume of silicon wafers required will inevitably rise. In the cutting-edge 300mm wafer market, two Japanese giants—Shin-Etsu Chemical and SUMCO—control roughly half of the global market share. Requiring sophisticated material science expertise, the silicon wafer business is a classic Japanese stronghold with exceptionally high barriers to entry. This structural advantage was a primary reason behind our decision to accumulate more shares of Shin-Etsu Chemical and begin to build a stake in SUMCO.

As the famous hockey legend Wayne Gretzky once said, "Skate to where the puck is going to be, not where it has been." In investing, as in hockey, success lies in anticipating the next move rather than chasing the prevailing trends. By focusing on supply-demand shifts one step ahead of the crowd, we attempt to avoid the risk of buying late at inflated prices.

Buying Growth Stocks at Value Stock-like Prices

When initiating new positions, our ideal approach goes beyond the conventional "Growth At a Reasonable Price" (GARP) strategy. The Fund's ultimate goal is to acquire highly attractive growth companies at deeply discounted valuations typically associated with value stocks. While this is easier said than done, we have successfully executed this strategy on numerous occasions:

•    Keyence (Late 2000s: entry at an implied net cash P/E of approximately 10x; Today: 31x)

•    Ryohin Keikaku (Late 2000s: entry at a P/E of approximately 10x; Exited)

•    Recruit Holdings (Initiated in 2016–2017: entry at 12.5x long-term projected free cash flow; Today: 28x)

•    Sony Group (Initiated in 2019–2020: entry at a P/E of approximately 11x; Today: 18x)

•    Hitachi (Initiated in 2021: entry at a P/E of approximately 10x; Today: 26x)

Although some of these investments took several years to bear fruit—as occasionally we have a tendency to be too early in anticipating market trends—each demonstrates our focus on exploiting market inefficiencies and periods of distress to seize the opportunity to invest in outstanding businesses at extremely attractive valuations. This also explains the Fund's historically low turnover.

Disciplined Long-Term Ownership and the Courage to Act Differently

Another characteristic of our investment strategy is that once we build conviction in a stock, we tend to hold it far longer than the average market participant. In pursuing this long-term horizon, we may occasionally appear to miss opportunities to lock in profits at short-term peaks. However, we believe that maintaining the discipline to hold patiently, even when others sell, is the key to long-term outperformance.

Even during market downturns or temporary corrections, our low average cost basis can provide the "staying power" to remain calm and steadfast. To consistently outperform the market index, we believe one must have the resolve to act differently from the crowd in many different ways.

Potentially High Returns from "Growth Stocks in Disguise"

Another distinctive approach, which we have highlighted in our commentaries since 2022, is our focus on identifying "Growth Stocks in Disguise." This is rooted in the belief that "sometimes great businesses are hiding in plain sight"—often disguised as seemingly dull or unexciting industries.

During speculative periods like the AI rally in the first half of this year, high-flying, glamorous stocks dominate the headlines every day, presenting a temptation for less experienced investors. However, one should never invest in hyped theme stocks or crowded trades simply because "everyone else is buying" unless there is a thorough understanding of the underlying business even if that means the Fund’s performance temporarily lagging the broader market.

Even for companies with guaranteed high growth, if that growth is already fully priced in, future returns will be highly constrained. When expectations peak, valuation multiples are far more likely to contract than to expand further. Any negative surprise can trigger panic and spark a cascading sell-off. Furthermore, because high-multiple stocks price in growth several years out, their valuations inevitably compress once the growth trajectory begins to plateau.

For example, consider a high-growth company growing its earnings at 20% annually, trading at a P/E of 40x. If its multiple contracts over the next five years to 20x (a modest premium to the market average today), this multiple compression will drag the stock price down by approximately 13% annually. Despite strong earnings growth, the impact of valuation compression would reduce investors’ annualized returns to only the mid-single digits. Conversely, consider a "Growth Stock in Disguise" growing earnings at a modest 7% to 8% annually, but neglected at a cheap valuation of 10x P/E. If the market gradually re-rates this company over five years to a multiple of 15x (still slightly below the market average), the resulting multiple expansion would contribute more than 8% annually to the stock price. Combined with underlying earnings growth and a 5% yield from shareholder returns (dividends and buybacks), the total expected annualized return could exceed 20%.

While high-single-digit earnings growth may pale in comparison to the eye-catching numbers of today's AI darlings, we view these companies as genuine growth stories (or "growth stocks") because they comfortably outpace global nominal gross domestic product (GDP) growth. Furthermore, their high, sustainable shareholder returns represent a powerful engine of investment return that is frequently overlooked by the market. This value-oriented stock selection—exemplified by our holdings in ORIX and the three major non-life insurers—is essential for achieving sustained, long-term investment success, in our view.

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