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 the first half of the month, concerns about excessive gains in artificial intelligence (AI)-related stocks triggered a sharp correction in the U.S. market, which subsequently weighed on Japanese equities. In contrast, value stocks and domestically oriented names showed resilience. Differences in index composition, particularly the weighting of these groups, led to divergent performance, with the Nikkei 225 Stock Average posting a larger decline, while the TOPIX remained relatively stable.

Mid-month, heightened Japan-China relations and the Chinese government's call for voluntary travel restraint to Japan rattled markets. Both the Nikkei 225 Stock Average and TOPIX declined sharply, with the Nikkei 225 Stock Average briefly dipping below the key 50,000-yen level. Japanese equities subsequently rebounded, supported by semiconductor-related names such as Advantest and Tokyo Electron, as well as SoftBank Group. NVIDIA’s strong earnings release triggered buying of its shares in U.S. after-hours trading, lifting the Nikkei 225 Stock Average by about 700 yen ($4.49) at one point. However, gains were capped by continued caution over excessive AI-related investment.

Toward the end of the month, expectations for a December rate cut strengthened following dovish comments from a high-ranking Federal Reserve Board official, contributing to a recovery in both U.S. and Japanese equities. As a result, the Nikkei 225 Stock Average posted its first monthly decline in eight months, while the TOPIX ended slightly higher.

The Fund’s Performance

This month, the Fund (HJPIX) returned -3.57%, underperforming its benchmark, the Russell/Nomura Total Market™ Index, which returned -0.15%.

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

Among the best performers were our investments in ORIX Corporation, Japan’s largest non-bank comprehensive financial services company, Seven & i Holdings Co., Ltd., a Japanese diversified retail group and operator of Seven-Eleven convenience stores, and Sony Group Corporation, a diversified consumer and professional electronics, gaming, entertainment and financial services conglomerate.

As for the laggards, SoftBank Group Corp., the telecom and Internet conglomerate and Hitachi, Ltd., one of Japan’s oldest electric equipment & heavy industrial machinery manufacturers.

December Commentary

We are now entering the final month of the year. Just like last year, we would like to look back on the markets and share our outlook for the year ahead and beyond.

Year 2025 in Review

As of the end of November 2025, the Japanese equity market remains resilient. There are lingering concerns over a U.S. economic slowdown and heightened U.S.–China tensions (also the recent Japan-China diplomatic tensions, which we believe is more temporary), but these have been more than offset by a powerful surge in AI-related themes.

Investor sentiment toward AI-related themes has also been a significant driver of stock market fluctuations. While remaining mindful of the potential overheating in AI-related infrastructure investment, we believe the positive impact of AI on labor productivity and long-term economic growth should not be underestimated.

Turning to the market analysis, we believe that the main drivers of the market up to the end of November 2025 have been the following groups of stocks:

1. Theme-driven names (i.e. AI, defense-related, and firms targeted by activists)
2. Large-cap domestically oriented businesses (i.e. financials, real estate developers, construction and related sectors)
3. Small- and mid-cap stocks more broadly

What these groups have in common is that they are only marginally exposed to the risk of "Trump tariffs."

By the end of the month, the TOPIX had risen an average of 18% over the past three years as of the end of November 2025. At the same time, the market appears to have become increasingly polarized as well.

AI-related stocks, select retail names, and gaming companies with little direct exposure to global growth risks or Trump tariffs have attracted investor interest. These stocks are now trading at valuation levels, in terms of price to equity (P/E) multiples, far above the TOPIX average.

Elsewhere, among defense-theme beneficiaries, heavy-industry companies are now valued sharply higher than the market average (in some cases, P/E greater than 25x based on profit levels expected four to five years from now), versus a current year market P/E of 17.8x as of the end of November 2025. Other defense-related stocks are changing hands at about P/E greater than 30x this year’s earnings, and instances of stretched valuations have become increasingly common in this area.

In contrast, shares of export-oriented companies that are heavily affected by Trump tariffs—particularly automakers and parts suppliers, which account for the bulk of Japan’s trade surplus with the U.S., have been stagnant. Many of these names are trading at very low valuation multiples. Other U.S. economy-sensitive names were also hit hard, though some appear to have been unjustifiably affected.

Also noteworthy is that the value index (TOPIX 500 Value) has significantly outperformed the growth index (TOPIX 500 Growth) yet again this year, as of the end of November 2025, a pattern that is the exact opposite of what we have seen in the U.S. market. This is largely because Japan does not have powerful tech companies comparable to the U.S. “Mag7.”

Outlook for 2026 and Beyond

Exactly one year ago, in our “Investment Outlook for 2025 and Beyond” (November 2024 commentary), we broke down the expected return for Japanese equities as follows.

(Excerpt from Nov. 2024 commentary)

•    +3.0-5.0% organic earnings per share (EPS) growth through sales volume growth and improving sales mix

•    +2.0% additional growth in EPS to reflect sustainable inflation

•    +3.0% from total capital return yield, of which +2.0%from dividends and +1.0% from share buybacks

•    +4.0-6.0% from change in valuation multiples

Therefore, 10+% compound annual return can be estimated for the next several years.

Since then, a year has passed, and by the end of November the TOPIX had risen by 25%. The main driver of this advance has been valuation multiple expansion, which went from 14~15x a year ago to 17.8x as of November, a roughly 20% increase.

Given that index performance has outpaced earnings growth, we believe the short-term return outlook for the broad market is somewhat more limited than the past few years—unless we see a sharp acceleration in earnings growth in 2026.

Conversely, the Fund invests in a relatively small number of carefully selected stocks—primarily large-cap, globally recognized Japanese companies. As a result, it is not unusual for its performance to diverge from the broader market. As we noted in the August commentary, we believe that the Fund’s expected return remains more attractive than that of the Japanese equity market as a whole (more on this in the latter half of this commentary).

On the other hand, from a medium- to long-term perspective, the overall appeal of Japanese equities would remain solid—an important contrast to the period when the economy was mired in deflation, as outlined below.

The Most Important Factor for the Japanese Stock Market is Corporate Governance Reform

Prime Minister Sanae Takaichi has taken office. Her proactive fiscal policies and dovish stance on monetary policies have so far been welcomed by the equity market.

However, unlike the early days of Abenomics, Japan’s current economic challenges stem more from supply constraints — such as labor shortages — than from weak demand. As such, the longer-term risk of inflationary side effects and a loosening of fiscal discipline are a source of concern. It remains to be seen whether “Sanaenomics” will prove well-suited to these conditions, and what it may mean for fiscal discipline going forward.

While the long-term market impact of this political shift is uncertain, one thing seems clear to us: Japan’s steady progress in corporate governance reform is likely to continue, regardless of changes in political leadership.

In essence, the core aim of Japan’s corporate governance reform is to raise returns on equity—an area where Japan has long lagged global peers, whereby enhancing the appeal of the Japanese equity market to global investors.

Japan’s corporate governance reform began under Abenomics, with the introduction of the Stewardship Code and Corporate Governance Code in 2014 and 2015, respectively. Many measures have been put in place since then. Consequently, the reform has progressed slowly yet steadily.

Japanese companies, often seen from overseas as slow to change and bound by past practices, were often viewed with scepticism on this front. Yet Japan’s relatively homogeneous corporate culture can, once a trend takes hold, deliver powerful and sustained change. We believe this to be the case for Japan's ongoing corporate governance reform endeavor. More than ten years have now passed since these government-led initiatives began, and we believe the process has entered a phase where private-sector companies are taking the lead in improving capital efficiency.

Revision of the Corporate Governance Code

Amid this, the Financial Services Agency of Japan has begun discussions on revising the Corporate Governance Code for the first time in five years. The focal point this time is listed companies that are holding excessive cash on their balance sheets.

As widely reported, ongoing initiatives have largely focused on corporate underperformers suffering from chronically low returns on capital. This effort culminated in the Tokyo Stock Exchange’s March 2023 request titled “Action to Implement Management that is Conscious of Cost of Capital and Stock Price",¹ calling for public disclosure of companies with share prices below book value per share (BPS). Prompted by this request, corporate awareness has improved, and the number of listed companies with a price to book ratio (P/B) of less than 1x has been declining.

By contrast, the upcoming revision appears to be aimed at companies trading above 1x P/B. Many of these firms are often high-quality profitable businesses whose return on equities (ROE) exceed their cost of equity. However, even among these blue-chip companies, there are those that are not optimizing their capital allocation, instead, choosing to accumulate the profits they earn as idle cash.

It is somewhat understandable that such companies did not have much incentive to act as the previous TSE initiative was commonly referred to as the “sub-1x P/B reform." Therefore, the real challenge in the Japanese equity market is to raise management awareness not only among companies with P/Bs below 1x, but also among those trading above 1x. The latter group has yet to fully embrace this shift.

The upcoming revision to the Corporate Governance Code is expected to deliver a stronger message addressing this issue, which is very much in line with the themes we raised in our May 2024 commentary.

We expect all listed companies to reassess their approach to capital costs. This could provide a fresh catalyst for renewed investor attention on the Japanese equity market.

Positive and Negative Factors Surrounding Japanese Equities

Positive external factors unique to the Japanese equity market would include the following:

•    Continued corporate governance reform and equity market reform aimed at enhancing the appeal of Japanese equities;

•    A shift in consumer behavior as inflation and positive real wage growth become the norm;

•    Continued progress toward the normalization of interest rates;

•    Booming inbound tourism, and continued inflows of foreign workers;

•    Japan’s geopolitical neutrality, which allows it to both deepen economic cooperation with the U.S. and continue exploring business opportunities with China;

•    Execution of Japan’s planned $550 billion in direct investment into the U.S., which should benefit Japanese exporters; and

•    Ongoing solid foreign direct investment into Japan.

Headwinds would include:

•    Despite companies’ efforts to raise wages, real wage growth remains negative; and

•    Under the new prime minister, the risk of weaker fiscal discipline, higher long-term interest rates, and a weaker yen may undermine Japan's secular growth.

As of the end of November, Japanese equities were trading at 18.67x forward earnings and 1.69x book value, implying an ROE of about 9.1%. This is a significant improvement from ten years ago but still remains low by international standards.

Crucially, with a shrinking working-age population, Japan has no choice but to improve productivity. Pressure from activists demanding greater capital efficiency, emerging opportunities to harness AI, and—above all—a growing willingness among Japanese companies to proactively reshape their corporate cultures toward performance-driven models should help labor productivity converge with levels seen in other major economies. This should translate into higher ROE, making it a uniquely compelling structural story for Japanese equities.

On today's inflation, it has the potential to fundamentally change household behavior. In a deflationary environment, households tend to postpone consumption in anticipation of lower prices in the future—leading to a vicious cycle of weaker consumption, lower corporate profits, falling household incomes, and further declines in consumption. By contrast, under inflation, households expect prices to rise, which encourages them to bring forward consumption. This increases the velocity of money—the lifeblood of the economy.

To protect their financial assets from inflation, households are also likely to accelerate the shift from bank deposits into equities. Japanese households hold over JPY 1,000 trillion ($6.4 billion) in bank deposits yielding negligible interest rates (out of more than JPY 2,200 trillion or $15 trillion worth of liquid household financial assets), while the total market capitalization of the Japanese equity market is over JPY 1,100 trillion ($7.1 billion). If households increase their equity allocations, the impact on the market could be substantial. To accelerate this shift, the government has been promoting NISA (Nippon Individual Savings Account), a tax-advantaged savings scheme designed for retail investors.

Japan also stands out among advanced economies in that real interest rates remain deeply negative. While Consumer Price Index (CPI) inflation is around 3%, the overnight call rate—effectively the policy rate—remains at 0.5%. Although it is difficult to pinpoint Japan’s neutral policy rate, there is little doubt that it is higher than the current 0.5%. We therefore continue to see further rate hikes by the Bank of Japan (BOJ) as the base case.

Given that previous attempts to exit the zero-interest rate policy in 2000 and 2006 ended in failure, however, we expect the BOJ to proceed very cautiously. This implies that nominal interest rates are likely to rise only gradually, and that overall monetary conditions will remain accommodative for some time. Such an environment is generally supportive for financial assets, including equities.

Meanwhile, higher nominal interest rates should boost financial-sector earnings and increase household interest income. By simple math, every 0.1 percentage point increase in deposit rates boosts household interest income by roughly $1 trillion (this will materialize with a lag), thereby increasing households’ spending power. This is equivalent to around 0.15% of Japan’s gross domestic product (GDP).

A gradual rise in interest rates should also ultimately weed out inefficient “zombie” firms, which would send a powerful signal that Japan is changing.

All of this illustrates that Japan is at a very different stage of the cycle compared with the U.S., where the debate now focuses on the timing of rate cuts.

Elsewhere, the positive economic impact of inbound tourism remains intact. From roughly 8 million annual visitors at the onset of Abenomics, arrivals are estimated to exceed 40 million this year, with average spending of $210,000–$220,000 ($1,400–$1,500 per trip). This equates to more than 1% of GDP, and the absolute scale of total expenditure is significant.

Foreign workers are increasing in numbers too. The majority is from Asia such as Vietnam, China and the Philippines, but the number of knowledge workers from western countries is rising as well. All told, the number of foreign residents is now around 4 million, accounting for 3.2% of Japan's total population (124 million), up from just 2.2% before COVID. These trends at least should partially alleviate the negative impact from the natural attrition of Japan’s population (about 900,000 people each year).

Japan’s relatively low geopolitical risk is another attraction for foreign investors. Firstly, the country is deepening economic cooperation with the U.S.—its key partner. The Japanese government’s commitment to $550 billion in direct investment into the U.S. is expected to be implemented by 2029, when President Trump’s current term ends.

Of particular note, in late October the two governments released a “Joint Fact Sheet on Investment between Japan and the United States,²" covering four priority areas: nuclear power and other energy-related projects, power development for AI, AI infrastructure, and critical minerals. Although details have yet to be disclosed, two of the eight Japanese companies reported by the Nikkei on 29 October as expressing interest in this initiative—SoftBank Group and Hitachi—are holdings in the Fund.³

Secondly, Japan is in an enviable position to be able to pursue business opportunities with China. Among Chinese consumers, Japanese products, food culture, games, and animation enjoy a large and loyal following, despite occasional diplomatic tensions between the two countries.

Foreign direct investment into Japan, such as TSMC’s construction of semiconductor fabs, has also been brisk. Behind this trend, we see several key factors: Japan’s relatively low geopolitical risk, the cost advantage derived from a weak yen, and the desire of overseas companies to secure highly skilled and reliable Japanese workers.

As noted earlier, another distinguishing feature of the Japanese market is that value stocks have significantly outperformed growth stocks—exactly the opposite pattern to the U.S. This illustrates that the dynamics of the Japanese market are quite different from those of other developed markets. For global investors, this strengthens the case for allocating capital to Japan from a diversification perspective.

Lastly, key risk factors include the continued decline in real wages due to persistent inflation, which is eroding household purchasing power. To counter this, the government has been urging private-sector companies to increase base salaries. The result of this is the country's wages rising by 3.6% and 5.3% in 2023 and 2024, respectively after decades of anaemic growth due to deflation. Sustaining the trend of wage increases remains crucial.

The potential weakening of fiscal discipline under the new administration also poses a risk. It is still too early to draw firm conclusions, and the situation warrants close monitoring for now.

Current Portfolio Positioning

Compared with the TOPIX, which has seen a sharp re-rating of its P/E ratio this year, we believe that the Fund’s portfolio consists of cheaper stocks with higher ROE, indicating a concentration in higher-quality companies.

As of the end of November, the portfolio trades at a forward P/E multiple of 16.5x, compared with 18.7x for the TOPIX. The respective ROEs are 11.0% for the Fund and 9.1% for the TOPIX.

Particularly, the Fund’s P/E remaining below that of the TOPIX is crucial, in our view, as Japan’s risk-free rates (Japanese Government Bond yields) have been inching up—with the 10-year at 1.81%, a 18-year high, and, of greater concern, the 30-year is at 3.34%, reaching an all-time high following Prime Minister Takaichi’s inauguration. It is important to remember that higher rates translate into higher discount rates applied to future business cash flows. In other words, high P/E stocks may come under pressure going forward.

In terms of earnings outlook for the Fund’s portfolio holdings, we see robust long-term growth prospects for the next fiscal year and onward even for holdings (such as Seven & i, Recruit, and homebuilders) whose earnings have been sluggish this fiscal year.

Turning to the portfolio makeup, until the middle of last year it held roughly equal exposures to four broad areas: ORIX (single security), Seven & i (single security), the three major insurance groups, and semiconductor-related names, which in aggregate made up about two-thirds of the Fund.

As of the end of November, we remain constructive on Seven & i and ORIX, both of which were initiated in 2022 and whose potential has yet to be fully recognized by the market. While Seven & i has been lackluster and ORIX has slightly outperformed the index this year, both continue to trade comfortably above our cost bases. Encouragingly, we are seeing signs of positive change that reinforce our expectations for long-term share price appreciation.

At Seven & i, the world’s largest convenience store operator by store count, the new management team led by Steve Dacus is now fully in charge. While media reports indicate that recovery at existing stores in Japan and the U.S. has been slow, we believe the organization is now progressing more decisively than under former CEO Isaka. A heightened sense of urgency appears to be driving faster and more focused execution. The convenience store format is a Japanese retail concept that can compete globally, and the prospect of accelerated international store openings over time remains positive.

ORIX, a well-run non-bank financial services provider/investment company with over a 60-year history, has recently announced the establishment of a co-investment fund with the Qatar Investment Authority (“QIA”). This marks the concrete start of the company’s long discussed shift toward a more “asset-light” fee-based business model, a theme we have repeatedly highlighted in our past commentaries.

Both Seven & i and ORIX are trading at significant discounts to the broader market on virtually every valuation metric. Seven & i currently trades at forward P/E of 14x based on pre-goodwill amortization EPS (company guidance), which is akin to cash-based EPS, or an 8% free cash flow (FCF) yield (estimated by SPARX), and total capital return yield of more than 13% (dividend yield 2.3%, buyback 10.7%). Though Couche Tard has backed away, a new suitor could emerge any day.

ORIX trades at barely 1x P/B. Better yet, if unrealized gains on its investment assets are considered, its valuation is effectively well below its BPS with forward P/E only a touch above 10x. If ORIX successfully finalizes its agreement with QIA, the stock will likely be valued based on P/E rather than P/B over time. As the P/B anchor is removed, the P/E multiple re-rating could take its share price meaningfully higher.

For both companies, the margin of safety is solid and the upside potential is compelling. When these two conditions are met, our default approach is to take large positions and wait patiently. So far, we see no reason to revise that view—unless more attractive investment opportunities arise or the thesis proves invalid.

We also continue to view the three general insurers—acquired as a basket in 2022—as the most attractive segment within Japan’s financial sector. The Japanese Property & Casualty (P&C) market is unusual by global standards in that:

1. Following years of consolidation, it has become an oligopoly dominated by three major players; and
2. These companies hold substantial unrealized gains on strategic equity stakes in their large corporate insurance clients, which, when liquidated, provide the capacity to sustain generous shareholder return policies and pursue an active M&A strategy.

To our knowledge, there is no insurance industry outside of Japan with such unique attributes. For these reasons, we have maintained a high allocation to the three major insurance groups thus far.

While the U.S. insurance underwriting cycle—a key growth market for Japanese players—has already peaked and premium rate declines are becoming a headwind for local insurers, this environment creates acquisition opportunities for Japanese companies. Historically, Japanese players have had lower ROEs compared with their U.S. counterparts. Japanese buyers often improve ROE through acquisitions, enhancing their deal leverage. These companies typically focus on attractive niche segments within specialty insurance, which tend to have high margins.

For instance, Sompo Holdings announced recently the acquisition of Aspen Insurance Holdings, a U.S. insurance and reinsurance underwriter, positioning itself to become a global player second only to Tokio Marine among Japanese insurers. Unlike Japanese banks and life insurers, which pursue overseas acquisitions primarily for scale, Japanese P&C insurers expand abroad not only to grow but also to diversify underwriting risks that are heavily concentrated in domestic earthquakes and typhoons. From an equity investor’s perspective, this risk diversification should, in theory, reduce the equity risk premium over time—creating a win–win outcome.

As for semiconductor-related names (mainly Renesas, Socionext, and Shin-etsu), we have reduced the Fund's exposure since late last year. The U.S. semiconductor export controls aimed at weakening China have ironically helped strengthen the competitiveness of China’s domestic semiconductor industry. We flagged this as a concern in our December 2024 commentary and have been lowering their positions accordingly.

Instead, in the first half of this year we raised the Fund’s exposure to the three housing manufacturers—Sekisui House, Sumitomo Forestry, and Daiwa House—and implemented a substantial increase in the allocation to SoftBank Group in June (before the sharp rally).

For the three housing manufacturers, we look forward to a recovery in the U.S. single-family housing market, which has likely been pushed out to next year and beyond. More importantly, we expect them not only to benefit from the long-term growth of the U.S. housing market but also to capitalize on Japanese-style manufacturing excellence. By combining cost-efficient homebuilding techniques with high-quality construction, they can cater to quality-focused homebuyers and expand market share. This is our long-term thesis.

Other major holdings—such as Sony Group, Hitachi, and Mitsubishi UFJ Financial Group—also remain core positions in the portfolio. We plan to provide a more detailed review of the performance of the Fund’s major holdings in next month’s commentary.

Click here for a full listing of Holdings.