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.

Fund Performance Review

In January, the Fund returned 2.49% (HJPIX), underperforming its benchmark, the Russell/Nomura Total Market™ Index, which returned 3.14%.

The month’s positive performers among the Global Industry Classification Standard (GICS) sectors included shares of Financials, Industrials, and Information Technology while Materials 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 Corporation, the largest trading company in Japan, and Mitsubishi UFJ Financial Group. Inc., one of Japan’s largest financial groups.

As for the laggards, Renesas Electronics Corporation, Japan’s largest semiconductor maker specializing in MCUs and analog chips, Shin Etsu Chemical Co., Ltd., Japan’s largest chemical company, and Recruit Holdings Co., Ltd., Japan’s unique human resources and media company and the owner of U.S.-based online job advertisement subsidiary “Indeed” were the largest detractors.

Our investment philosophy, “Invest in a great business with exceptional management at an attractive price,” reflects our valuation discipline when investing. This involves carefully identifying undervalued stocks and spotting value that the stock market has yet to notice.

In introducing new stocks to our portfolio in the monthly commentary, we make it a point to explain why we believe they are undervalued to the extent possible. No matter how great a company is, if we invest in it at an overvalued price, we cannot expect market-beating returns. It’s crucial to patiently wait for the rare opportunity to invest at a discounted price. Such opportunities should arise when stock prices plummet due to temporary factors like a short-term downturn in earnings, an overreaction by the stock market to a corporate scandal, or panic selling during financial market turmoil.

Our holding periods for stocks in the portfolio tend to be long. We invest when we are confident that a stock is undervalued relative to its intrinsic value and often continue to hold it even after its price has risen and its undervaluation is corrected insofar as we believe the company will remain a long-term above-average grower. Here, “average” refers to the growth rate of nominal global gross domestic product (GDP).

Intrinsic value, for most of the stocks in our portfolio, is defined as the sum of the future cash flows that a business will generate for its shareholders over the remainder of its life, discounted back to their present value at a certain rate (known as the required rate of return). This is the same concept used to value bonds and real estate. To this end, we primarily use the discounted cash flow (DCF) model to calculate a business’s intrinsic value and determine whether a stock is over- or undervalued though it is more challenging to forecast the per-share cash flow. In our view, discounting future cash flows to their present value is the most mathematically logical concept when assessing equities, or any cash-generating asset for that matter.

Another commonly used method is to multiply earnings per share (EPS) by the price-to-earnings ratio (PER) to calculate a target stock price. While the DCF model may provide a more thorough economic basis for valuing a stock, PER can still provide valuable insights. As a matter of fact, given certain conditions, it is possible to view PER as a simplified DCF model. For example, 1/PER, which is an inverse of PER, is called “earnings yield” (e.g., a PER of 20 implies an earnings yield of 5%, and a PER of 15 implies 6.67%). Therefore, the equation “EPS (in yen) x PER (times) = stock price (in yen)” can be rewritten as “EPS/earnings yield (%) = stock price.”

We often use PER to explain a company’s stock price in the Fund because of these reasons. For example, in our February 2020 commentary, we discussed Sony’s perpetual growth rate and its relation to PER: “Using a simple DCF model, a price to equity (P/E) of 13.8 x implies a 10% discount rate and 2.8% terminal growth rate, which we believe also confirms that the current share price is cheap.”

Even when we read research reports, we feel much more convinced if the intrinsic value is determined based on PER with a “DCF” mindset than an argument focused around “target PER” or “historical average PER” and we hope our readers feel the same way. That said, the simple way of thinking PER in terms of “recovering the investment in x years with EPS at the current stock price,” may be more intuitive for understanding valuation. Whatever the case, no single valuation method is perfect, and they should all be used as part of a broader analysis.

As for the Fund’s valuation as of the end of 2023, the average PER is approximately 16.2x (weighted average PER). This is only slightly higher than the average of 15.1x for the TOPIX benchmark. Considering that our portfolio is made up of what we believe to be high-quality companies with above-average growth profiles and returns on capital, we believe that the Fund’s valuation is attractive. Furthermore, some of the stocks in the Fund have significant differences between accounting profit (reported profit) and actual cash-based earnings. Top holdings such as Seven & I Holdings and mega general insurance groups (Tokio Marine, MS&AD, SOMPO) are good examples. If we take these into account, the adjusted average PER of the Fund drops to 15.5x, almost the same as the average of the TOPIX. In other words, despite having profitability and growth potential far exceeding the average Japanese company, the Fund’s valuation level is not much different from the TOPIX. The Japanese stock market has been performing well, but we do not believe there is excessive overheating in the stock prices of our portfolio companies.

In next month’s monthly commentary, we plan to write about how we identify undervalued stocks that the stock market has yet to notice.

Click here for a full listing of Holdings.