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 February 2026, the Japanese equity market posted substantial gains, with the TOPIX, a representative index of Japan’s stock market, advancing 9.15% month-on-month.

During the first part of the month, market volatility increased ahead of the House of Representatives election. On February 8th, the Liberal Democratic Party secured a historic landslide victory with  316 seats, the largest postwar total. This outcome strengthened expectations for Prime Minister Takaichi’s political stability and additional fiscal expansion, triggering a sharp market rally. Record-high trading value on the Tokyo Stock Exchange (TSE) Prime Market, supported by significant net buying from foreign investors, further accelerated the upward momentum and propelled Japanese equities to materially higher levels.

In mid-February, profit-taking emerged after the market’s rapid rise, reflecting growing concerns about market overheating. Additionally, renewed investor concerns regarding “Artificial Intelligence (AI) replacing existing software-related functions” prompted broad-based selling, particularly in software names. Conversely, AI infrastructure-related equities attracted strong inflows, supported by the formation of the second Takaichi Cabinet and progress in Japan–U.S. investment initiatives. While heightened geopolitical tensions in the Middle East temporarily weighed on the market, selective rotation among sectors helped the market stabilize at lower levels.

Toward the end of the month, early interest-rate hike expectations receded after Takaichi’s government proposed the appointment of two reflationist candidates for the Bank of Japan’s Policy Board. This shift helped restore market momentum. Semiconductor-related stocks led the rally, and software stocks—previously sold off mid-month—rebounded sharply due to perceived undervaluation. As a result, buying spread across a wide range of stocks. Consequently, the TOPIX reached a new all-time high, marking its 11th consecutive monthly gain.

The Fund’s Performance

In February, the Fund returned 6.22% (HJPIX), underperforming its benchmark, the Russell/Nomura Total Market™ Index, which returned 8.83%.

The month's positive performer among the Global Industry Classification Standard (GICS) sectors included shares of Financials, Information Technology, and Consumer Discretionary while Communication Services 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, Mitsubishi Corporation, the largest trading company in Japan, and Sompo Holdings, Inc., one of the three largest general insurance company in Japan.

As for the laggards, Recruit Holdings Co., Ltd., Japan’s unique Human Resources (HR) and media company and the owner of U.S.-based online job advertisement subsidiary "Indeed," Hitachi, Ltd., one of Japan’s oldest electric equipment & heavy industrial machinery manufacturers, and SoftBank Group Corp., the telecom and Internet conglomerate.

February Commentary

Accelerating AI Threat Narratives Since the Start of the Year

Since the start of the year, rapid advances in generative AI have fueled concerns that established companies across multiple industries may struggle to survive. Headlines such as “the death of SaaS,” “software becoming obsolete,” and “a flood of AI-generated content” have become increasingly common. Against this backdrop, several of our portfolio holdings such as Recruit and Sony Group have experienced share price pressure.

Sure enough, AI is a game changer and could pose an existential threat to existing companies. However, we find the extreme pessimism that has accelerated since January difficult to reconcile with observable fundamentals. The companies currently under heavy selling pressure continue to report strong earnings for the current fiscal year and, importantly, maintain confidence in delivering further profit growth in the next fiscal year.

The market’s anxiety appears to stem from a sudden reassessment of businesses’ so called “terminal value.” Yet it seems odd that equity markets—typically focused on the short-term—would abruptly adopt an unusually long-range view only in the context of AI.

A more plausible explanation is that vague, generalized AI concerns triggered sharp declines in certain stocks, which then fueled additional fear among shareholders. This dynamic likely led to a wave of selling driven more by sentiment than by fundamentals—essentially, a “sell now, think later” environment. We have seen similar patterns in the past, including the early internet era with the rise of e-commerce and again during the COVID-19 pandemic.

Markets, often described as "the wisdom of crowds," often anticipate future developments correctly, but they can also be dramatically wrong. The pandemic period—characterized by soaring valuations of certain tech stocks and a steep drop in cyclical “old economy” names—is a prime example. We believe the current AI-related dislocations may similarly reflect that the market is wrong.

Among the companies whose shares have recently come under selling pressure, many are already harnessing AI in an attempt to strengthen their competitive advantages. Recruit is a clear example. Its subsidiary Indeed, the world’s largest online recruiting platform, possesses extensive proprietary data on job seekers. The company is steadily enhancing matching accuracy and automating recruitment processes, areas where generative AI can be applied with significant impact.

Concerns that AI will make human workers redundant also appear overstated. In a recent interview,¹ Recruit’s CEO Idekoba highlighted that while demand for U.S. software engineers has fallen about 40% from pre COVID levels, this category represents only a very small fraction of the overall labor market. He dismissed claims of a "10% unemployment rate" asConcerns that AI will make human workers redundant also appear overstated. In a recent interview,1 Recruit’s CEO Idekoba highlighted that while demand for U.S. software engineers has fallen about 40% from pre COVID levels, this category represents only a very small fraction of the overall labor market. He dismissed claims of a "10% unemployment rate" as entirely unfounded. Idekoba also noted that even the largest U.S. tech firms, which have been responsible for recent massive layoffs, collectively employ less than 2% of the nation’s workforce.

Given his unique vantage point with access to real-time worldwide employment, his perspective suggests that the market’s bleak scenario is inconsistent with underlying labor trends. It is also worth noting that throughout human history, every major leap in productivity has ultimately led to the creation of new job categories.*

Sony Group’s diverse content portfolio should also prove resilient. In music, human-created works are likely to become more valuable—not less—should AI- generated material proliferate. In gaming and film, companies with deep expertise are best positioned to use AI to produce higher-quality content at lower costs and in shorter timeframes.

More broadly, we view the current market situation as an over-reaction driven by vague anxieties around AI disruption rather than a rational assessment of fundamentals. The idea that AI will wipe out all software and internet-based companies seems clearly overstated. As sentiment stabilizes and investors refocus on fundamentals, including a company’s ability to harness AI productively, we expect the market to differentiate more rationally between winners and losers. In that environment, we expect both Recruit and Sony Group to benefit from renewed investor interest.

The Role of Trading and Portfolio Rebalancing

Shifting topics—continuing from last month—we would like to elaborate further on the Fund's  portfolio management philosophy.

Our investment strategy aims to grow assets by

"Investing in a great business with exceptional management at an attractive price.”

This long-term philosophy often results in an investment horizon that can extend beyond ten years. That said, even with a long term focus, we do make selective and deliberate adjustments to the portfolio. A position may be sold when:

1. The stock price becomes excessively overvalued.
2. The company’s fundamentals deteriorate, indicating erosion of its competitive moat—or if we determine that our original investment rationale was flawed.
3. A more compelling opportunity emerges, offering a superior combination of expected return/expected risk relative to current holdings.

As an equity fund, the Fund must maintain a high allocation to equities. Accordingly, almost every sale is paired with a purchase—and vice versa. Each transaction, no matter how modest in size, is executed only when we believe the combined action of buying and selling will improve the Fund’s future performance relative to leaving the portfolio unchanged. In other words, every decision must be expected to add "value."

In our view, trades are motivated by one or both of the following objectives: 1) enhancing expected returns, or 2) reducing expected risks.

Both expected return and expected risk are inherently forward looking concepts and therefore cannot be quantified with precision in advance. Nonetheless, careful analysis is essential.

Trades Aimed at Enhancing Portfolio Returns

Trades intended to enhance expected returns can, over time, be evaluated objectively. The simplest illustration of a value adding trade is when the stock we purchase subsequently appreciates, while the stock we sell declines. Conversely, if the new holding declines and the divested stock appreciates, the trade detracts from value.

There are also cases where both securities move in the same direction. In these cases, the trade is still considered value-accretive if the purchased stock rises more—or falls less—than the one sold.

Put differently, even if both stocks decline, the decision can still add value relative to leaving the portfolio unchanged.

Assessing trades through this lens over multi-year periods allows us to quantify how much value trading activity has contributed. A recent analysis shows that, through February 2026, the Fund’s actual performance exceeded by approximately 30% on a cumulative basis the return that would have resulted had we simply held the portfolio as it stood at the end of 2021. Expressed differently, this corresponds to an annualized outperformance of approximately 5% compound annual growth rate (CAGR)—a reflection of the incremental “value” generated by trades executed during this period.*

For this exercise, we have selected the December 2021 portfolio as a reference point. In 2022, the Fund underwent an extraordinary level of repositioning in response to a structural shift in the market— specifically, the onset of inflation and the subsequent rise in interest rates. (The details of this transition were discussed in our November 2023 commentary). In retrospect, the substantial portfolio adjustments implemented from 2022 have, thus far, proven to be the right decision.

Reviewing individual transactions that have added value since the beginning of 2022, several long-standing positions—such as Nidec, Terumo, Shimano, Misumi Group, and Kao—were fully exited after contributing meaningfully to the Fund’s performance over the prior decade. These holdings were replaced with new positions, including the three major non life insurers, ORIX, Tokyo Electron (all initiated in 2022), as well as Mitsubishi UFJ Financial Group (added in early 2023). Collectively, these additions have made positive contributions to performance.

One inherent challenge in evaluating trade effectiveness is that value creation cannot be conclusively assessed over short periods. The Fund's investment approach focuses on identifying companies whose intrinsic value is underappreciated or not yet recognized by the market. Consequently, it often takes time for the market to validate these views through share-price appreciation.

The significant portfolio realignment undertaken in 2022 contributed to a marked improvement in the Fund’s performance in both 2023 and 2024. Although the Fund lagged the index in 2025, the medium-to long-term growth prospects of the current holdings are robust. With the intrinsic value of these companies still not yet fully reflected in their stock prices, we remain optimistic about future returns.

Trades Aimed at Reducing Portfolio Risk

Another reason for trading is to lower risk, thereby mitigating potential downside in the portfolio.

Equity investing inevitably involves accepting a certain level of risk to achieve returns. The central question for any investor is whether the returns achieved are commensurate with the risks assumed—or ideally, whether they exceed them.

Our Fund does not define risk in terms of conventional volatility measures such as “standard deviation.” Instead, we view risk as the "possibility of incurring permanent losses" at the individual stock level. This concept is, by nature, abstract. Once a risk materializes, it ceases to be “risk” but becomes an actual "investment loss."

To illustrate this concept, consider two hypothetical portfolios, A and B, each holding ten stocks and both delivering a 30% return. Portfolio A consists of overvalued companies with weak balance sheets and unattractive businesses. By contrast, Portfolio B is well diversified and comprised of financially sound businesses trading at reasonably valuations. Despite the stark difference in quality and risk characteristics, the headline performance appears identical as long as nothing goes wrong. However, when two portfolios offer the same expected return, the rational choice is to favor the one with lower expected risk. Focusing solely on return potential, without regard to the risk required to achieve it, is unwise.

Evaluating trades made with the objective of reducing risk is inherently more challenging than assessing trades aimed at enhancing expected returns. Still, improvements in “portfolio quality” can be assessed. At the risk of making a claim that is open to debate, we believe that our portfolio's risk profile declined last year while expected returns were broadly maintained. Several qualitative factors support this view:

1. The Fund’s valuation discount relative to the market has widened, despite stronger fundamentals. The Fund's price to earnings ratio (P/E) now stands at 17.5x, below the TOPIX level of 20.4x, while its average return on equity (ROE) of 11.9% exceeds the index’s 9.6%. This combination indicates relative undervaluation. The shift in our valuation profile since 2022 merits additional explanation.

Throughout the 2010s, the Fund consistently traded at a premium P/E to the market. This was a natural result of our focus on traditional growth stocks—companies characterized by strong earnings growth and correspondingly high P/Es. At that time, Japan remained in a zero-interest-rate environment. Under such conditions, the earnings yield of high-P/E growth companies (the inverse of P/E) comfortably exceeded the risk-free rate. Therefore, a portfolio concentrated in high-P/E growth stocks was entirely reasonable and aligned with intrinsic-value considerations. Although the Fund traded at a valuation premium to the market, our holdings were undervalued relative to their long-term earnings power.

However, this premise changed materially beginning in 2022, when inflation took hold and interest rates began to rise. The substantial portfolio rebalancing undertaken in response was aimed at aligning the portfolio with this structurally new market environment.

Interestingly, yields on 10-year and 30-year Japanese Government Bonds (JGB) continued to climb significantly last year. A rising risk-free rate mathematically increases the discount rate applied to future corporate cash flows, creating a valuation headwind for high-P/E stocks unless interest-rate pressures subside. This shift has materially altered the relative attractiveness of growth-oriented, high-multiple equities.

At the same time, the main driver of Japanese equities' advance over the last 15 months has been valuation expansion. The market's forward P/E rose from 15x to 20x—an increase of roughly 30%. Corporate earnings did not rise nearly as much during this period, which is the reason why we avoid holding a large number of stocks and instead focus on selecting businesses with promising long-term growth prospects.

As noted in our November 2025 commentary, it seems that the Japanese stock market has also become increasingly bifurcated. Today, there are examples of stocks trading on forward P/Es of 40-50x, or at 30x earnings that are forecasted three years ahead. In contrast to earlier years, high-P/E stocks have become less attractive compared to JGBs, which now offer meaningfully higher yields. This shift is one of the factors behind the portfolio’s lower-than-market P/E today. The current portfolio comprises companies whose valuations, in our view, do not fully reflect their long-term earnings growth potential.

2. We believe improved diversification within the portfolio should also contribute to lowering risk. Although the portfolio remains concentrated in 20 to 30 stocks, the holdings are, in our view, well diversified across industries. Current holdings include ORIX (financial services/alternative investments), Seven & i (convenience stores), general insurance groups, banks, semiconductor-related companies, homebuilders, Sony Group (entertainment), SoftBank Group (AI), Hitachi (power infrastructure), Recruit Holdings (online job platform), Mitsubishi Corporation (general trading house), and Keyence (factory automation).

Homebuilders were a new addition in 2025, and we believe their inclusion has enhanced the overall diversification of the portfolio. While banks and insurers benefit from rising interest rates, homebuilders tend to be supported when interest rates remain low. Furthermore, their business exposure spans single-family home demand in the U.S. and Japan, with some presence in Australia, thereby adding a layer of geographical diversification. Their valuation—characterized by P/E and price to book ratio (PB) levels below the market average—also provide a counterbalance to some of the higher-than-average P/E stocks within the portfolio.

3. A substantial margin of safety at the individual-stock level is also expected to reduce the overall portfolio risk. We have emphasized this point repeatedly in past commentaries when discussing individual holdings.

For example, Seven & i trades at a P/E—based on earnings per share (EPS) before goodwill amortization—that is significantly below the market average. Its free cash flow yield is also expected to rank among the highest within the large-cap universe in Japan. ORIX likewise remains undervalued relative to its net asset value (NAV) per share when unrealized gains on its investment assets are taken into account. Should the market begin to value ORIX on a forward P/E basis, the implied valuation would fall into the low-teens range.

The margin of safety can also be considered qualitatively. In the case of Seven & i, shareholder dissatisfaction has increased since the proposed acquisition by Alimentation Couche-Tard fell through. This pressure has prompted the company to accelerate shareholder-return initiatives. Continuous large-scale share buybacks provide support for the stock price. More importantly, Seven & i is a global leader in the convenience store sector and possesses considerable strategic acquisition appeal. The possibility that a new suitor could emerge at any time could potentially limit the downside risk of the stock.

Taken together, these factors reinforce our view  that the trades executed in recent years have consistently contributed to lowering the portfolio's overall risk profile.

Click here for a full listing of Holdings.