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 September 2026, with the TOPIX rising 1.35% from the end of the previous month.

During the first half of the month, the market traded weakly. Geopolitical tensions in the Middle East resurfaced following a U.S. military strike on Iran, while higher crude oil prices and rising long-term interest rates globally weighed on investor sentiment, leading to declines in artificial intelligence (AI) and semiconductor-related stocks. Although the market temporarily rebounded on the back of strength in U.S. semiconductor shares, renewed yen appreciation and a further rise in oil prices pressured equities once again. In addition, comments from the CEO of a major U.S. AI company advocating a slowdown in the development of advanced AI heightened concerns over a moderation in AI-related investment, triggering another bout of selling.

In the latter half of the month, however, the market recovered. Interest rate hikes by the central banks of Japan and the United States were absorbed smoothly, helping to reduce market uncertainty. Subsequently, optimism regarding expanding AI demand supported gains in U.S. technology stocks, which in turn fueled a rebound in Japanese AI- and semiconductor-related shares. Financial stocks also attracted buying interest amid continued increases in interest rates, driven by expectations of improving lending margins. By month-end, the TOPIX finished slightly higher than at the end of August.

The Fund’s Performance

In September, the Fund (HJPIX) returned 2.32%, outperforming the Russell/Nomura Total Market™ Index, which returned 1.65%. The month’s positive performers among the Global Industry Classification Standard (GICS) sectors included shares of Communication Services, Financials, and Information Technology while Consumer Discretionary, Industrials, and Real Estate detracted from the Fund’s performance.

Among the best performers were our investments in SoftBank Group Corp., the telecom and internet conglomerate, Tokyo Electron Limited, one of the world’s largest manufacturer of semiconductor production equipment, and Tokio Marine Holdings, Inc., Japan’s largest general insurance company with arguably the best underwriting track record and successful overseas expansion.

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”, Sony Group Corporation, a leading global entertainment, technology, and electronics conglomerate, and ORIX Corporation, Japan’s largest non-bank comprehensive financial services company.

September Commentary

To consistently generate excess returns well above the cost of capital, a business requires a robust competitive advantage, or an economic moat. These barriers manifest in various forms: brand equity in consumer goods, economies of scale in manufacturing, network effects for internet companies, high switching costs in enterprise software, and geographical monopolies in real estate.

Among these, brand power was once considered crucial, but over time we have come to believe that relying on it alone is insufficient justification for investment.

Long-term readers of this letter may recall our past investments in consumer brands. These include Ryohin Keikaku (MUJI-branded household goods and apparels), Rohto Pharmaceutical (over-the-counter eye drops and skincare cosmetics), Kao (homecare and personal care goods), Unicharm (baby diaper and sanitary napkins), Asics (running shoes), Shimano (bike parts), and Pigeon (baby care products). We have already sold the majority of these investments or have completed a full exit over the years. This reflects our belief that “brand,” as a source of competitive advantage, has weakened over time amid changing industry dynamics. In short, simply having a well-known brand is no longer enough to make a business fundamentally compelling.

Our Take On Brands

Brand is an interesting form of competitive advantage that capitalizes on human psychology. Consider a pair of branded shoes versus unbranded ones. To manufacture a pair, both types require a certain amount of manual labor and production equipment to complete the job. Aside from differences in raw material quality and craftsmanship, total production costs should not differ materially. Yet, consumers are much more willing to pay for the former than the latter for the privilege of wearing them. The basic function of shoes is universal, yet the range of prices consumers are willing to pay can be astonishing (branded shoes are not only more expensive but they could even give you discomfort initially fresh out of the box due to the stiffness of new leather).

Brands deeply rooted in the public consciousness are said to command a high “mindshare.” This is the fruit of years—often decades—of substantial advertising and promotional investment, creating an accumulated moat that new entrants cannot easily replicate. For this reason, established brands have historically been viewed as possessing formidable barriers to entry.

Not All Brands Are Created Equal

There are a broad range of brands. To begin with, at least two distinctive types of consumer brands would come to mind.

The first category is the “luxury brand” segment, whose value proposition is predicated entirely on scarcity. For example, brands like Hermes, Louis Vuitton, and Cartier are known for their designer bags and accessories, while Ferrari is famous for their luxury cars. These brands have a strong appeal to many people, but not everyone can afford them. Their high prices preserve exclusivity, while limited supply often supports high margins.

Interestingly, luxury goods have a unique mechanism called the Veblen Effect that drives consumer behavior. People tend to consume luxury goods to show off their wealth and social status. This phenomenon is different from the typical downward-sloping demand curve in economics as higher prices make luxury goods more desirable to certain consumers.

However, luxury brands face an inherent dilemma. If they produce too much, the value of their products decreases, and they risk diluting their brand image. On the other hand, if they raise their prices too high, they may lose customers and suffer a backlash. For instance, after the COVID-19 pandemic, luxury consumption in China surged as consumers, unable to travel abroad, splurged on luxury goods instead.

Brands like Burberry and Gucci raised their prices significantly, but this strategy backfired when consumers became wary of the high prices and the brands’ images suffered as a result. As the brand appetite from so-called aspirational middle-class consumers failed to keep up, inventories of unsold goods quickly built up. This led to price cuts by these brands only to see their brand image tarnished in the process. This is a risk that luxury brands must contend with. While brands such as Hermes and Ferrari have preserved their prestige during this period, others have struggled. The Veblen Effect can be both a blessing and a curse for them, and finding the right balance is critical to their success.

At the other end of the spectrum are “mass brands,” where people are inclined to purchase precisely because everyone else has it. Buyers know that it is a sign of good quality and safety. If you are accustomed to using certain everyday goods that carry a particular brand and the price is easily affordable, you would not bother switching to another product. Consumer stickiness is the biggest advantage here. Even though per-unit profit is nowhere near that of luxury goods, the sheer volume of sales can allow the brand owners to generate substantial profits.

In the past, we generally favored mass consumer brand businesses as more durable and stable when it comes to long-term investing. Since everyday consumer staples are largely insulated from economic cycles, they have traditionally offered businesses that investors could hold with peace of mind across varying macro environments. Companies such as Kao and Unicharm precisely fit this bill at the time we owned them.

Varieties Within Mass Brands

Mass brands can be further broken down into several categories: global, regional, and local.

In the beverages industry, Coca-Cola is a prime example of a global brand. Its brand equity is recognized worldwide, giving consumers unwavering confidence wherever they travel.

Beers, by contrast, are largely regional brands. For example, Asahi and Kirin boast dominant domestic footprints and reasonable awareness across Asia, but they lack a ubiquitous global presence. Similarly, Budweiser is predominantly consumed in North America, while Heineken, Stella Artois, and Carlsberg are household names in Europe but their presence diminishes notably outside of their core regions.

There are also local brands that are well-known only in Japan, such as Mitsuya Cider, a popular Japanese carbonated soft drink which has been around since 1884.

On the other hand, bottled water brands have successfully created an image of safety and quality, and are well-known globally, with brands like Evian and Volvic being popular. However, many consumers do not have a strong preference for a specific brand of bottled water and view them as interchangeable.

Seen in this light, it is easier to understand why Warren Buffett has long regarded Coca-Cola as one of the most formidable and irreplaceable brands in modern business.

The Brand Business Environment Has Been Permanently Shifting

That being said, time-tested consumer brands are not bulletproof. As with any business, competitive forces abound and we are keenly aware of changing dynamics around the consumer products’ space of late. Below are excerpts from a commentary we wrote in November 2018 (a bit dated), outlining several structural threats that could undermine consumer-brand franchises.

1.    Traditional brand advertising is not as effective as before:
In the early days, brand owners’ main source of competitiveness was the spending power for brand advertising. Since TV, radio and newspaper advertisements were cost-prohibitive for small players, there was always an incentive to grow big in order to enhance the “moat”. Today, this theory does not hold anymore. Thanks to the Internet, even a small mom & pop business can identify target consumers and beam their ads through online platforms (i.e., Facebook and Google). Furthermore, in traditional sales channels such as supermarkets, big consumer companies have been using their financial firepower to “buy up” store shelves as prime real estate to display their products, elbowing out weaker rivals in the process. In the e-commerce era, this dynamic is no longer applicable either.

2.    Bargaining power is shifting from the brand owners to e-commerce retailers:
As e-commerce platforms become more dominant, brand owners can no longer ignore their formidable customer reach. Brand owners used to be at the top of the retail food chain and controlled everything because if there were no products from brand owners, there would not be any retail to be done. In any negotiation, brand owners had the upper hand. This relationship is now changing. Brand owners are gradually losing their bargaining power against giant retailers.

3.    Consumers are better equipped to compare prices for better deals:
In the Internet era, consumers can instantly compare prices across different points of sale for the same products. With home delivery services becoming more widely available and less expensive, the average selling prices are under pressure to converge toward the low end of the range, potentially contracting the margins of the brand owners.

4.    Rise of subscription models:
Over the last several years, subscription-based models have become increasingly popular. While most services have yet to prove themselves to be sustainable business models, We feel that there is a reasonable possibility that routine purchases of low-price, bulky items will be replaced by subscription services over time. Items such as razor blades, pet food, meal kits and even clothing have been targeted by new start-ups.

5.    Changing consumer tastes with more diversity:
It is often mentioned that millennials are the most divergent consumer group. Due to more affluent upbringings and proficiency in technology, these young consumers demand more choices, originality and uniqueness in the things they buy. As such, traditional capital-intensive advertising to promote a generic product to a mass audience is no longer an effective marketing model. It also makes it challenging for big consumer companies to benefit from economies of scale. Nimble and more niche brands are chipping away at big players’ profits.

6.    Threat of private brands:
Big retailers have been morphing into brand owners themselves through the development of private labels. In Japan, notable brands include Seven Premium of the convenience store operator Seven Eleven and TOPVALU of the supermarket chain AEON Group. For many years, consumer staples such as bread and soy sauce have been sold under these brands in large quantities. Turning to overseas, Amazon is also aggressively making a push into this arena. Notably, one of their offerings is baby diapers.

Additionally, the following trends have emerged in recent years.

7.    Consumer goods that are considered harmful to health will struggle due to rising health-consciousness:
This includes snacks, soft drinks, alcohol, tobacco, and other similar products. The rapid uptake of GLP-1 anti-obesity drugs has led to a structural decrease in demand for snack and soft drink products that are high in sugar and calories. The Gen-Z is already experiencing a noticeable decline in alcohol consumption. Moreover, alcoholic beverages are expected to face strong headwinds in the future, following the release of research papers in 2024 and renewed warnings from the World Health Organization.

8.    AI agents replacing human decision-makers:
The rise of AI agents has the potential to fundamentally reshape the e-commerce landscape. Traditionally, companies have invested heavily in building brands that appeal to human consumers. However, if AI agents increasingly take over purchasing decisions on behalf of users, brand strength may become far less important than it is today. We will be watching closely how agent-based tools such as Muse, recently launched by Meta, become integrated into consumers’ daily lives and what implications this may have for the future of e-commerce.

Taken together, these developments suggest that consumer mindshare alone is no longer a particularly strong barrier to entry. It is for these reasons that the consumer stocks that we held during the 2010s have mostly disappeared from the portfolio in recent years.

How We Incorporate Brand Into Our Investment Framework

How, then, can brand manufacturers defend against these threats?

In our view, the strongest brands do not rely solely on advertising-driven image, but rather one underpinned by tangible, hard-to-replicate functional advantages alongside a long-term track record of excellence. We believe that Japan’s fundamental strength in manufacturing is what sets Japanese brands apart and allows them to thrive.

Consider the fashion and apparel industry. Historically, competition revolved around brand image advertising—for instance “youthful Ivy League style” or “classic British luxury look.” Fast Retailing’s UNIQLO, however, built its brand around highly functional everyday apparel offered at competitive price points.

UNIQLO’s best-known products include HEATTECH, AIRism, and Ultra Light Down. The HEATTECH line is a thermal innerwear that keeps you warm and dry in winter thanks to its unique fibre technology. It is packed with value-added features such as easy fitting, comfort without tightness, anti-static, deodorant, antimicrobial, and moisture retention functions. The AIRism line is designed for summer wear and features a material that quickly dissipates sweat and provides a refreshing wear experience. The Ultra Light Down line offers high warmth retention despite its super-lightweight design, made from durable water-repellent materials, and the lining is anti-static to ensure maximum comfort.

UNIQLO deliberately zeroed in on product functionality—an area long overlooked by traditional casual apparel brands. In recent years, it has augmented this technical edge with refined design aesthetics, accelerating its global expansion under the cohesive brand concept of “LifeWear.”

Ultimately, unless a business sells a pure commodity, virtually every company possesses some degree of a brand. Within our current portfolio, holdings such as Seven & i Holdings, Sony, Mitsubishi UFJ Financial Group (MUFG), and Recruit Holdings (Indeed) all enjoy brand recognition among general consumers.

In assessing these companies, however, we first focus on competitive moats beyond branding; consumer mindshare is a useful supplement, not the core investment thesis.

Japanese Brands That Transcend Cultural Barriers Internationally

Japanese companies are required to develop their business not only in the domestic market, but also to target consumers worldwide in order to truly thrive. Historically, European businesses with small home markets have long emphasized overseas expansion. Countries like the Netherlands and the UK have established a strong presence in emerging markets through their colonial history. Global companies like Nestle of Switzerland, IKEA of Sweden, and LEGO of Denmark are industry leaders today that originated in small countries. We believe that our portfolio companies are ahead of the curve in their global expansion efforts.

However, it is not enough to simply aim for overseas expansion. It is also crucial that the products, goods, and services of these companies can transcend cultural barriers internationally. This refers to something that is universally used regardless of regional or cultural differences or customs. For instance, Unicharm and Pigeon, both of which we have owned in the past, produce diapers, baby bottles, and other childcare products that are consumed across cultures and are largely unaffected by cultural or religious preferences. Coca-Cola is another example—it’s loved by people all over the world.  On the contrary, if we were to expand overseas a gyudon business, or beef rice bowls, one of Japan’s popular restaurant categories, it might face challenges in India, where Hinduism is prevalent and cows are considered sacred animals, even though the country has the world’s largest population and youthful demographic in the world with promising economic outlook. Therefore, it’s essential to consider such cultural and religious factors when investing in Japanese global businesses that cater to diverse consumers.

Ultimately, while brand remains an important asset, we no longer view it as a sufficient source of competitive advantage on its own. The businesses that interest us most are those whose brands are reinforced by durable functional advantages that competitors cannot easily replicate. In that sense, brand is best viewed as a complement to a moat, rather than the moat itself.

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