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 December 2025, the TOPIX, a representative index of the Japanese stock market, rose 0.58% compared to the previous month.

In the first half of the month, long-term interest rates rose sharply after comments by Bank of Japan (BOJ) Governor Ueda heightened expectations of a rate hike at the December policy meeting. This led to broad-based selling across a wide range of stocks, excluding bank shares, and major indices declined significantly. Subsequently, sentiment improved on growing expectations of U.S. interest rate cuts and the U.S. government’s announcement of plans to support the robotics industry. Shares related to physical artificial intelligence (AI), including factory automation and robotics, rallied strongly, lifting the overall market and pushing the TOPIX to a new all-time high.

Around mid-month, after a temporary pullback after the U.S. interest rate cut decision, Japanese equities regained momentum as U.S. stocks remained firm and major indices hit new highs. The TOPIX again reached a record high. However, market sentiment weakened as concerns emerged over the profitability of AI-related investments, highlighted by reports of delays in AI data center projects by U.S. information technology (IT) giant Oracle and by weaker-than-expected earnings by semiconductor giant Broadcom. This led to a widespread sell-off, particularly semiconductor-related stocks, and the market entered a corrective phase.

In the latter half of December, the BOJ decided to raise interest rates, but the yen weakened as the governor’s press conference was perceived as relatively dovish. This supported buying in export-related stocks and semiconductor stocks. Toward month-end, however, trading volumes declined and the market direction became less clear. As a result, the TOPIX maintained a relatively resilient upward trajectory, while the Nikkei Stock Average finished the month modestly higher. Looking at the year as a whole, although both indices experienced significant declines in the first half, they rebounded in the second half and repeatedly reached new highs, ending the year at elevated levels.

The Fund’s Performance

Within the environment, the Fund (HJSIX) returned 2.27%, outperforming its benchmark, the Russell/Nomura Small Cap™ Index, which returned 1.22%.

This month, key positive contributors to the Fund’s performance included Raksul, Inc., Nishi-Nippon Financial Holdings, Inc., and Daihen Corporation. Raksul’s share price rose following the announcement of its management buyout (MBO). Shares of Nishi-Nippon Financial Holdings climbed as the banking sector performed well amid growing expectations of interest rate hikes by the BOJ. Daihen’s share price rebounded after being under pressure from its November second-quarter earnings announcement. During the December earnings briefing, management highlighted favorable market conditions, prompting re-evaluation buying. Growth prospects were further supported by plans to launch a panel transport robot for semiconductor back-end processes and expand capacity for large-scale transformers.

Meanwhile, key detractors from the Fund’s performance included Penta-Ocean Construction Co., Ltd., Musashi Seimitsu Industry Co., Ltd., and Maeda Kosen Co., Ltd. Penta-Ocean shares declined, likely driven by profit-taking after a sharp rise in its stock price in the previous month, despite no significant news during the period. Musashi Seimitsu Industry continued to underperform due to delays in the full-scale shipments of its hybrid supercapacitors and concerns over credit risk at Oracle, which utilizes their supercapacitors. Maeda Kosen’s share price remained broadly flat during the month, with no notable company-specific news.

From an investment perspective, we continued to increase holdings in existing positions while selling shares of companies where recent price appreciation had reduced their relative attractiveness. We initiated a new position in a bank, where we believe the improving industry environment is not yet fully reflected in its current valuation.

Japan’s transition toward an inflationary economy and ongoing corporate governance reforms will remain key themes in 2026. While concerns persist over fiscal deterioration stemming from high-pressure economic policies¹ under the Takaichi administration, these measures can also be viewed positively for Japanese equities, as they reflect the government’s commitment to re-start economic growth. Even in industries where deflationary sentiment remains entrenched, a shift in mindset is expected, creating opportunities for revaluation through improved profitability. We will continue to focus on identifying attractive investment opportunities aimed at generating medium- to long-term returns.

In recent years, we have commented on the growing polarization of consumption. We believe this trend is structural rather than transitory, reflecting a fundamental shift in consumer spending behavior that is driving structural transformation within the retail industry.

In categories such as groceries and household goods, consumer cost-consciousness has grown stronger. Companies that have strengthened their ability to offer private-label products at prices lower than national brands, as well as those that have optimized store operations and logistics to deliver lower-cost offerings, are steadily taking market share from traditional supermarkets and convenience stores. Importantly, price competitiveness is not driven by price reductions only, but by operational efficiency across the entire operation, creating a structural competitive advantage.

On the other hand, a completely different trend can be observed in discretionary spending.² Department stores offering a wide range of luxury goods have maintained relatively strong performance, supported in part by the recovery in inbound demand. In areas where experiences, quality, and brand value are prioritized over price, consumers are showing a clear preference for companies that can offer value beyond affordability. Reflecting this view, we have initiated positions in select discretionary consumption names that we believe are capable to achieve medium- to long-term growth.

The first company is a retailer aiming for regrowth by undertaking a significant shift from its historically conservative pricing strategy. The new strategy leverages its core strength of providing exceptional customer service, while introducing pricing that reflects this added value. Operating in an extremely competitive apparel market, the company had been cautious about revising prices for many years. However, with a change in leadership, it recognized that the company’s key differentiator lies in exceptional service, and that this value should be properly reflected in its pricing. Rather than competing on lower prices, the company is adopting a strategy focused on enhancing the customer’s experience and charging a fair but higher price. This new strategy is well suited with the growing polarization of consumer spending.

The second company is a musical instruments manufacturer whose share price has yet to fully reflect its solid growth, mainly due to external factors such as industry downturns and tariff-related uncertainties. The musical instrument market currently faces severe oversupply, with piano demand sharply declining following policy changes in China. Investor sentiment remains subdued amid overlapping concerns, including potential demand weakness from U.S. tariffs and a post-pandemic correction following the surge in stay-at-home purchases during COVID-19.

Despite these challenges, the company has steadily acquired customers by capitalizing on the structural shift toward digital instruments while leveraging its strong brand. Although faced with short-term external challenges, we believe that as these factors begin to dissipate, the company’s competitive position and earnings growth potential will be reevaluated.

Changes in consumer behavior are making the divide between winners and losers increasingly clear. We will remain focused on generating medium- to long-term returns by carefully identifying these structural shifts and investing in companies with strong pricing power, brand strength, and clear intrinsic value in their offerings.

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