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 July 2025, Japan’s major stock indices were primarily flat, with the TOPIX falling 1%.

During the first half of the month, profit-taking following the previous month’s sharp rally, coupled with uncertainty over U.S. reciprocal tariffs and expectations of a challenging Upper House election for the ruling party, limited market movements.

Additional uncertainty arose from reports of NVIDIA resuming artificial intelligence (AI) chip exports to China and speculation regarding the possible dismissal of U.S. Federal Reserve Chair Powell, resulting in a lack of clear market direction and sideways trading.

In the latter half of the month, the Upper House election on July 20 resulted in the ruling party failing to secure a majority even when including non-contested seats; however, as this outcome was widely anticipated, the market reaction when trading resumed on July 22 was limited. Stock prices surged following reports of a Japan-U.S. trade agreement on July 23, with the TOPIX reaching a record high and the Nikkei 225 climbing sharply on July 24. Despite a brief correction due to overheating concerns, the market rebounded toward the end of the month, supported by strong earnings from U.S. tech stocks. Consequently, the Japanese stock market closed the month substantially higher than at the end of June.

The Fund’s Performance

As a result, the Fund returned 1.49% (HJSIX), outperforming its benchmark, the Russell/Nomura Small Cap™ Index, which returned 1.28%.

This month, stocks that contributed positively to the Fund’s performance included AEON Fantasy Co., Ltd. and Musashino Bank, Ltd. AEON Fantasy announced its first-quarter results, with its Prizes Division leading the way, resulting in a significant increase in profits for domestic operations. In addition, earnings improvements, driven by progress in structural reforms in China, were also well received. Musashino Bank rose amid increased expectations for interest rate hikes within the year, following developments such as the agreement on Japan-U.S. trade negotiations.

Meanwhile, stocks that contributed negatively to the Fund’s performance included Treasure Factory Co., Ltd. and Yamami Company. Treasure Factory announced its first-quarter results, reporting stronger-than-expected sales growth at existing stores and contributions from new stores, resulting in solid performance and a rise in its stock price. However, despite no significant news, the stock price has since trended downward. Yamami also reported no noteworthy news, but concerns over rising cost ratios, likely caused by the slight weakening of the yen, appeared to contribute to its stock price decline.

As for investment activities, we continued to accumulate more shares of existing holdings, while also selling stocks whose share prices had risen and were no longer considered undervalued, as well as stocks for which the initial investment hypothesis had expired. We also started a new investment in a retail company that is expected to see an increase in corporate value through governance reforms.

Last month, Japan and the U.S. announced a trade agreement after tariff negotiations that had continued since April. The reported tariff rate of 15% is less severe than initially feared, and we believe that uncertainty in the Japanese economy has been reduced. With labor costs on the rise, we expect that efforts to expand capital investment aimed at improving productivity will continue. We are actively researching stocks that are considered undervalued as a result of concerns about tariffs and other factors. Preference for domestic demand-related stocks has continued in response to heightened geopolitical risks, and we believe that investment opportunities in overseas demand-related stocks are increasing, driven by growing performance and valuation gaps between domestic and overseas demand-related companies. Amid changes in the business environment, we are shifting to stocks that are better positioned within the domestic demand-related space.

Based on the hypothesis that consumption will become increasingly polarized, we have invested in department stores, which are expected to benefit from this trend. Following the sharp recovery in inbound tourism after the COVID-19 pandemic, the stock prices of our investments have remained firm. However, with the yen’s depreciation beginning to slow, signs of weakness are emerging in inbound consumption. In response to this situation, we have initiated a new investment in a company that is less susceptible to demand fluctuations and is expected to enhance its corporate value through governance reforms.

This company is a long-established operator of department stores and shopping centers in major cities across Japan, such as Tokyo and Osaka. As a result of its asset-heavy business model, the company has accumulated significant unrealized capital gains on its real estate holdings. In recent years, however, there has been growing awareness of capital efficiency, and the company is shifting its asset utilization policy, with measures such as classifying its holdings into core and non-core assets and making strategic decisions on divestment and reinvestment. The recent introduction of “store-specific ROIC” (return on invested capital) highlights the company’s move toward improved transparency and its intent to enhance corporate value through active dialogue with shareholders.

In addition, given the company’s long history, the market value of its cross-shareholdings has grown significantly. Looking ahead, we expect that by streamlining underperforming assets such as real estate and reallocating capital toward growth investments or shareholder returns, the company can enhance its per-share value over the medium to long term.

From a growth investment perspective, the company’s department store expansion in Asia is noteworthy. It has established brand power in the Asian market since its entry into Singapore in the 1990s. Since the mid-2010s, it has been expanding into other ASEAN countries such as Vietnam and Thailand. These regions are experiencing growth in both per capita gross domestic product (GDP) and population and are expected to follow a similar growth pattern to that of the department store industry in Japan.

Currently, stock prices are weakening amid sluggish inbound consumption at domestic department stores. However, from a medium- to long-term perspective, we believe the current stock price level represents an extremely promising entry point, and we have started investing in the company accordingly.

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