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 June 2025, the Japanese stock market saw gains, with the TOPIX rising 1.86% compared to the previous month.

While geopolitical risks and developments in U.S. trade policy influenced market sentiment at times, improving external conditions and expectations for potential monetary easing in the U.S. fueled a stronger risk-on appetite among investors throughout the month.

In the first half of June, Japanese stocks were initially weighed down by concerns over U.S. tariffs and a potential economic slowdown. However, the market rebounded on the back of strong U.S. employment data and gains in U.S. semiconductor-related stocks. Reports of Israeli attacks on Iran then heightened tensions in the Middle East, triggering a temporary risk-off mood and pushing the market lower.

However, the Bank of Japan (BOJ) kept its policy rates unchanged and signaled a slower pace of government bond purchase reductions. Similarly, the U.S. Federal Reserve (FOMC) held interest rates steady, which supported investor sentiment and stabilized the market. While Japanese equities traded within a narrow range amid shifting external factors, they gradually trended higher.

In the latter part of the month, although renewed tensions in the Middle East and reports of U.S. airstrikes on Iranian nuclear facilities briefly triggered risk aversion, geopolitical concerns eased quickly. A rebound in U.S. equities subsequently supported the Japanese market. Additionally, comments from President Trump regarding a potential ceasefire, along with dovish comments from Federal Reserve officials hinting at possible rate cuts, further boosted investor confidence and risk appetite.

High-priced semiconductor stocks led the rally, and demand from reinvestment following the ex-dividend date provided an extra tailwind. As a result, the Nikkei 225 reached a new year-to-date high, and the overall Japanese stock market ended the month with substantial gains.

The Fund’s Performance

As a result, the Fund returned 2.74% (HJSIX), underperforming its benchmark, the Russell/Nomura Small Cap™ Index, which returned 2.75%.

This month, the stocks that contributed positively to the Fund’s performance included Tanseisha Co., Ltd. and Towa Corporation. Tanseisha announced an upward revision of its performance forecast and a dividend increase, which was well received, as costs for its projects related to the Expo 2025 Osaka, Kansai, were lower than initially anticipated. The rise in Towa’s stock price is likely due to the recovery of expectations for semiconductor-related stocks in general, driven by factors such as continued strong demand for artificial intelligence (AI) data center investments.

Meanwhile, the stocks that contributed negatively to the performance included Maeda Kosen Co., Ltd. and Treasure Factory Co., LTD. Maeda Kosen experienced a selloff, likely due to factors such as the significant increase in its stock price the previous month, despite the absence of any particular news or developments. Treasure Factory reported strong monthly sales for May, but the stock price fell due to concerns about a decline in high-end inbound consumption.

As for the 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 initiated new investments, including in a machinery manufacturer expected to benefit from growth opportunities driven by advances in the miniaturization of semiconductor manufacturing equipment.

The Japanese stock market is currently at a major turning point. We believe that there is growing momentum for revaluation from three perspectives, namely, attractive valuation, structural shift from deflation to inflation, and corporate governance reforms.

1. Attractive Valuation

Japanese stocks remain undervalued relative to other major regions. Looking at indicators such as the price to earnings ratio (P/E) and price to book ratio (P/B), the TOPIX is lower than the S&P 500 and is at the same level or slightly undervalued compared to major European countries’ indices. This undervaluation is particularly pronounced in the small-cap market, where a significant discount compared to large-cap stocks persists.

Although there is a long-held bias that Japanese stocks are perpetually undervalued, we believe that there is significant room for structural revaluation going forward as profit margins and capital efficiency improve.

2. Structural Shift from Deflation to Inflation

The Japanese economy is entering a period of transition from more than 30 years of deflation to a sustained inflationary economy.

Wage trends:

The 2024 spring labor negotiations (Shunto) resulted in the highest wage increase rate in 33 years, and high wage increases continue. Although the yen’s depreciation has contributed to rising prices, we believe that the continued strength in wage growth—even as the rate of price increases has slowed—indicates that inflation is becoming more deeply entrenched.

Employment overview:

Labor shortages have become even more severe. The diffusion index for employment conditions (an index indicating companies’ judgments on the adequacy of their workforce) indicates tighter circumstances than in the latter half of the 2010s, when the economy was booming. In particular, hiring competition has intensified among small and medium-sized enterprises, leading to healthy wage increases and economic renewal.

Number of bankruptcies:

With the end of low-interest rate policies and the termination of subsidy programs, the number of bankruptcies began to increase after bottoming out in 2021 to 2022. This reflects a healthy process of the market replacing the old with the new, with weaker companies exiting the market and more competitive companies expanding their market share and achieving growth.

Although mature, Japan’s domestic market is large, and there is still plenty of room to grow for small-cap companies. In addition, the inflationary environment is boosting companies’ price increases and profit margin improvements, which is a positive change for corporate performance.

3. Corporate Governance Reforms

Since 2013, corporate governance reforms have been implemented, bringing about significant changes in corporate management structures, such as an increase in the number of outside directors and the establishment of nomination and compensation committees.

In recent years, practical governance reforms aimed at strengthening “earning power” have made headway, shifting the focus beyond mere prevention of scandals and risk avoidance to improving corporate profitability and capital efficiency.

Even among small-cap stocks, governance reforms that had previously lagged behind are quickly picking up speed, and measures and awareness reforms aimed at improving capital profitability are steadily progressing. The Tokyo Stock Exchange’s request for improvements in P/B ratios and deeper dialogue with investors are also driving these changes.

The Japanese stock market is entering a phase of rerating, backed by compelling valuations, a structural shift from deflation to inflation, and corporate governance reforms. In particular, the small-cap sector is expected to continue offering attractive investment opportunities, given its relatively reasonable valuations and significant potential for structural reforms.

Underpinning the improvements in profit margins and progress in management reforms, we will continue to focus on the Japanese stock market as an investment destination with potential for medium- to long-term growth and increased corporate value.

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