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 May 2026, Japanese equities delivered a strong performance, with the TOPIX, a representative index of Japan’s stock market, rising 4.58% over the month.

Early in May, market sentiment was buoyed by a sharp rally in U.S. semiconductor stocks and easing geopolitical concerns in the Middle East. Against this backdrop, Japanese equities moved higher, led by robust gains in artificial intelligence (AI)- and semiconductor-related names.

By mid-month, however, market dynamics shifted. Escalating tensions in the Middle East pushed energy prices higher, driving a rise in global interest rates. In Japan, long-term yields climbed to their highest levels in nearly three decades, prompting profit-taking, particularly in technology stocks. As earnings season progressed, stock selection became increasingly important. The Nikkei 225 temporarily retraced below the 60,000 level, while the TOPIX proved relatively resilient, supported in part by a rotation into value-oriented stocks.

In the latter part of May, sentiment improved once again. A decline in oil prices helped alleviate inflation concerns, while renewed optimism surrounding AI and semiconductor stocks—supported by expectations of a large-scale AI-related U.S. IPO—triggered a rebound. Japanese equities rallied strongly into month-end, with gains broadening across sectors. Both the TOPIX and the Nikkei 225 closed the period at record highs, capping a volatile but ultimately positive month for the market.

The Fund’s Performance

Within the environment, the Fund (HJSIX) returned 5.50%, underperforming its benchmark, the Russell/Nomura Small Cap™ Index, which returned 5.74%.

During the month, key positive contributors to the Fund’s performance included Musashi Seimitsu Industry Co., Ltd. and Optex Group Co., Ltd. Musashi Seimitsu Industry announced its full-year financial results and, during the earnings briefing, the company reiterated that demand for its hybrid supercapacitors used in AI servers remains very strong, driving the share price higher. Optex Group disclosed its first-quarter results, and the market reacted positively to the strong performance of its factory automation business, which benefited from robust demand for capital investment.

Meanwhile, key detractors from the Fund’s performance included Daikokuten Bussan Co., Ltd. and Fukuda Corporation. Although there was no company-specific news regarding Daikokuten Bussan, it was one of several domestic consumer staples stocks that declined amid a backdrop of continued yen weakness and high crude oil prices. Fukuda Corporation posted its first-quarter earnings, delivering solid results driven by improved profit margins in the construction sector. However, concerns over a potential slowdown in construction demand due to rising geopolitical risks and declining profit margins caused by higher costs led to a decline in construction stocks, including Fukuda Corporation.

We made a new investment in a logistics company that we believe continues to trade at an attractive valuation. In our view, the market has yet to recognize the company’s improved profitability, which is driven by successful cost pass-through measures and ongoing productivity gains. Concerns about the sustainability of profit growth appear to be weighing on the share price, creating an attractive entry opportunity.

May Commentary

Although the Japanese equity market underwent a correction in March amid worsening conditions in the Middle East, it rebounded sharply from April through May. This rally was led by AI semiconductor-related stocks, supported by strong growth expectations for the semiconductor industry as U.S. hyperscalers continue to boost large-scale capital expenditures in AI data centers. On the other hand, investor interest has become increasingly concentrated on certain AI and semiconductor-related stocks, contributing to growing polarization within the market. We are observing signs of overheating.

Against this backdrop, we believe it is an opportune moment to reiterate the core of our investment strategy, which centers on identifying hidden investment opportunities, namely businesses that are fundamentally sound but are either undervalued by the market or temporarily out of favor. This opportunity set is particularly abundant in Japan’s small- and mid-cap stock market, where differences between a company’s intrinsic value and market price can arise for a variety of reasons. These include limited investor awareness, differences in the depth of understanding a company’s business model, and varying assumptions regarding the time horizon over which returns can be realized. We believe these factors as well as others can obscure longer-term value creation potential. We view these valuation gaps as a key source of medium- to long-term returns. By conducting rigorous bottom-up research and maintaining a long-term investment perspective, we seek to capitalize on such inefficiencies as they gradually correct over time.

In an environment where attention is increasingly concentrated on a narrow group of high-growth themes, we believe our differentiated approach grounded in fundamental analysis and valuation discipline positions the Fund well to uncover attractive opportunities beyond the market’s primary focus. This does not imply an avoidance of the high-tech sector; rather, it underscores the importance of maintaining a disciplined and analytical investment framework.

While the high-tech industry offers significant economic benefits driven by ongoing technological innovation, it is also characterized by intense competition and rapidly evolving trends. As a result, it is inherently difficult to assess the sector accurately from a purely top-down perspective or to consistently make sound investment decisions at the industry level. In particular, investments based solely on superficial themes or short-term market expectations carry meaningful risks. These include misjudging the technical feasibility of emerging technologies, underestimating manufacturing challenges, incorrectly anticipating the timing of mass production, and overestimating the speed at which revenue can be realized.

That said, this does not suggest a lack of investment opportunity in the high-tech sector. Rather, it highlights the need for a structured and selective approach. We seek to identify investment opportunities by first forming a view on medium- to long-term industry trends, and then conducting deep bottom-up analysis to uncover inefficiencies at the level of specific technologies and companies. In practice, this involves engaging extensively with companies that hold leading positions within their respective fields. Through these discussions, we aim to assess whether a given technology is supported by a sound technical foundation and a compelling economic rationale for future adoption. At the same time, we carefully evaluate the feasibility of commercialization.

Our analysis extends beyond technical trends and market forecasts to include qualitative insights gained through ongoing dialogue with management. Factors such as the consistency of their statements, the level of conviction they demonstrate regarding their business opportunities, the strength of their relationships with customers, and their depth of understanding of competitive advantages are all important considerations when assessing future outcomes. Admittedly, it is difficult to fully eliminate subjectivity from such qualitative assessments. Nevertheless, we seek to mitigate this by continuously cross-checking management commentary against actual business execution over time.

We invest in high-tech companies only after completing this level of research and analysis and concluding that the market price represents a meaningful discount to the company’s intrinsic value. Investment decisions are not driven simply by a company’s classification as a high-tech or semiconductor-related business. Rather, the key consideration is the extent to which future potential are already reflected in the current valuation, and whether the potential return adequately compensates for the associated risks.

Given the recent surge in semiconductor-related stocks, we have reassessed corporate valuations through interviews with management and are selectively reducing positions where we believe the investment case has diminished. While we will refrain from mentioning specific names, our assessment for equipment-related stocks, whose earnings typically lead the broader semiconductor cycle, optimistic growth expectations over the next two to three years are, in many cases, already largely priced into their share prices, despite the inherently cyclical nature of the industry. This does not imply a negative view on semiconductor-related stocks in general. Rather, it reflects a reassessment of individual companies where the balance between risk and return has become less attractive as valuations have risen.

When it comes to innovative technologies, expectations often run high that they will fundamentally transform industry structures. In reality, however, there is often a meaningful lag between a technological inflection point and its practical commercialization, including scaling production and generating meaningful revenue. Even within the semiconductor industry, recent examples such as extreme ultraviolet (EUV) lithography and high-bandwidth memory (HBM) illustrate this dynamic, having taken more than 10 years to progress from development to mass production. These timelines underscore the complexity involved in translating technological breakthroughs into sustainable economic value. Accordingly, even when the direction of technological innovation is on the right track, caution is warranted when market expectations become overly optimistic.

We remain attentive to the potential of technological innovation and intend to reallocate capital from holdings where investment appeal has diminished toward more attractive opportunities. At the same time, maintaining excessive exposure to specific investment strategies or ideas can introduce unintended risks within portfolio management. In the event that the rally in semiconductor-related stocks continues, there is a possibility that the Fund’s performance may lag the broader market over the short term. Nonetheless, rather than chasing market momentum, our focus remains on generating sustainable returns by maintaining an investment discipline and capitalizing on the divergence between intrinsic value and market price.

In contrast, while semiconductor-related stocks have surged, domestic demand-related stocks continued to underperform. This reflects growing fears around factors such as the impact of rising crude oil prices on domestic consumption and the potential implications of AI-driven disruption on the information technology (IT) industry. That said, should these uncertainties lead to a level of pessimism that materially depresses share prices below what we assess to be intrinsic value, we will actively consider such opportunities for investment. We believe that when market attention becomes heavily concentrated on specific growth areas, inefficiencies tend to emerge elsewhere. In particular, opportunities often emerge among overlooked domestic demand-related stocks.

Overall, we do not dispute the long-term growth potential of the AI and semiconductor sectors. The expansion of investment in AI data centers and the continued advancement of semiconductor technologies are likely to play a pivotal role in shaping the future industrial landscape. However, successful investing is not simply about identifying promising trends. Rather, it requires a careful assessment of how much of that future potential is already priced into a stock’s price. Even the most compelling growth narratives can fail to translate into attractive returns if expectations are overly reflected in share prices. Through a combination of firsthand research, disciplined valuation analysis, and a focus on identifying discrepancies between intrinsic value and market pricing, we aim to generate sustainable medium- to long-term returns. At the same time, we aim to avoid excessive concentration in areas where market enthusiasm may have led to overheated valuations.

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