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 February 2026, the Japanese equity market posted substantial gains, with the TOPIX, a representative index of Japan’s stock market, advancing 9.15% month-on-month.

During the first part of the month, market volatility increased ahead of the House of Representatives election. On February 8th, the Liberal Democratic Party secured a historic landslide victory with 316 seats, the largest postwar total. This outcome strengthened expectations for Prime Minister Takaichi’s political stability and additional fiscal expansion, triggering a sharp market rally. Record-high trading value on the Tokyo Stock Exchange (TSE) Prime Market, supported by significant net buying from foreign investors, further accelerated the upward momentum and propelled Japanese equities to materially higher levels.

In mid-February, profit-taking emerged after the market’s rapid rise, reflecting growing concerns about market overheating. Additionally, renewed investor concerns regarding “Artificial Intelligence (AI) replacing existing software-related functions” prompted broad-based selling, particularly in software names. Conversely, AI infrastructure-related equities attracted strong inflows, supported by the formation of the second Takaichi Cabinet and progress in Japan–U.S. investment initiatives. While heightened geopolitical tensions in the Middle East temporarily weighed on the market, selective rotation among sectors helped the market stabilize at lower levels.

Toward the end of the month, early interest-rate hike expectations receded after Takaichi’s government proposed the appointment of two reflationist candidates for the Bank of Japan’s Policy Board. This shift helped restore market momentum. Semiconductor-related stocks led the rally, and software stocks—previously sold off mid-month—rebounded sharply due to perceived undervaluation. As a result, buying spread across a wide range of stocks. Consequently, the TOPIX reached a new all-time high, marking its 11th consecutive monthly gain.

The Fund’s Performance

Within the environment, the Fund returned 12.46% (HJSIX), outperforming its benchmark, the Russell/Nomura Small Cap™ Index, which returned 9.72%.

This month, key positive contributors to the Fund’s performance included Nissei ASB Machine Co., Ltd., Nishi-Nippon Financial Holdings, Inc., and CKD Corporation. Nissei ASB Machine announced its first-quarter results, with orders received, net sales, and operating profit all reaching record-high levels for the first quarter, which drove its share price higher. Nishi-Nippon Financial Holdings released its third-quarter earnings, showing solid results supported by rising interest rates. Expectations for further rate hikes continued to boost its stock price. CKD’s share price rose after its third-quarter earnings results indicated improved order levels and factory utilization.

Meanwhile, key detractors from the Fund’s performance included Computer Engineering & Consulting Ltd., PeptiDream Inc., and Aeon Fantasy Co., Ltd. Computer Engineering & Consulting, despite the absence of company-specific news, saw its stock price decline primarily due to unfavorable news about Anthropic, namely that rapid advances in generative AI have fueled concerns that established companies across multiple industries may struggle to survive. PeptiDream disclosed its full-year results and outlined plans that did not incorporate related upfront partnership payments, although expectations were high for major partnerships involving oral myostatin inhibitors. This led to market disappointment and selling pressure. Aeon Fantasy’s shares fell even though it reported robust January same-store sales growth of 7.7% year-on-year and there was no significant negative news.

At the end of this month, the U.S. and Israel carried out large-scale airstrikes against Iran, heightening tensions in the Middle East. The situation remains fluid, and it is necessary to closely monitor the economic impact, including rising crude oil prices. However, we do not believe this will significantly affect the improving profitability of Japanese companies that we focus on.

As the Japanese economy transitions from its long-standing deflationary environment to an inflationary one, we believe there remains significant room for improvement in return on equity (ROE) among Japanese small and mid-cap companies, starting with a shift in management mindset toward more disciplined capital allocation. Meanwhile, in many industries, profitability improvements have been slow, as industry structures have limited their ability to pass rising costs on to customers. These industries have long faced persistent skepticism in the stock market, resulting in consistent low valuations. However, structural changes triggered by environmental shifts and management decisions could ultimately lift valuations. In this report, we’d like to outline the signs of change that are currently emerging, focusing on the healthcare and logistics industries as prime examples.

The healthcare industry operates under a fixed revenue structure due to government-set medical fees, while costs, primarily labor expenses, fluctuate. Consequently, profitability is easily strained in inflationary environments, leading to a prolonged downturn in financial health, particularly among large hospitals with substantial staffing. In recent years, a series of medical institution bankruptcies has raised serious concerns about the viability of regional healthcare. Amidst this difficult environment, we are focusing on the fiscal year 2026 revision of medical service fees.

The government has announced that the base medical fee schedule will be raised by an average of 3.09% in fiscal year 2026, marking the first increase exceeding 3% in roughly three decades. This adjustment was enacted despite continued fiscal restraint, as policymakers prioritized supporting wage growth and addressing cost pressures—particularly inflation—as central economic objectives. For the medical industry, this revision represents a significant structural turning point. In addition to functioning as an extraordinary measure to support healthcare wage increases, the policy also implies the potential restart of capital expenditures—especially equipment renewal and information technology (IT) investments—that had previously been deferred to offset rising labor costs. These developments may facilitate medium to long term productivity improvements, as advancements in healthcare operations are closely tied to sustained IT and capital investment. Against this backdrop, we expect the sector to enter a phase in which capital investment demand gradually recovers. Nihon Kohden Corporation, a portfolio holding of the Fund, should be well positioned to benefit from a rebound in healthcare facility investment, given its strong product portfolio and its alignment with hospitals’ modernization needs.

Next, let’s take a look at the logistics industry. While truck transportation plays a central role in domestic logistics, its low-profit structure has long been an issue, stemming from a multi-tiered subcontracting system and excessive competition. Even major lead carriers do not necessarily possess strong bargaining power with large clients, and the industry as a whole continues to face difficulties in passing on costs. In this environment, we select stocks based not only on companies’ ability to pass through higher costs but also on the scope for earnings improvement through self-help measures based on their business model.

In the logistics industry, improving the load factor of a company’s own fleet leads to higher revenue per truck and improved profitability. Nevertheless, the feasibility of this depends significantly on customer mix and business model. Among the various models—home delivery, trunk line transport, and B2B logistics—trunk line logistics operators generally exhibit lower customer concentration risk, possess relatively stronger pricing power, and are better positioned to implement self help initiatives such as increasing load factors. Fukuyama Transporting, one of the Fund’s holdings, is a major player within the industry. Having prioritized scale expansion until now, its pricing policy has lagged behind, resulting in a prolonged downturn in business conditions. However, following a change in president, the company is steering its management policy toward prioritizing profitability improvement. While the structural challenges facing the broader logistics industry will take time to resolve, shifts in management mindset and strategic priority are likely to be reflected gradually in operational and financial outcomes. This transition represents an important element in our investment assessment.

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