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 October 2025, the TOPIX, a representative index of the Japanese stock market, rose 1.81% compared to the end of the previous month.

The first half of the month started off soft amid concerns over a potential U.S. government shutdown. Market sentiment shifted sharply when Sanae Takaichi became leader of the ruling Liberal Democratic Party (LDP), as expectations for proactive fiscal policy and growth initiatives triggered a rapid rally in stocks and a weaker yen—in what came to be known as the “Takaichi Trade.” Around mid-month, reports that the Komeito party would end its 26-year coalition alliance with the LDP fueled political uncertainty. Around the same time, the announcement of additional U.S. tariffs on China and China’s retaliatory measures intensified risk-off sentiment, temporarily driving the Nikkei Stock Average lower. Political uncertainty eased following reports of coalition talks between the LDP and the Japan Innovation Party (JIP), while gains in the U.S. SOX Index (Philadelphia Semiconductor Index) further supported a market rebound.

In the latter half of the month, global macro factors ranging from renewed U.S.-China trade tensions and credit concerns surrounding U.S. regional banks weighed on market sentiment. While short-term overheating also contributed to a temporary correction, Japan’s stock market resumed its upward trend as policy expectations rose following the formal coalition agreement on the 20th between the LDP and JIP, and the establishment of new Prime Minister Takaichi’s cabinet.

Toward the end of the month, the U.S. Federal Open Market Committee announced the expected 0.25% rate cut, while prospects for an additional December cut receded following remarks by the Federal Reserve Board’s Chair. Meanwhile, the Bank of Japan’s Monetary Policy Meeting refrained from raising rates and signaled caution regarding future hikes, contributing to continued yen weakness. Positive developments in U.S.-China trade talks, along with China’s decision to delay rare earth mineral export restrictions, further supported risk-on sentiment.

Against this backdrop, artificial intelligence (AI) and semiconductor-related stocks advanced steadily, supported by strong earnings from Advantest and a sharp share price increase for Lasertec, while the Nikkei Stock Average set new daily record highs. As a result, although the increase in gains widely varied across indices, the Japanese stock market ended October at a significantly higher level than at the end of the previous month.

The Fund’s Performance

As a result, the Fund returned -3.49% (HJSIX), underperforming its benchmark, the Russell/Nomura Small Cap™ Index, which returned -2.88%.

This month, key positive contributors to the Fund’s performance included Penta-Ocean Construction Co., Ltd., Daihen Corporation, and Nabtesco Corporation. Penta-Ocean Construction continued to perform well from last month as analysts raised their share price targets, supported by its solid results and substantial project backlog. Daihen’s share price rose, driven by multiple brokerages target price upgrades and strength in semiconductor-related stocks. Nabtesco’s stock price also rose on growing expectations for sales expansion in industrial robots following Yaskawa Electric Corporation’s earnings report, as well as optimism for growth in its Precision Reduction Gears segment amid news of SoftBank Group’s acquisition of ABB’s robotics business.

Meanwhile, key detractors from the Fund’s performance included Aeon Fantasy Co., Ltd., and Daikokutenbussan Co., Ltd. Aeon Fantasy came under selling pressure after the announcement of its Q2 FY2026 earnings results, as profitability improvement in its China operations were smaller than expected compared with the first quarter, resulting in only a limited increase in operating profit. Daikokutenbussan’s shares declined after its Q1 FY2026 earnings results showed a significant decline in operating profit due to a weaker gross profit margin and higher SG&A expenses.

From an investment perspective, we continued to increase holdings in existing positions while selling shares of companies whose price appreciation had reduced their relative attractiveness. Additionally, we initiated a new position in a real estate company that we believe has a strong potential for earnings growth amid rising inflation expectations.

The Japanese stock market has gained momentum on expectations surrounding the new Takaichi administration’s policies, speculation over U.S. interest rate cuts, and growing AI related demand. However, the rally has been concentrated in a narrow set of themes such as semiconductors, defense, and nuclear power, where valuations have become increasingly stretched. Signs of FOMO, or the Fear of Missing Out, are also emerging, raising concerns about the market overheating and bubble risks.

On the other hand, we believe many stocks have been overlooked during the recent rally, offering significant opportunities for selective investment. Japanese companies have ample capacity for capital investment after years of conservative financial management, and we expect capital efficiency to improve as corporate mindsets evolve in an inflationary environment. Going forward, we will continue to seek medium- to long-term returns through investments grounded in their intrinsic value, while aiming to avoid excessive optimism.

Currently, wage growth is gradually catching up with rising prices, suggesting that real wages are nearing a positive turning point. This development is expected to revive consumer sentiment, which has been sluggish for an extended period. While pessimism about consumption remains widespread, we do not share this overly negative view. Nevertheless, sustained inflation has clearly altered spending behavior. Consumers are increasingly saving on essential goods and other commoditized items through private brands and discount retailers, while spending more actively on areas they value, such as travel and brand-name fashion.

In addition to the long-standing income gap between high- and low-income earners, we believe a new form of polarization is emerging, where spending habits at the individual level are diverging across different products and service categories. This month, we would like to highlight investment opportunities arising from the growing focus on frugality.

Japan’s retail industry, particularly supermarkets that sell daily necessities, continues to face a challenging business environment. As consumers prioritize savings, rising costs such as labor and utilities are reducing profitability. This trend is especially pronounced in rural areas suffering with population decline and aging demographics. However, such conditions may actually favor major chain retailers. The shakeout of smaller players with limited resources could lead to market share gains for larger companies. In this environment, heightened price sensitivity is creating new growth opportunities for major publicly listed retailers.

Daikokutenbussan, a discount supermarket operator, has consistently attracted customers through its relentless low-price strategy. Although this strategy has temporarily compressed profit margins, we view the current phase as one with increasing potential for future profitability. The company’s sustained low pricing has enhanced the relative affordability of its products, creating a buffer that now allows for price increases while maintaining its cost advantage. Based on this view, we remain bullish on the company.

Suburban drugstore chains such as Genky DrugStores and Yakuodo Holdings also warrant attention. By leveraging efficient store operations and high margins of its healthcare products, these companies can offer competitively priced food items, capturing demand from both supermarkets and convenience stores while expanding their customer base. In addition to low prices, these stores provide the added value of convenience or allowing customers to complete all their shopping in one place. This “time” value is especially meaningful in an environment of rising wages. We therefore believe that companies capable of providing this added value of time will continue to attract customers and achieve sustainable growth.

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