Alma Eikoh Japan Large Cap Equity Fund

Market Review and Outlook

Topix advanced for the sixth straight month in September, up 2.98% on a total return basis. The market was helped by the rise in global equities and hopes for a more expansionary fiscal policy under a new Japanese administration following the resignation of Prime Minister Ishiba. The announcement that the BOJ would start to sell its ETF and J-REIT holdings had a limited impact on the market reflecting the very slow pace of the planned divestment. Foreign investors turned sellers of the market after four months of heavy buying, selling Y0.9trn over the month whilst business corporations remained significant net buyers as has been the case all year. Topix Value continued to outperform Topix Growth, rising by 3.48% against 2.40%. Tech and tech materials performed strongly with electrical appliances and non-ferrous metals leading the gainers, real estate and banking were also firm. Shipping, air transport and insurance all lagged the market and pharmaceuticals continued to underperform. Domestic economic data announced over the period was unsurprising and investor interest was focused closely on the unfolding election campaign. The BOJ Tankan survey announced at the end of the period showed an unchanged outlook for large manufacturers at +12 and a small improvement from
+13 to +14 for coincident conditions. For non-manufacturers the outlook improved slightly from +27 to +28 with the coincident index unchanged at +34. Encouragingly capital spending plans were revised up from +9.6% to +10.4% for manufacturers and from +7.7% to +8.6% for non-manufacturers.

The election of Sanae Takaichi as leader of the LDP at the start of October was a surprise to political commentators and investors, this resulted in a sharp move up in the equity market and weakness in the Yen as investors digested the implications of the result. The Takaichi campaign was helped by the fact that she ranked top amongst LDP party members in 31 prefectures compared to just 9 for Koizumi in the first round of voting, a starker contrast than expected. The emergence of former Prime Minister Aso as a powerful backer of her campaign helped swing the votes of Diet members in her favour in the run-off vote. While both Takaichi and Koizumi were careful to cleave to the centre during the campaign, Takaichi is known to favour several policy positions that are likely to be expressed in her administration. These include aggressive fiscal expansion, both through direct spending and tax cuts, and retaining a low-interest rate policy to help stimulate demand growth; this follows closely the thinking of her former mentor Abe. She has a hawkish stance towards national security and is expected to further strengthen Japan’s defense and cybersecurity capabilities. She is a supporter of industrial policy which is expected to promote the semiconductor industry and AI, the development of next generation
nuclear reactors, space technology and the pharmaceutical sector. Key to the effectiveness of her administration will be whether she can assemble an effective governing coalition and this will not be easy; the LDP’s longstanding coalition partner, Komeito, is not aligned with her hawkish defence and constitutional instincts and she will need to find another coalition member to achieve a majority. The Democratic Party for the people is currently considered the most likely candidate as it shares similar stimulatory economic policy goals. She will also need to construct a cabinet that unifies the LDP and there are reports that indicate she is moving in this direction already with plans to include her leadership rivals in key posts within her cabinet.

If the pitfalls can be avoided, we see the election of Takaichi as positive for Japan and the equity market. If she can form a stable governing coalition, her pro-growth and investment policies should effectively boost demand. Globally, conditions appear little changed with AI investment the primary driver of resilient growth in the US and conditions mixed elsewhere. While the fund has a broadly balanced overall economic exposure, its overweight in technology has been a positive in the current environment and through KHI and Mitsubishi Electric there is exposure to higher defense spending. We retain strong confidence in prospects for the portfolio and its constituents. Stock specific risk accounts for a high 77% of tracking error and within factor risk, the negative exposure to momentum is the most significant element followed by the positive bias towards growth and the negative exposure to earnings yield.

Fund

The fund rose by +4.06% (JPY share class) in September, outperforming the Topix (dividends reinvested) by 1.08%.

Sector allocation was the main driver of the outperformance over the month with stock selection also positive. In a slight rebound versus the performance in August, being overweight Semiconductors & Semiconductor Equipment helped the fund, as did the zero weightings in Media & Entertainment, Insurance and Consumer Discretionary Distribution. Being overweight Health Care Equipment & Services and Household & Personal Products as well as being underweight in Telecommunication Services were slight drags on fund performance.

At the stock level the strongest outperformer over the month was Ibiden, which continued the very strong rally seen so far this year driven by the boom in demand for AI data centres and the associated components of which Ibiden is a key supplier. The announcement of a new OpenAI and NVIDIA strategic joint venture provided a boost for several stocks highly geared to this area. Two of the fund’s smaller cap stocks, JMDC and Peptidream, also performed strongly over the month, though on no specific news. The fund’s holding in megabank Mitsubishi UFJ outperformed the wider banking sector which continued to grind upwards and component supplier Murata also added value. Detractors to performance included Daikin, the air conditioning manufacturer with concerns of a weakening economic environment weighing on the shares. The system-on-chip designer Socionext underperformed a buoyant semiconductor sector and Japan Post Bank lagged the rising banking sector though with no specific news in either name. Other underperformers included sports shoemaker Asics, whose shares have been very strong this year, and the brewer Asahi.

We were active in September, selling out of 5 existing positions and entering 3 new ones. We sold our small position in the retailer Seven & I where our confidence in their ability to recover same store sales as well as passing on costs to customers in the US has waned reflecting the weaker consumption environment. We sold our position in Eneos, the oil refiner, after a strong rally over the last 4 months left us with little upside in our model. We also exited our small position in the chemicals maker Kuraray where demand has been weaker than we expected and the recent two-year delay by the EPA for the implementation of new drinking water standards is negative for the PFAS treatment area. Finally, we exited from two stocks that have benefitted from the bull run in AI related demand and have reallocated this to other parts of the portfolio which are similarly exposed but with more attractive risk reward profiles. We bought the back-end SPE company Disco in the wake of Trump’s ‘liberation day’ tariffs in April since when it has risen sharply and no longer looks attractively priced to us despite excellent growth prospects and so we have sold our shares. We also sold our position in cable-maker Furukawa Electric which has also performed very strongly this year on the boom in AI data centre capex to which they are exposed through their cable and interconnect businesses. We bought new positions in wafer maker Sumco and SOC designer Socionext as well as adding slightly to our position in Ibiden, the packaging maker. Wafer maker Sumco looks attractive as we believe demand for epitaxial wafers for leading edge applications looks bright and the current valuation compelling; the free cash flow yield in the coming years looks close to 20%. For Socionext, we expect strong demand from the growth of data centres and electrification within autos to propel revenues and earnings. Our confidence is backed up by a strong and growing number of recent design wins in the Data Centre area. We also purchased a position in the telecoms company KDDI where we think weak share price action now offers an attractive entry point. The company is the best run of the 3 major players in the space where we believe price competition has subsided after measures first introduced by Prime Minister Suga in 2020.