Alma Eikoh Japan Large Cap Equity Fund

Market Review and Outlook

October represented the first down month for the Topix (total return index) this year with the index falling by 3.0%, giving up the gains made during the 3rd quarter of the year. Overseas investors were the heaviest sellers of the market at Y0.9tn and have now bought a net Y4.5tn so far this year and other domestic institutional investors also sold the market. Interestingly, domestic retail investors were again buyers of the market in what is perhaps the start of a shift in the mindset of Japanese savers in this new economic environment. One key theme driving market forces this year has been the behaviour of the Fed, and other central banks in turn. At the beginning of October speculation about the Fed continuing the tightening cycle drove a sell-off in global equities and after a brief recovery, Jerome Powell’s comments later in the month further propelled this narrative and weakness in markets. An additional concern for Japanese investors has been the decision making by the BOJ and the potential exit of the YCC policy and on 31st of September the Bank announced a decision to remove the ‘strict cap’ of 1% on the 10-year yield in its fixed rate purchase operation. Anticipation of this move drove Japanese bonds lower and the yield on the generic 10-year bond climbed steadily throughout the month before shooting up further after the BOJ announcement, ending the month at 0.95%. US yields also rose through the month but in a more modest manner and the currency move in October was muted with Y/$ starting the month at 149.3 and ending it at 151. There was also muted factor performance within the Japanese market with the Topix Value Index matching the performance of the Growth Index despite its strong outperformance so far this year. Broadly, financial sectors and generally economically defensive areas led the market with Insurance, Food Beverage & Tobacco, Banks, Consumer Staples, Telecommunication Services and Financial Services among the top performers. Laggards included Pharmaceuticals & Biotechnology, Automobiles & Components, Semiconductors & Semiconductor Equipment and Capital Goods.

Domestic economic news remains reasonably steady and has not so far shown the sort of slowdown beginning to be seen across other developed markets where the rise in interest rates has begun to take its toll. The BOJ Tankan showed business conditions were up for a second consecutive month in September at +9 and though modestly down, the economy watchers survey current conditions came in at 50.4, a steady reading. Industrial production figures also held steady up 0.2% MoM and bank lending continues to grow at around 3% YoY. Inflation statistics remain modest with National CPI at 3.0% for September and CPI ex fresh food & energy at 2.6%. This was in line with forecasts and remains slightly above the target of the BOJ for core inflation of 2%. The sustainability of this number is what the BOJ is now considering when making its decision on rate policy and wage hikes seem likely to hold the key to this. The labour market remains incredibly tight with an unemployment rate of 2.6% and a jobs-to-applicants ratio of 1.3x. Corporate growth remains solid and the government continues to be supportive with Kishida’s new economic package, first mooted in September, now having been officially declared. With poll ratings dwindling and a continued desire to seize the moment and drag Japan out of its long-term stagnation, Kishida has announced a $113bn stimulus package to be implemented before the end of the fiscal year in March 2024. There are various measures to address the cost of living through moves such as temporary cuts to income tax and cash handouts to low earners as well as tax credits for SMEs designed to promote wage increases. It seems increasingly likely that the next round of wage hikes in spring 2024 will remain somewhat elevated and that the BOJ will abandon its negative interest rate policy at some point in the first half of the year.

Fund

The Fund fell by 6.53% (JPY share class) in October, underperforming the Topix which fell by 2.99% (dividends reinvested).

The performance this month was both exceptional and very disappointing; we will give as much detail as we can to provide as full an explanation of this as possible. Sector allocation had a negligible impact on performance with all the value lost through stock selection. October was a month when any growth value tilt made little difference, Topix growth fell by 3.07% while Topix Value fell by 2.94% so that aspect of factor bias would have been negligible, and the valuation of the portfolio is in any case very similar to that of the overall market. In broad terms, close to 80% of the risk relative to the market is stock specific, 15% style and 5% industry. Having looked carefully at alternative possibilities we believe that the culprit behind disappointing October returns was overwhelmingly stock specific, and we seek to address this below.

In consumer durables Panasonic underperformed, hit by weakness in its consumer facing areas causing it to make a small downward revision to earnings, prospects for its automotive battery operations remain excellent however. Asics was also a negative contributor, giving back some of the very strong gains made so far this year on profit taking on no news. In financial services GMO Payment Gateway fell sharply over the month reflecting investor concerns that growth may slow sharply in 2024 and beyond, we believe that these concerns are misplaced and have added to this position after its decline. In pharmaceuticals performance was hurt by the performance of PeptiDream which fell sharply on the news that BMS would not advance its PDL1 therapeutic program beyond the current phase 1. While this is disappointing, PeptiDream is the leading company working with synthetic peptides and peptide drug conjugates and has a wide variety of partners amongst its 127 compound programs and this move is not a reflection of the validity of its core technology and value to its partners. In semiconductors both Renesas and Rohm declined reflecting shorter-term weakness in the consumer facing part of their business though auto demand remains robust; we retain both stocks in the portfolio. In healthcare equipment M3 underperformed, hit partly by the ongoing derating of growth stocks since the summer and on an absence of company specific news. In technology hardware, Ibiden fell sharply on the news that the Gama plant built at a cost of Y180bn for Intel would now not be required for possibly another two years due to client delays. We cut our exposure to this name as soon as this news was announced. In materials, Nippon Steel declined over the month, we retain confidence in the company’s strong fundamentals.

Other than the modest changes described above, the changes made to the portfolio over the month were the sale of our position in JMDC, the medical data company, and purchasing a position in Fujitsu. We made the decision to close our position in JMDC after Omron made a tender offer to increase its stake in the business from 32% to 54% at a 22% premium. We continue to like the fundamental story and outlook for the company but believe the tender price of Y5,700 offered fully valued the shares. After their results announcement at the end of the month, we decided to purchase a position in Fujitsu for the fund. The domestic demand environment, driven by Japan’s digital transition, remains very strong and we believe that the company’s exit from the mainframe area by 2030 will drive strong growth for their high margin consulting operations and cloud solutions from existing clients. Contract pricing continues to improve, offsetting wage hikes and the company is making progress overseas, notably in the US. We think the growth in profits and especially cash flow generation is under appreciated by the market at the current price.