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The Japanese equity market went through a moderate correction phase in early April, but it gradually recovered by the end of the second quarter. Although the market traded within a narrow range, it still managed to generate a positive return of 1.7% in Japanese yen terms for TOPIX Total Return during the quarter. However, due to the continued depreciation of the Japanese yen, the foreign currency-based return turned negative. Sterling based return was reduced to -4.4%. The yen weakness was primarily driven by the strength of the US Dollar, which was supported by a stronger US economy and the expectation of a "higher for longer" scenario. In March, the Bank of Japan (BOJ) took actions and there was a moderate rise in JGB yields, which supported financial stocks in Japan. The BOJ also announced that they would reduce the amount of JGB purchases starting in July. However, these actions were not robust enough to change the trend of yen weakness towards the end of the quarter.

Both the Japanese government and the BOJ expressed concerns about the negative impact of yen weakness on inflation. Additionally, real-term wage growth remained negative as the slow increase in wages has not yet surpassed the level of inflation. This has resulted in stagnant consumer sentiment so far this year. However, the record-high number of inbound tourists has contributed to increased spending in Japan, which has supported consumption. The testing scandals involving major auto manufacturers also raised concerns about industrial production, as they were required to halt auto production until their testing processes were rectified.

The second quarter is the full-year earnings season, and it concluded with stronger-than-expected results. Japanese companies showed sales growth, pricing power, and cost control, leading to improved corporate profitability. However, market sentiment was weighed down by conservative earnings guidance from company management for the new fiscal year.

During the earnings season, an increasing number of companies announced their commitment to initiatives by the Tokyo Stock Exchange, focusing on the cost of capital and share price. Their responses included setting realistic financial targets and renewing capital policies, including payout policies. As of the end of May, 63% of Prime listed companies had already disclosed their management plans, indicating notable progress. However, there were interesting discrepancies within this data. While 86% of large-cap companies with PBR ratios below 1x had responded, only 48% of small-cap companies with PBR ratios above 1x had done so. This suggests that there is still room for more corporate responses and actions, particularly among small-cap companies. June is typically the peak season for AGMs for Japanese companies. While there were no major headline-grabbing cases during this period, we did observe a significant increase in the number of activist investors advocating for change within Japanese companies. This trend is likely to continue and exert pressure on company management. As a result, there has been a record-high amount of share buybacks in the new fiscal year. Generally, companies that announced their renewed capital allocation plans received a positive stock price reaction.

The market concentration, measured by TOPIX 30 returns against the broader TOPIX, accelerated during the quarter but eased towards the end of the quarter. This led to a recovery in small-cap stocks in June. The market continued to favour value stocks in April and May, but this trend reversed in June, with growth stocks recovering momentum. In terms of sector performance, the financial sector, particularly insurance and banks, continued to perform well due to rising yields on Japanese government bonds and expectations of the BOJ possibly raising interest rates sooner than expected. The services and technology sectors also performed well thanks to their turning around in June. Conversely, the auto sector faced challenges due to testing scandals involving major auto manufacturers, including Toyota Motor.

The Fund delivered strong outperformance compared to the benchmark during the quarter. The overall market normalization and the prevailing value-oriented market trend further contributed to our performance. The size factor had a moderately positive impact, but, more importantly, our holdings experienced mostly positive outcomes during the period of full-year earnings results announcements. As a result, we benefited from positive stock price reactions.

While sector allocation had neutral impact, stock selection effect added strong values.

Against the Fund’s benchmark, the largest individual positive contributor was Hitachi, a large cap industrials conglomerate, thanks to increasing investors’ confidence on their strong fundamentals and growth potentials. Fujikura, a non-ferrous metal and cable company, also added value thanks to their earnings strength. Financial stocks contributed as well given increasing yields in Japan, and Mitsui Sumitomo Financial Group, one of largest banking group, was another leading contributor.

On the other hand, there were some offsetting negative contributions mainly coming from not holding large cap stocks including Itochu, a general trading company, and Mitsubishi UFJ Financial Group, a banking group. Among stocks held, Nippon Soda, a small cap chemical company, detracted due to weaker than expected earnings result and guidance.

• Concentration risk: The company may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the company, both up or down, which may adversely impact the performance of the company.

• Currency risk: The company can be exposed to different currencies. Changes in foreign exchange rates could create losses.

• Concentration risk: The fund may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the fund, both up or down.

• Currency risk: The fund may lose value as a result of movements in foreign exchange rates, otherwise known as currency rates.

• Derivatives risk: Derivatives, which are financial instruments deriving their value from an underlying asset, may be used to manage the portfolio efficiently. The fund may also materially invest in derivatives including using short selling and leverage techniques with the aim of making a return. A derivative may not perform as expected, may create losses greater than the cost of the derivative and may result in losses to the fund.

• Gearing risk: The company may borrow money to make further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase by more than the cost of borrowing, or reduce returns if they fail to do so. In falling markets, the whole of the value in that investment could be lost, which would result in losses to the fund.

• Liquidity risk: In difficult market conditions, the fund may not be able to sell a security for full value or at all. This could affect performance and could cause the fund to defer or suspend redemptions of its shares, meaning investors may not be able to have immediate access to their holdings.

• Operational risk: Operational processes, including those related to the safekeeping of assets, may fail. This may result in losses to the fund.

• Performance risk: Investment objectives express an intended result but there is no guarantee that such a result will be achieved. Depending on market conditions and the macro economic environment, investment objectives may become more difficult to achieve.

• Counterparty risk: The fund may have contractual agreements with counterparties. If a counterparty is unable to fulfil their obligations, the sum that they owe to the fund may be lost in part or in whole.

• Market risk: The value of investments can go up and down and an investor may not get back the amount initially invested.