For the first quarter ending March 31, 2023, the Matthews Japan Fund (Trades, Portfolio) returned 8.12% (Investor Class) and 8.17% (Institutional Class), while its benchmark, the MSCI Japan Index, returned 6.38% over the same period.
Market Environment:
Japan equity markets performed well in the first quarter, along with other developed markets as China’s re-opening and relaxation of international travel and the pace of U.S. Federal Reserve rate hikes decelerating due to inflation rates beginning to peak out. However, markets fell in March as the collapse of Silicon Valley Bank triggered major financial system instability in the U.S. and Europe and pressured the financial sector in particular. The Japanese yen traded in a range bound for the quarter, remaining mostly unchanged year to date. After hitting 150 yen to the U.S. dollar in October—a level last seen in 1998—the weakness in yen was a breather as with the rising U.S. bond yields.
Performance Contributors and Detractors:
In the first quarter, the majority of the Fund’s outperformance versus the benchmark index were attributed to good stock selection. From a sector perspective, our stock selection in information technology and consumer staples contributed the most to relative performance. On the other hand, stock selection in the industrials sector was the biggest detractor to relative performance.
At the holdings level, semiconductor company Renesas Electronics (TSE:6723, Financial) was the largest contributor to relative performance. The company’s shares reacted positively after its earnings results in February. The progress being made in Renesas’ inventory adjustments exhibited the company’s solid execution during downturns. We continue to see the name constructively given the potential to further improve shareholder returns and its valuation remains compelling, even after the strong year-to-date performance. Electronic materials and chemical product company Shin-Etsu Chemical (TSE:4063, Financial) was also a top contributor to both absolute and relative performance. The company continued to impress the market with its solid execution capability during economic downturns and inventory adjustment in both semiconductor wafers and polyvinyl chloride (PVC). Over the long term, we remain bullish on the semiconductor market as well as the wafer market where Shin-Etsu is a solid global leader with pricing power.
On the other hand, property and casualty insurance company Tokio Marine Holdings (TSE:8766, Financial) detracted the most, after being the third-largest contributor to performance last year. While the turmoil in the financial sector pressured Tokio Marine’s share price, we regard the company as a prudent allocator of capital with a mid-teens dividend compound annual growth rate (CAGR) coupled with earnings-per-share (EPS) growth that is driven by both earnings and buybacks. Debt guarantor eGuarantee (TSE:8771, Financial) was also a detractor for the quarter. The company’s shares weakened as small-cap growth companies overall faced unfavorable style movements in markets, but we believe eGuarantee is poised to benefit from a rise in bankruptcies as COVID-related relief funds have started to expire. eGuarantee is in the business of guaranteeing various types of credit that arise between companies doing business with each other. The credit guarantee business is a niche market, but it is a growing market in which eGuarantee is the leader.
Notable Portfolio Changes:
During the first quarter, we initiated a position in entertainment company Sega Sammy Holdings (TSE:6460, Financial). The company has been making progress in growing its “Sonic” intellectual property (IP) via movies and games globally. We also see shoots of recovery in Sega Sammy’s domestic pachinko and slot machine business after nearly a decade of struggling industry dynamics. We also initiated a position in Nissin Foods Holdings (TSE:2897, Financial) on the prospect of longer-term earnings growth as its instant noodle products shift towards the premium end of the market globally. Nissin recently succeeded in raising prices to counter the raw material price increase.
To fund these positions, we exited several holdings, including Kikkoman(TSE:2801, Financial), Nintendo (TSE:7974, Financial), Seven & I (TSE:3382, Financial), Terumo (TSE:4543, Financial) and Ushio (TSE:6925, Financial).
Outlook:
While the market seems ready for the Federal Reserve to pivot its interest-rate policy and for inflation to peak out, we believe the Fed is hesitant to prematurely remove its hawkish policies to contain inflation. With this backdrop, we don’t see a sudden reversal of growth underperformance in Japan anytime soon, although we also think that we have seen the worst in terms of style shift. We continue to prefer taking a more balanced approach towards multiple stages of growth and valuation levels. For the year of 2023, earnings growth and cash flow-generation ability will be ever more important as financial estimates for Japanese corporates have started to be revised down.
Looking ahead, we continue to believe the earnings capability of Japanese companies has improved meaningfully over the past economic cycle. Last year, the Japanese equity market outperformed both developed markets (MSCI World) and emerging markets (MSCI Emerging Market) in U.S. dollar terms. With the yen at a near quarter-century-low to the dollar, Japanese companies are in good health and, importantly, the country is firmly open for tourism. We believe this is the time for investors to add a long-term exposure to the market.
Top 10 holdings as of March 31, 2023. Current and future holdings are subject to change and risk.
All performance quoted is past performance and is no guarantee of future results. Investment return and principal value will fluctuate with changing market conditions so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the return figures quoted. Returns would have been lower if certain of the Fund's fees and expenses had not been waived. Please see the Fund's most recent month-end performance.
