In recent months, both the tech-heavy Nikkei 225 and the broader Topix index have followed the AI trade. However – as in other global markets – the headline figures hide considerable dispersion in returns. For us, this dispersion in performance offers significant opportunities in the small-cap value area in which we invest. 

For the past decade, our focus in the Fund has been the changing corporate governance landscape. This began under Prime Minister Abe in 2012 and more recently gained momentum thanks to Tokyo Stock Exchange (TSE) reforms. It has led to a series of shareholder friendly actions including share buybacks, increased dividend payouts and corporate restructuring. 

A major outcome from this reform process has been a steady reduction in cross shareholdings, which have been a prominent feature of the Japanese stock market for decades. Although these cross shareholdings take various forms, one aspect that we have focused on is so-called ‘parent child listings’, where a listed subsidiary is more than 50% owned by another listed company. Many of these have been unwound over recent years as holding companies decide if the subsidiaries are core or non-core to their businesses and either ‘buy in’ or dispose of them accordingly. We target potential candidates in our ‘M&A basket’ within the portfolio. 

We remain extremely constructive on valuations across the rest of the market

The trend has recently accelerated – in 2025 five of our portfolio holdings were taken in by their parent companies or sold off, often at substantial premiums. This has continued in 2026. A recent example is Paltac (a wholesaler), which has been subject to a takeover bid from its parent company Medipal (medical supplies), at a 43% premium. We bought Paltac in 2024 as part of our M&A basket. In March, we sold our holding in Solasto, a healthcare service provider, following the announcement of a management buyout. A rumour initially emerged in the media last December suggesting the company’s leading shareholder, Daito Trust, had put its shares up for sale. The eventual offer price was a 100% premium compared to the price prior to the media report in December.

The political and monetary backdrop

The long-term investment environment has been supported by a positive political landscape. In February 2026, Prime Minister Sanae Takaichi and the LDP secured a supermajority in the Lower House election, giving the government the ability to pass legislation without reliance on a coalition. That mandate creates a stable, business-friendly backdrop for continued reform.

In June Takaichi announced an investment plan to revitalise Japan’s economy. It calls for investing Y370trn ($2.3trn) in the 14-year period to March 2041. The plan spans 17 strategic sectors with around a third of the investment destined for AI and semiconductors.

This more business-friendly environment, together with the corporate governance reforms, is attracting overseas investors. The first half of 2026 has seen 9.7trn yen¹($60bn) in net buying from foreign investors, a record figure.

On monetary policy, the Bank of Japan (BoJ) has in June raised interest rates to 1% (the highest rate since 1995) and pledged to steady bond purchases, as it continues to normalise policy after years of heavy stimulus. Comments from the press conference suggested further rate hikes to come because of inflationary concerns. The prospect of higher rates has boosted the banking sector.

Outlook

The performance of market leaders in the AI space has become more volatile in recent weeks, as investors weigh strong earnings momentum against the sustainability of returns given high valuation levels. At a portfolio level, we retain some exposure to AI-related names where we still find valuation support but have a significantly lower weighting than the benchmark.

On the geopolitical front, the ceasefire in Iran, agreed in April and subsequently extended, appeared for a time to be holding, offering the prospect of an end to the energy-driven inflation overhang that had delayed the long-awaited transition to real wage growth and weighed on domestically exposed businesses. However, this has proven fragile: as we write, the truce has broken down following renewed strikes between the US and Iran, and oil prices have jumped sharply in response. The situation remains volatile and we are monitoring developments closely, given the direct read-through to energy costs, the yen, and domestic consumer sentiment. Separately, the yen remains at depressed levels, and continued pressure on US rates poses a further complicating factor for the BoJ’s own policy path. 

For the past decade, our focus in the Fund has been the changing corporate governance landscape

In terms of portfolio turnover, there have recently been a larger than normal number of new buy ideas following a research trip to Japan. Our overall impression from the visit was how cheap the non-AI related parts of the market still are despite strong market returns over the last 12 months. We remain extremely constructive on valuations across the rest of the market, with the exception of a small number of pockets where AI-related enthusiasm has pushed prices ahead of fundamentals.

The portfolio continues to retain core exposure to the theme of corporate reform via its substantial exposure to smaller companies. Japan's Corporate Governance Code is due to be revised this summer, the first update in five years, with a particular focus on requiring boards to justify cash and deposit holdings and demonstrate that capital is being allocated efficiently towards growth. We expect this to place further downward pressure on cash hoarding across corporate Japan, which should prove especially supportive for the small-cap universe, where balance sheets tend to be most under-optimised, and has the potential to accelerate growth prospects through increased M&A activity and investment. Japanese companies currently hold in excess of ¥160tn in cash and equivalents (see chart).

Source: Factset, Jeffries, 31 December 2025.

We continue to believe that behavioural, capital and informational inefficiencies in Japan create a unique opportunity in the global context.

The core of our portfolio remains positioned in smaller companies with excess capital where the potential for change remains high while valuations, for now, remain low.