Letter to Shareholders
As we review the first half of the year, we continue to see the same trends as in the recent past, with corporations in both Japan and the U.S. driving shareholder value by making acquisitions, initiating and raising dividends, investing in internal infrastructure, and buying back stock. In fact, the total amount of dividends paid by Japanese companies reached a historic high over the twelve months ended March 31, 2013. I believe we will likely see continued dividend increases from cash-rich companies, and we may also begin to see these firms initiate capital expenditure programs.
Up until this point, there has been no real cost for firms to defer spending, but I do believe there will now be companies that want to improve their margins and will begin spending money to expand their revenue, and may even begin to hire. Once a competitor begins to move in this way, then the cost to defer becomes real for companies. This movement to expansion may well be a catalyst to propel the financial markets. With almost $3 trillion in cash sitting on the sidelines in the U.S. alone, it should help the economic recovery here in the U.S. for companies to begin spending their idle capital, which will likely have ripple effects to the Japan market and beyond.
The Japan financial markets were volatile over the past six months ended April 30, 2014, with the Tokyo Price Index, or TOPIX, falling -5.41% (in U.S. Dollar terms) during the period. While the Japanese market started the period on a positive note as a result of constructive economic developments in Japan and overseas, the market recorded negative returns for the overall six-month period ended April 30, 2014. This was due in large part to profit taking by investors following the surging Japanese market in 2013, and also due to concerns over the economies of developing countries and the instability of their currencies, the appreciation of the yen, growing tensions in Ukraine, and the volatile global economy.
On April 1, Japan’s long-anticipated consumption tax increase took effect, raising the tax by three percent to eight percent. Initial reports suggest that the impact from the rise in taxes has been muted, which has put investors’ minds at ease. Longer term economic indicators suggest that the benefits of Prime Minister Abe’s aggressive monetary and fiscal policies, referred to as “Abenomics,” are spreading and gaining traction. While many investors may now have concerns about the third arrow of Abenomics, which is the growth strategy, I believe that cyclical recovery will continue in Japan for the next few years with or without the growth strategy. Corporate balance sheets were strengthened significantly over recent years, which allowed Japanese companies to stay competitive at much higher currency rates, and I believe Japanese corporations will likely maintain their growth momentum irrespective of any future movement of the yen. With favorable top line and bottom line results, I expect many companies to further grow their cash flow, which can stimulate future capital expenditures and which is sorely needed following two decades of underinvestment. The trickle-down effect should benefit many domestic Japanese industries and has the potential to create a positive economic cycle for years to come.
I believe that Japanese investors, including pensions and individuals, will finally start investing in the domestic equity market, which should support the normalization of the valuation of the Japanese equity market and undervalued names. The Japanese private sector is holding historically high financial assets, with cash and cash deposits held by corporations and individuals at $2.1 trillion and $8.7 trillion, respectively. This money on the sidelines represents approximately two times the size of Japan’s total equity market cap. This liquidity has never been invested, which was a smart decision made by investors in the deflationary environment of the past.
The Japanese government is creating a private pension plan modeled on the Individual Retirement Account, or IRA, in the U.S. IRAs were introduced in the U.S. in 1974 to encourage individuals to invest by introducing tax breaks. Assets in U.S. IRA accounts grew 80-fold over 20 years, from $6.8 billion in 1980 to $5.4 trillion in 2010. In 1980, bank deposits accounted for 82% of U.S. IRA assets, and today they account for just 10%. In 1980, mutual funds accounted for just 3% of U.S. IRA assets, and today they account for 46%. With this new government program, I strongly believe that a large structural shift from bank deposits into equities is likely to occur in Japan, much like it did in the U.S. This in turn should help to drive the growth of the Japanese equity markets.
I am confident that even with all the hurdles facing corporations both in the U.S. and Japan, companies will continue to provide value for their shareholders. To me, that means the financial markets are in good shape and should remain strong moving forward. I also believe that the next few months may be volatile for the worldwide economy and the financial markets. After over 35 years in the business, I still firmly believe the best way to position your portfolio is by investing in good companies over the long term, rather than trying to buy the next hot idea at exactly the right time. At Hennessy Funds, hunches and fads have no place in our investment process, and we understand that successful investing comes from time in the market, not timing the market.
We remain focused on investing based on proven fundamentals, and we are committed to managing money for the sole benefit of our shareholders. If you have any questions or want to speak with us directly, please don’t hesitate to call us at (800) 966-4354.
Neil J. Hennessy
President and Chief Investment Officer
Past performance does not guarantee future results.
Mutual fund investing involves risk. Principal loss is possible.
Opinions expressed are those of Neil Hennessy and are subject to change, are not guaranteed and should not be considered investment advice.
The Tokyo Price Index (TOPIX) is a market capitalization-weighted index of all companies listed on the First Section of the Tokyo Stock Exchange. One cannot invest directly in an index.
Cash ﬂow can be used as an indication of a company’s financial strength and represents earnings before depreciation, amortization, and non-cash charges.
Performance Overview (Unaudited)
The opinions expressed in the following commentary reﬂect those of the Portfolio Managers as of the date written. Any such opinions are subject to change based on market or other conditions and are not guaranteed. These opinions may not be relied upon as investment advice. Investment decisions for the Fund are based on several factors, and may not be relied upon as an indication of trading intent on behalf of the Fund. Security positions can and do change.
SPARX ASSET MANAGEMENT CO., LTD, SUB-ADVISOR
Portfolio Managers: Masakazu Takeda, CMA, and Yu Shimizu, CMA, SPARX Asset Management Co., Ltd. (sub-advisor)
Over the previous six months, how did the Fund perform and what factors contributed to this performance?
For the six-month period ended April 30, 2014, the Investor Class of the Hennessy Japan Fund (Trades, Portfolio) returned -1.47%, significantly outperforming the Russell/Nomura Total Market™ Index, the Tokyo Price Index (TOPIX), and the Morningstar Japan Category Average, which returned -5.27%, -5.41%, and -4.31% for the same period, respectively.
The largest positive contributors to the Fund’s performance among the 33 TOPIX sub-industries were shares of chemical manufacturers, miscellaneous manufacturing firms, and retailers. Conversely, shares of wholesalers, banks, and precision instrument makers performed negatively during the six-month period.
Among the strongest performing stocks in the Fund during the period were Rohto Pharmaceutical Co., Ltd. (TSE:4527), the leading over-the-counter ophthalmic medicines and skincare cosmetics producer, Nidec Corporation (TSE:6594), the world’s major electric motor manufacturer, and Ryohin Keikaku Co., Ltd. (TSE:7453), the operator of the MUJI brand retail chain store. Shares of both Rohto Pharmaceutical Co., Ltd. and Nidec Corporation jumped over 28% and 24%, respectively, following strong earnings results for the fourth quarter of calendar year 2013. The market also welcomed Nidec Corporation’s upward revision of its full-year earnings guidance for its fiscal year ended March 31, 2014. Finally, shares of Ryohin Keikaku Co., Ltd. surged 18% due to the solid earnings announcement for its fiscal year ended February 28, 2014, and the upbeat guidance for the new fiscal year. The Fund continues to hold all of these positions.
Conversely, Terumo Medical Corporation (TSE:4543), Japan’s largest medical device manufacturer, MISUMI Group, Inc. (TSE:9962), the maker and distributor of metal mold components and precision machinery parts, and Unicharm Corporation (TSE:8113), the baby and feminine care products maker, were among the major detractors from the Fund’s performance. Shares of Terumo Medical Corporation fell 13% following its third quarter earnings announcement for its fiscal year ended March 31, 2014, as investors were disappointed with the decline in sales. Shares of MISUMI Group, Inc. declined 11% on what we believe was the market’s growing concern over its outlook for fiscal year 2014. Lastly, shares of Unicharm Corporation fell 8% as the perception of an intensifying competitive landscape became widely recognized by investors.
Additional Portfolio Manager commentary and related investment outlook:
Going forward, we will continue to increase our exposure to companies with a distinct manufacturing edge, high-quality craftsmanship, energy-efficient technologies, or a superior brand image that may benefit from the growing demand from the economies of developed and emerging countries. We will also continue to favor general trading firms that span those technologies to the emerging nations.
The Russell/Nomura Total Market™ Index contains the top 98% of all stocks listed on Japan’s stock exchange and registered on Japan’s OTC market in terms of market capitalization. The Tokyo Price Index (TOPIX) is a market capitalization-weighted index of all companies listed on the First Section of the Tokyo Stock Exchange. The Russell/Nomura Total Market™ and TOPIX indices are presented in U.S. dollar terms and take into account reinvestment of dividends. You cannot invest directly in an index. Performance data for an index does not reflect any deductions for fees, expenses or taxes.
The Fund may invest in small- and medium capitalization companies, which may have limited liquidity and greater price volatility than large-capitalization companies. Investments in foreign securities involve greater volatility and political, economic and currency risk and differences in accounting methods. The Fund may invest in IPOs, which may fluctuate considerably due to the absence of a prior public market and may have a magnified impact on the Fund. References to specific securities should not be considered a recommendation to buy or sell any security. Fund holdings and sector allocations are subject to change. Please refer to the Schedule of Investments included in this report for additional portfolio information.
Each Morningstar category average represents a universe of funds with similar investment objectives. © Morningstar, Inc. All Rights Reserved. The information contained herein: 1) is proprietary to Morningstar; 2) may not be copied or distributed and 3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance does not guarantee future results.