This month was, to put it mildly, unpleasant. It was our 3rd worst month on a relative basis since inception and the 2nd worst month on an absolute basis. Diversification didn’t help much because it was the 2nd worst month on both relative and absolute basis for our diversified portfolio. While I don’t have a factor modeler, excluding minor effects like cash, monthly fund costs, intramonth trading PnL, and dividend differentials, my analysis calculates that about 1/3 of the weak return came from sector selection and 2/3 from idiosyncratic (it was closer to 50:50 for the diversified portfolio). The effect from non-industry factors were negligible.

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Usually, I’d be pretty upset. And don’t get me wrong, I’m not dismissing the weak return either. Nothing ruins my day, month, or year more than poor performance. But we’ve had a very good run year-to-date so a reversal was statistically bound to happen unless we frequently changed the portfolio profile (which we obviously don’t). Second and more importantly, I know exactly what the causes were, both from a sector perspective as well as the idiosyncratic ones. Having a concentrated portfolio (or a relatively concentrated one for our “diversified” book) makes it fairly easy to isolate the reasons. Finally and most importantly, I am perfectly comfortable with our sector exposures and the stock-specific causes of the weak September return. And, unlike the past, we are much more liquid should I need to adjust my views, thanks partly to the rise of the overall market liquidity but also our stock selection and portfolio weighting process that purposely raised the liquidity profile. Anyway, I’m going to spend a little more space than usual to discuss the monthly return and why I am not as concerned as I normally would be after such dismal performance.

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With regards to the sector allocation, essentially the reduction of hardware technology stocks in place of mostly software names as well as non-technology stocks, was almost the entire reason for our sector drag. This can be easily seen from the N/T ratio (Nikkei vs Topix) which, after 2 months of decline, had begun to rise again (and continues to do so in October). Perhaps a more intuitive way to think about this ratio for non-Japanese investors is the SOX vs S&P 500 ratio. If you were to chart that ratio against the N/T ratio, they’d look equivalent this year (although the magnitude is much sharper with the SOX/S&P). That ratio was a tailwind during the first half of the year where we were significantly overweight hardware technology. In fact, if we held any of our month end portfolios from the end of last year to Apr, we would have actually been up for the month, outperforming even the Nikkei 225 for certain month-end portfolios. However, this is a deliberate and intentional choice that we made over the course of the year for reasons which we’ve highlighted in the past monthlies.

But it’s not just the stock action of AI companies globally or the circular financing funded increasingly through debt that had been concerning to me to reduce our beta via reduction in hardware exposure. Global yields are reaching multi-decade highs across all regions. Despite the rising AI dominance in benchmarks across the world, equity indices have failed to break new highs in September. Looking across other developed countries such as the UK, Germany, and particularly France, the picture looks highly foreboding. The political environment is becoming further destabilizing in most developed markets (except for Japan). The equity picture across emerging markets is even bleaker whether it be China, India, and even South Korea. Taiwan is the one breakout but, again, this index is primarily technology with TSMC alone accounting for over 40% of the benchmark (and only one constituent in the top 10 is non-technology). Despite inflation expectations continuing to rise, precious metals have softened. Even copper, which has a fundamental long-term growth story and high visibility of tight supply-demand, has stalled. Global currencies have mostly weakened against the dollar which may be due to higher yields but may also be due to flight to safety.
 
In October, the S&P500 finally did break to new highs. But looking across the constituents, very few names actually made their own new high; in fact, only 16 did. Conversely, 364 names are more than -10% below their 52-week high while 183 names are more than -20% below; in fact the average distance on Oct 6 of S&P500 constituents from their 52-week high is -18.4%. The weak breadth is staggering, and the index is being driven by just a handful of names, a situation that is similar in Japan and South Korea.
 
As for the individual stocks in our portfolio that underperformed significantly in September, they were almost entirely software names. But three in particular significantly underperformed the Software & Services index as well as the broader benchmark. I’d like to briefly touch on all three as they are all above average position sizes in our portfolios. At a later date, I will introduce them more thoroughly by introducing their business models and what their competitve moats are.

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One is the leader in the Japanese C2C marketplace. This marketplace is particularly popular among the younger generation that are more environmental and waste-conscious, choosing to resell their own products to buy other used products. The stock had been stagnant since 2022 due to a variety of idiosyncratic factors, but we began our investment late last year as we believed many of the headwinds that the company had faced have been addressed and would likely see a return of double-digit growth rates. Furthermore, we became bullish on their FinTech business that had structurally low delinquency rates yielding high margins in a segment of the market traditionally seen to be risky. As our thesis began to be realized, the stock began a strong rally until roughly a month ago. A significant proportion of their business is linked to the trading of trading cards whose values had begun to fall from late May after a two-year run. Additionally, the company banned listings of the new 30th anniversary Pokemon cards that are expected to be released in October due to worries of excessive price scalping which accelerated the decline. We actually applaud that decision, even if short-term growth rates are sacrificed temporarily. The marketplace can continue to grow mid-to-upper single digits without depending on Pokemon cards while their FinTech and their cross-border e-commerce businesses continue to grow double-digits. They had reached their +25% CAGR target earnings nearly one-year in advance and we see little reason why this momentum cannot continue. And yet, the stock, after its recent adjustment, now trades at a 16x one-year forward multiple.

 

The second is Timee, the leader in “spot-work” matching, where we had recently filed as a large shareholder. They had created a new gig-economy genre of work that instantly matches a large pool of workers looking for single-day, part-time shifts with businesses needing immediate, on-demand labor without the hassle for resumes or interviews. Not only can large volumes be matched on short notice, it can be processed at lower cost than other recruiting services. Workers are paid instantly after the work is complete, unlike most other job markets that can take weeks to a month to receive their wage, making the service attractive for both employers and workers. They have been growing revenue at double-digits as labor shortages become more acute, especially in the categories where Timee has the largest pool of available workers, namely retail, warehousing, and hospitality. The stock had fallen after Q1 (May-Jul 2026) results mainly due to macroeconomic factors such as a slowdown in warehousing demand from the war in Iran as well as a cool summer causing weakness in retailing. Furthermore, they have expanded into new businesses that are very synergetic with their main business, but, because these new businesses are expanding faster than expected, Timee has been increasing resources into these areas, causing a short-term earnings drag. We too feel these new businesses have enormous potential, and we are confident that management will not throw capital and resources at them indefinitely based on a disciplined trajectory to achieve their high ROI expectations. The short-termism of the market has allowed us to invest in a business that is expected to grow at +30% CAGR bottom-line over the next 3 years at 20x one-year forward earnings.

 

Finally, the third is the leader in online commerce, the business we are most excited with among these three. While their marketplace continues to grow double-digits, the company entered the mobile market to become the 4th MNO, taking on the three mobile incumbents. Needless to say, the capital required has been astronomical to date. IR said, “even until just two years ago, the only 2 questions from investors were 1. How can you stay afloat and 2. When are you going to give up on mobile?” However, last fiscal year, after only 5 years of building out a greenfield nationwide network, they had become EBITDA positive with just 4% market share. This was possible because they were able to deploy the world’s first large-scale, fully virtualized greenfield network based on an open-interface architecture that eliminates hardware vendor lock-in making future upgrades to 6G and beyond highly cost-effective. Furthermore, it is capable of advanced automation and intelligent operations, contributing to its low-cost maintenance and operations. As such, they are the lowest priced carrier, helping to achieve profitability quickly even with low market share. In addition to being the largest domestic e-commerce site, the group includes the largest online bank, online securities firm, and credit card company in Japan. They have created a unique ecosystem centered around loyalty points that is unrivaled by other carriers who are attempting to expand their competitive mobile business into e-commerce and FinTech via acquisitions although, to date, they have yet to create a coherent ecosystem. However, the stock has been stagnant for the past 10 years almost entirely due to their mobile entry with four of the past eight fiscal years generating an operating loss and just barely breaking even in the last two. While this year would have been the inflection point, their mobile business had been partly dependent on a roaming contract with one of the major carriers whose contract ended in October. While well publicized in advance and obviously had been well-prepared for, the negative sentiment had been boiling up as the date approached. However, we believe any service quality disruptions will be temporary and mostly negligible. As such, we believe that any rise in churn will also be short-term and temporary and the price they offer compared to their peers will be too large to ignore. In fact, all three of the mobile competitors, including each of their low-priced brands, have or will be raising prices while our company will not. We believe we are on the cusp of a major inflection point where mobile will no longer be a drag to earnings and will become not only accretive but synergistic to the entire ecosystem. Their e-commerce and FinTech businesses have continually risen double-digits during the mobile roll-out but was largely ignored due to the possible mobile risks. We believe mobile can achieve break even on the operating level in 2 years. Even if all other businesses were flat until then, the stock would then be trading at 6x forward earnings, not including the large DTAs that they have accumulated during the 8 years of pre-tax losses. While we only recently began our investment, it has quickly grown to the second largest position in our concentrated portfolio (third largest in our diversified), and we would use any pullback to increase it further. In the meantime, we (or rather my AI agents) have been scouring the Internet on a daily basis for any news regarding service quality deterioration since October 1 and, so far, there has been few developments aside for the occasional tweet or blog from subscribers whose disruptions have been very localized and have yet to notice area-wide downtime.
 

Overall, while we are cautious on the macro environment, we are highly bullish of our portfolio which have structural and idiosyncratic tailwinds that we believe can overcome the macro headwinds that we are facing now.

Masaki Gotoh
 
*** We will be co-hosting the inaugural SOHN Tokyo Investment Conference on Oct. 16. We hope you can all attend and help support a great cause with the Karen Leung Foundation *** ​​​

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​​<Given the length of the main commentary, I will skip my usual blurb on the second part of our monthly but will return again from next month>

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