Japan Small Cap Investing:
Insight on Engagement Activities
Makoto Ito, CMA
Senior Portfolio Manager
Published July 2024

Japan Small Cap Equity Strategy’s Senior Portfolio Manager
Makoto Ito shares his insight into the unique opportunities
provided by Japanese small caps, the Strategy‘s approach toinvesting, with its focus on engagement activities

Contents:• An examination of long-term structural changes that, alongside pressure fromincreasingly vocal institutional investors and government-led encouragementof engagement, create an appealing opportunity for investing in Japaneseequities• Case Studies in engagement activities• Investment Strategy: The Nomura Japan Small Cap Equity Strategy

Trends in Improving Capital Efficiency ofJapanese Companies
The Japanese equity market is experiencing two
significant structural shifts that increase theappeal of buying Japanese stocks from a longterm perspective. One is a macroeconomictrend, namely, an end to the prolonged
deflationary environment and the beginning of avirtuous cycle of wage increases and inflation.
The other is steady progress in corporate
governance, including accelerated efforts bylisted companies to improve their capitalefficiency. It is difficult to confidently assert thatthe macroeconomic shift will come to fruition, as
it may be influenced by overseas political andeconomic factors, as well as the Bank of Japan’s
policy management. However, the latter is atheme that we investors can bet on with highconfidence.
There has been a noticeable change in attitudes
toward corporate governance, largely thanks to aseries of government-led reforms, starting with
the introduction of the Stewardship Code in 2014
and the Corporate Governance Code in 2015,
and followed by the Tokyo Stock Exchange’s(“TSE”) market reforms and efforts to improve
capital efficiency. This change is especiallyapparent among firms that previously had low
awareness of capital costs and stock prices(especially among small-cap stocks).
As recently as ten years ago, it was notuncommon to find corporate managers who
could not understand the terms "cost of capital"and "ROIC". There were also many companies
that did not hold earnings briefings, or would
simply refuse requests for engagement. In recentyears, such cases have decreased markedly.
Building upon this trend, traditionally silentinstitutional investors in Japan are increasingly
finding their voices and speaking out against
listed companies, thanks in part to governmentled encouragement of engagement activities. In
truth, there is not much difference in theinvestment theory of active fund managers, eventraditional institutional investors, and that ofactivists. Pressure from regular institutional
investors is growing alongside the number ofactivists year by year, and it is highly likely thatthe overall capital efficiency of Japanesecompanies will improve further.
There is a high proportion of Japanese companies
that have accumulated excessive amounts ofcash and have bloated their shareholders' equity.
In the past, the ROE of Japanese companies as awhole was rarely above 10%. However, with thepractice of properly controlling shareholder equity
taking root, it seems a likely future where the ROElevels of Japanese companies as a whole is in the
mid-10% range, on par with European markets, if
not with the U.S. market (close to 20%).
In recent years, small-cap stocks have lagged
behind large-cap stocks. The main reason behind
this is the advantage that large-cap stocks, manyof which are export-related businesses, gained
due to the yen's depreciation. Small-cap stocks
have also lagged behind large-cap stocks in theirefforts to improve corporate governance andcapital efficiency, but this trend has beenchanging in a promising direction.
Since the beginning of 2024, the TSE has
published a monthly list of companies that havedisclosed plans related to "Action to Implement
Management That is Conscious of Cost of Capitaland Stock Price". The chart below shows changes
in the disclosure status by company size. Initially,
only 36% of Russell/Nomura (R/N) Smallcompanies had disclosed plans, compared to
61% of R/N Large companies. However, over thelast five months, R/N Small has been graduallycatching up to R/N Large. Though the gap
remains wide, 60% of R/N Small companies had
disclosed plans by the end of May. As morecompanies join this trend, it has the potential to bea driving force for small cap outperformance overlarge caps, whose efforts have already begun tomature.

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Percentage of Companies that haveDisclosed Plans

Note: Russell/Nomura (R/N) Large Cap: top 300 stocks,
R/N Small Cap: approximately 1,100 stocks excluding top300 stocks. Source: Nomura Asset Management basedon data from Russell Investments and Nomura Securities
for Russell/Nomura Indexes, and Tokyo Stock Exchange.
https://www.jpx.co.jp/english/equities/follow-up/02.html

Meanwhile, at Nomura Asset Management, ourengagement activities with portfolio companies

are a combined effort between our portfolio
managers, corporate research analysts, ESG
specialists, and engagement managers. In order
to better support the work done by the Corporate
Research Group, we have bolstered ourcapabilities for assessing and engaging withcompanies over the past few years by expanding
our Responsible Investment Department andEngagement Department. As of the end of May
2024, the JSC portfolio comprised 132 stocks.
Our team is conducting ongoing engagementwith more than 70% of these companies with aparticular focus on improving governance andcapital efficiency. Below, we offer case studies ofengagement activities with three companies
among our Top 10 holdings.

Example of Engagement: Maruzen (5982)
Maruzen Co., Ltd. is a manufacturer and seller of commercial kitchen equipment. The company isexpected to enjoy solid sales growth linked to Japan’s serious labor shortage and the resulting demand
for labor-saving investment in restaurants and other businesses. The increase in inbound travelers will
also indirectly benefit the company. Maruzen is gradually becoming more shareholder friendly.
10 years ago, the company turned down our requests for engagement interviews, but over the past sixyears, we've held regular investor relations meetings. The company has been accumulating cash on itsbalance sheet due to insufficient shareholder returns amid high profitability but limited growth. However,
due to years of dialogue and pressure from the government and the TSE, the company's stance has
gradually changed. The dividend payout ratio, which was in the 10% range just four years ago, has risen
steadily from just under 30% two years ago to 40% since last year. Market pressure has also increased,with an activist fund proposing to return 100% of profits to shareholders last year. Just one or two years
ago, the company's market capitalization was below its financial assets. Today, however, the company
has rectified that situation and has achieved a PBR of 1.0x. Although the ROE target disclosed by thecompany is only 8%, the company is highly profitable and has the potential to generate an ROE that is
easily double the company's low target if the company controls shareholder equity properly using its
surplus cash. We will continue to engage with the company for further improvements.

Example of Engagement: Yurtec (1934)
Yurtec is a consolidated subsidiary of Tohoku Electric Power (9506) that is engaged in general facility
engineering, including construction, maintenance, and repair work for its parent company. It has abundantfinancial assets and low ROE. It is expected to benefit from growing demand for renewable energy such as wind
power generation and investment to expand its wide-area power transmission and distribution network. Only a
few years ago, the company did not hold earnings conferences for investors. We have discussed improving
capital efficiency and the issue of parent-subsidiary listings with both Yurtec and its parent company, Tohoku
Electric Power. In the most recent medium-term management plans of the two companies, Tohoku ElectricNomura Asset Management | Japan Small Cap Investing

Page 3Power set a ROE target of 8% or more in two years, while Yurtec disclosed a ROE target of 6% or more in
FY2028, four years from now, and a ROE of 8% sometime in the first half of the 2030s. Yurtec has abundantfinancial assets, and we believe the company has the potential to raise its ROE level even earlier if it has the willto do so. We have pointed out to Yurtec that the speed of management is extremely slow. Furthermore, we areengaged in ongoing discussions with the parent company regarding managing this gap and whether it shouldencourage improvement on this issue. While we recognize that electrical construction companies like Yurtec are
indispensable for maintaining the power grid, which is the lifeblood of electric power companies, we believe thatthe time has come for the parent company to reexamine the necessity of maintaining its subsidiary’s listing.

Example of Engagement: Osaka Steel (5449)
Osaka Steel, a consolidated subsidiary of Nippon Steel (5401), has abundant financial assets and low ROE. We
have long been discussing measures to improve Osaka Steel’s efficiency and the issue of parent-subsidiarylistings with both Osaka Steel and Nippon Steel. In January 2024, Osaka Steel responded to the TSE's request
for "Action to Implement Management That is Conscious of Cost of Capital and Stock Price”. The content of therelease, excluding the cover and past ROE/PBR charts, was essentially a single sheet of paper with nonumerical targets for ROE or otherwise. We not only pressed Osaka Steel on whether this content truly compliedwith the TSE's request, but also pressed the parent company, Nippon Steel, to provide guidance to its
consolidated subsidiaries. Up until last fiscal year, Osaka Steel did not issue any dividend forecasts at thebeginning of the fiscal year, although it did issue earnings forecasts. This provides a glimpse of the company'sdisregard for minority shareholders. However, this spring, Osaka Steel presented a dividend forecast at thebeginning of the fiscal year for the first time. The company's attitude is changing. Most recently, an activist fundmade a shareholder proposal that has attracted market attention.

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The Nomura Japan Small Cap Equity Strategy
This Strategy has been managed since February 2020 with the investment objective of achieving
long-term capital growth. With nearly 4,000 listed companies in Japan, our focus is on unearthinghidden gems among small- and medium-sized listed companies. In other words, we offer investors abroad, unique and under researched opportunity set.

“We like to dig for companies that are profitable,
have strong balance sheets, yet are undervalued. We actively monitor management quality
and corporate fundamentals – factors representing the heartbeat of companies that arepoorly covered by sell side analysts, and havethe most potential to be mispriced.”

Access to Companies
The Portfolio Manager conducts over 500 meetings per year with listed companies.
In total, our analysts conduct more than 5,000 meetings annually.

Investment Style
While the Japan Small Cap Equity Strategy has a slight value bias, we also lookfor elements of growth. There are mainly three types of investments that we lookfor:
1. High Quality Value Stocks: Profitable companies with strong balance sheetsthat are undervalued due to the lack of research coverage.
2. Growth Stocks: Companies with firm expectations of superior growth
opportunities offered both by cutting edge technologies and innovative businessmodels that are highly competitive and disruptive to traditional Japanesebusiness practices.
3. Opportunistic Investments: Our approach is designed to identify not only
quality businesses, but also businesses that are deeply undervalued, despite
being well-run and able to ride the recovery wave.

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We actively monitor management quality and corporate fundamentals – factors representing theheartbeat of companies that are poorly covered by sell side analysts, and have the most potential to be
mispriced. Selecting these winners requires patience and a commitment of resources to cover the vast
number of companies and diverse range of businesses.
The Strategy typically holds around 100 to 200 stocks. In the small cap markets in particular,
diversification helps to mitigate liquidity risk, and we want to achieve exposure to a breadth of investment
opportunities in order to raise risk-adjusted returns.

About the Portfolio Manager
Makoto Ito, CMA, has more than 20 years ofinvestment and research experience.
Previously, he had experience in investment
research in emerging market equities, particularly
Chinese equities, and after joining Nomura AssetManagement in 2006, he worked as a financial
sector analyst before managing Japanese equities
in 2008. He was appointed as a Senior Portfolio
Manager in 2015.
Note: CMA is a Chartered Member of the Securities Analysts
Association of Japan.

Disclaimer
This report was prepared by Nomura Asset Management Co., Ltd. (“NAM”) for information purposes
only. Although this report is based upon sources we believe to be reliable, we do not guarantee its
accuracy or completeness. Unless otherwise stated, all statements, figures, graphs and otherinformation included in this report are as of the date of this report and are subject to change without
notice. The contents of this report are not intended in any way to indicate or guarantee future investment
results. Further, this report is not intended as a solicitation or recommendation with respect to thepurchase or sale of any particular investment. This report may not be copied, re-distributed orreproduced in whole or in part without the prior written approval of Nomura Asset Management Co. Ltd.
Registration Number: Director-General of the Kanto Local Financial Bureau No.373 Membership: The
Investment Trusts Association, Japan, Japan Investment Advisers Association, Type II Financial
Instruments Firms Association
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