The Japan Fund

SJPNX
Portfolio Manager Commentary as of 3/31/14
QUARTERLY REVIEW
The Fund recorded a negative return of -6.54% in terms of Net Asset Value (NAV) per share during the quarterly review period from December 31, 2013 to March 31, 2014. The corresponding return figures for the TOPIX index (the “benchmark”) with gross dividends reinvested and for the MSCI Japan Index with gross dividends reinvested were -5.04% and -5.47% in U.S. dollar terms, respectively. Therefore, the Fund underperformed relative to its benchmark by 1.51% (151 basis points) and underperformed the MSCI Japan Index by 1.07% (107 basis points).

After having quickly rallied to a 7-year high at the end of 2013, the TOPIX index (including dividends) fell by 6.8% in local currency terms during the review period. This correction partly reflected profit-taking, but was largely the result of two factors. First was the external factor, or concerns about falling equity markets and currencies in some emerging countries such as Argentina, a slowing Chinese economy, and the growing geopolitical tensions in the Ukraine. The second factor was the domestic situation, or the uncertainty surrounding the impact of the consumption tax rate hike at the beginning of April, 2014, together with waning expectations that the Bank of Japan (BOJ) would adopt further monetary policy easing measures. The yen appreciated slightly against the US dollar, gaining 1.8% during the review period, so the TOPIX index fell by 5.0% in USD terms as noted above.

The Fund seeks long-term capital appreciation derived not only from value stocks but also from growth stocks. Considering this objective, Nomura Asset Management utilizes a “multi-manager” approach to managing the Fund’s investments, while also selecting from both large-cap and small-cap stock markets in Japan. The Fund’s investments are initially allocated to three portfolio management teams who are responsible for the large cap value, large cap growth, and small cap blend strategies, respectively. Decisions regarding the allocation of assets to a particular style are made by a dedicated asset allocation committee. Through this style diversification, Nomura Asset Management aims to capture the broader investment opportunities as well as ensuring that the portfolio is well diversified.

In terms of style allocation, we have maintained the existing strategy throughout this review period. At the end of March 2014, we allocated 52.5% of the equity position to large cap value, 37.6% to large cap growth, and 9.9% to the small cap blend strategy. The total equity portfolio consisted of 302 stocks. The five largest sector weightings were Electrical Appliances, Machinery, Transportation Equipment, Information & Communication and Banks. Within the top five sectors, the Fund held overweight exposures relative to the benchmark in the Machinery and Information & Communication sectors, and it held underweight exposures to the Banks and Transportation Equipment sectors. The position in the Electric Appliances sector was close to neutral. The Fund’s underperformance of 1.51% against the benchmark for the quarter was the result of negative outcomes from both the style allocation strategy and stock selection results. The underweight position in the small cap portion and overweight position in the large cap value portion relative to the benchmark had a negative impact on the style allocation strategy.


MARKET OUTLOOK
Japan’s consumption tax rate was raised from 5% to 8% at the beginning of April 2014. Real gross domestic product (GDP) was forecast to expand by 2.8% quarter-on-quarter (qoq, annualized) in the first quarter 2014, later shrinking by -2.6% in the second quarter 2014. This economic dip is expected to be limited and temporary thanks to the expansionary fiscal measures and improvements in household income. Capital investment in the corporate sector could pick up, backed by robust domestic demand and a recovery in external demand. We expect the Japanese economy to continue expanding, with a +1.2% year-over-year (yoy) real GDP growth rate in calendar year (CY) 2014 and +1.5% in CY2015.

Corporate Earnings of Japanese companies have grown significantly in recent quarters. According to the latest forecast in March, recurring profits of major Japanese companies (excluding Financials) were expected to grow by 39.0% (yoy) for fiscal year (FY) 2013 ending March 31 and by a further 11.0% for FY2014. The main contribution to this profit growth is expected to come from rising sales, as revenue is estimated to have expanded by 11.7% (yoy) for FY2013, the fastest pace in the post-bubble era since FY1990, and by 3.7% for FY2014. Over the past deflationary two decades, Japanese companies had found it difficult to expand corporate sales, and have seen occasional downtrend phases in sales and revenue. Amid such an environment, most Japanese companies were reluctant to increase capital investment and employment, and they have tended instead to enhance their internal balance sheet reserves. However, this economic environment is beginning to change. We now expect Japanese companies to reassess this cautious approach to capital investment, hiring and wage increases.

Japan’s core inflation rate (consumer prices excluding fresh food) was +1.3% (yoy) in February 2014, while it was -0.2% a year ago. The main drivers of this change were the depreciation of the yen and rising energy costs. Although these influences are expected to weaken, the core inflation rate should maintain a steady positive trend, mainly pulled along by the improving labor market. Japan’s unemployment rate slipped to 3.6% in February, the lowest level since July 2007. The BOJ’s Tankan survey issued in March 2014, revealed an Employment Conditions Diffusion Index of -15, clearly implying a labor shortage. The data suggested Japan’s labor market had tightened so much that household sector income could continue to rise gradually. This was one of the most important conditions allowing Japan to exit from its deflationary phase.

Whether or not Japan’s economy is able to escape from deflation is a major issue for the Japanese equity market. If deflation is left behind, then there is a chance that Japanese equity valuations might shift from their current level. The TOPIX price-to-earnings ratio (PER) based on current earnings forecasts for FY2014 is 13.9, which was below the S&P500’s PER of 16.0 (as of March 31, Bloomberg estimates). The Price-to-book-value ratio (PBR) was 1.32 while that of the S&P500 Index was 2.62. In our assessment, Japan’s equity market valuations are still depressed and the growth potential of Japanese companies is not being discounted fairly due to the prolonged deflationary economic circumstances. As investors become more convinced that Japan can overcome deflation and can realize sustainable economic growth, the more fairly equity markets will discount the growth potential of Japanese companies.

We believe the Japanese equity market is attractive from a long-term investment perspective, and in our judgment, there are many attractive stocks available in this market. We will maintain a well diversified portfolio and select the most attractive candidates from among the value stocks, growth stocks, and small-capitalization stocks using our extensive equity research capabilities.

This material contains the current opinions of the Fund's manager, which are subject to change without notice. It should not be considered investment advice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that these investment strategies will work under all market conditions, and each investor should evaluate their ability to invest for the long-term. Past performance is not a guarantee of future results. There is a risk of loss. Performance shown represents that of the Fund's Class A shares. Performance does not reflect any applicable front-end sales charge or redemption fees. Diversification and asset allocation do not guarantee a profit, nor do they eliminate the risk of loss of principal.

The Tokyo Stock Exchange Price Index (TOPIX) is an unmanaged capitalization weighted measure (adjusted in U.S. Dollars) of all shares listed on the first section of the Tokyo Stock Exchange. The MSCI Japan Index is a free-float weighted index that includes every listed security in the Japanese market. The S&P 500 Index is a broad based unmanaged index representing the performance of 500 widely held common stocks. One cannot invest directly in an index. Price to earnings (PER) ratio is the valuation of a company's current share price relative to company earnings. Price to book value (PBR) is a ratio used to compare a stock's market value to its book value. Book value is the total asset of a company minus total liability.

The MSCI information contained in this material may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an "as is" basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the "MSCI Parties") expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages.

Effective October 16, 2013, all of the Funds of Nomura Partners Funds, Inc. were closed to purchases and exchanges. As noted within the supplement dated April 4, 2014, the Board of Directors of Nomura Partners Funds, Inc. (the “Board”) has approved the reorganization of The Japan Fund, a series of Nomura Partners Funds, Inc., into the Matthews Japan Fund, a series of Matthews International Funds (the “Reorganization”). At any time prior to the Reorganization, shareholders may redeem their shares and receive the net asset value thereof pursuant to the procedures set forth in the Funds’ prospectus.

Nomura

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