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Japan Smaller Capitalization Fund, Inc.

 

October 25, 2018

 

To Our Shareholders:

 

We present the Semi-Annual Report of Japan Smaller Capitalization Fund, Inc. (the “Fund”) for the six months ended August 31, 2018.

 

The net asset value per share (“NAV”) of the Fund decreased by 9.6% and the closing market price of the Fund (on the New York Stock Exchange) decreased by 12.8% for the six months ended August 31, 2018. The closing market price of the Fund on August 31, 2018 was $10.88, representing a discount of 14.1% to the NAV of $12.67. The net assets of the Fund totaled $358,913,909 on August 31, 2018.

 

The Russell/Nomura Small Cap^TM Index, the Fund’s benchmark (“Benchmark”), decreased by 5.9% in United States (“U.S.”) dollar terms for the six months ended August 31, 2018. During the six months ended August 31, 2018, the Fund underperformed the Benchmark by 3.7% on a NAV basis. The Tokyo Price Index (the “TOPIX”), a capitalization-weighted index of all companies listed on the First Section of the Tokyo Stock Exchange (the “TSE”), decreased by 5.7% and the Nikkei Stock Average Index (“Nikkei”), a price-weighted index of the 225 leading stocks on the TSE, decreased by 0.5% in U.S. dollar terms during the six months ended August 31, 2018. The Japanese yen (“Yen”) depreciated by 4.1% against the U.S. dollar during the six months ended August 31, 2018.

 

For the quarter ended August 31, 2018, the Benchmark decreased by 4.6%, the TOPIX decreased by 2.7%, and the Nikkei increased by 0.9% in U.S. dollar terms. The NAV of the Fund decreased by 8.1% and underperformed the Benchmark by 3.5%. The Fund’s share price decreased by 11.0% during the quarter. The Yen depreciated by 2.1% against the U.S. dollar during the quarter.

 

Investment Strategy

 

The Fund invests in undervalued stocks that offer fundamental strength and potential for improvement. The Fund performs extensive fundamental research to identify stocks that can create shareholder value. The Fund focuses on companies that are leaders in certain niche markets, companies with large or expanding market shares, stocks with superior shareholder distribution policies, and stocks that offer good growth prospects. In the Japanese small cap equity market, valuation anomalies do exist and can be exploited through active management. There are a number of factors that the Fund considers when selling an investment, including a stock which appears fully valued, unexpected deterioration in earnings or a substantial loss that impairs the company’s net assets, and a stock’s diminishing potential given declining competitiveness due to a change of business environment or failure of business strategy.

 

Performance

 

In terms of the sector allocation strategy, an overweight position in the Utilities sector and an underweight position in the Electric Appliances sector generated the largest positive contributions. Sector returns were eroded by an underweight position in the Information and Communication sector and an overweight position in the Metal Products sector.

 

Relative performance was positively impacted by Kusuri No Aoki Holdings Co., Ltd. in the Retail Trade sector, Okinawa Cellular Telephone Company in the Information and Communication sector, and Pigeon Corporation in the Other Products sector. Conversely, relative performance was negatively impacted by Saizeriya Co., Ltd., Daikokutenbussan Co., Ltd. and Amiyaki Tei Co., Ltd. in the Retail Trade sector.

 

 

 

Market Review

 

The Benchmark decreased by 2.0% and underperformed the TOPIX index, which decreased by 1.9% in local currency terms, for the six months ended August 31, 2018. Although Japanese companies have announced strong earnings during the period, the market fluctuated because of concerns over geopolitical risks.

 

The Japanese equity market fell given the prospect of a trade war between two of the largest national economies from the U.S. government’s decision to impose tariffs on Chinese goods. Also, a decline in the approval rating of Prime Minister Abe’s government triggered further sustained selling by foreign investors in the Japanese equity market.

 

From April to May 2018, the Japanese equity market rebounded and posted a strong rally as Japan’s corporate sector continued to offer stable earnings growth prospects supported by favorable foreign exchange rates and cost reduction efforts. In May 2018, volatility returned to the global equity market as the U.S. adopted a more hawkish attitude to both Iran and North Korea and difficult political transitions in Spain and Italy questioned the sustainability of the European Union.

 

Global growth prospects and political events appeared to affect the Japanese equity market in June 2018. President Trump’s statements regarding tariffs on imported goods to the U.S. spread uncertainty, especially for the earnings prospects of multinational companies. In July 2018, Japanese stocks remained steady as the shadow of the ongoing trade dispute between the U.S. and China seems to have been at least partly built into the markets. Economic stimulus policies announced by the Chinese government and favorable earnings results from Japanese companies also supported the recovery in market sentiment.

 

Despite favorable quarterly earnings results from Japanese companies, the Japanese equity market declined as trade tensions between the U.S., its neighboring North American Free Trade Agreement countries, and China remained unresolved. Also, the further political rift between the Trump administration and the Turkish government took a toll on investor confidence.

 

Outlook and Future Strategy

 

Despite signs that the global economy is approaching the later stages of the current cycle, steady economic growth continues due to support from expansionary fiscal policies in the U.S., including tax reform plans and infrastructure investment. In China, recently announced economic stimulus measures should mitigate the negative impact from higher U.S. tariffs on Chinese goods and prevent a sudden deterioration in the Chinese economy. Outside of the U.S. and China, downward sentiment in some economic indicators have levelled off gradually as noted in the European Purchasing Managers’ Index data. Central banks, including the U.S. Federal Reserve Bank and the Bank of Japan, still appear to prioritize steady economic growth momentum rather than quickening the normalization of current monetary easing policies. Thus, aside from uncertainty over the trade war issue, the Fund notes that the global macro outlook has improved compared to a few months ago.

 

Japanese companies have continued to deliver solid earnings momentum during the April to June 2018 earnings reporting period. Manufacturing sectors secured higher profit growth relative to domestic-oriented industries, aided to some extent by favorable currency trends. For the fiscal year ending March 2019, the recurring profit growth estimate for Russell/Nomura Small Cap stocks, excluding Financial sectors, is expected to increase 10.4% year over year. The forward price-earnings ratio of the Russell/Nomura Small Cap Index is expected to be around 16 for the fiscal year ending March 2019 earnings, which seems consistent with other major markets. Positive earnings revisions should strengthen the Japanese equity market assuming the currency remains within the current range of around 110 Yen-dollar rate.

 

 

 

Japanese companies are increasingly trying to raise product and service prices in response to a tighter supply-demand balance and higher labor and material costs. Such efforts are especially evident in sectors such as land transport, cosmetics, electronic components, commodities and chemical products. These price hikes indicate an improving competitive landscape and may lead to better margin prospects in some sectors, which could be an important growth driver for Japanese companies. The Fund believes the recent solid fundamentals of Japanese companies are not only due to the steady global macro conditions, but also to such company specific efforts. Therefore, steady corporate fundamentals, even amid rising input cost inflation, should support the Japanese equity market.

 

The Fund appreciates your continuing support.

 

	Sincerely,
	Yukata Itabashi
	President

 

DISCLOSURES   Sources: Nomura Asset Management U.S.A. Inc., Nomura Asset Management Co., Ltd., and Bloomberg L.P. Past performance is not indicative of future results. There is a risk of loss.   The NAV price is adjusted for reinvestment of income dividends, ordinary income distributions, and long-term capital gain distributions. The New York Stock Exchange’s closing market price is adjusted for reinvestment of income dividends, ordinary income distributions, and long-term capital gain distributions. The Fund’s performance does not reflect sales commissions.   This material contains the current opinions of the Fund’s manager, which are subject to change without notice. This material should not be considered investment advice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. 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.   Comparisons between changes in the Fund’s net asset value or market price per share and changes in the Fund’s benchmark should be considered in light of the Fund’s investment policy and objective, the characteristics and quality of the Fund’s investments, the size of the Fund, and variations in the Yen/U.S. Dollar exchange rate. This report is for informational purposes only. Investment products offered are not FDIC insured, may lose value, and are not bank guaranteed.   Indices are unmanaged. An index cannot be directly invested into.   Certain information discussed in this report may constitute forward-looking statements within the meaning of the U.S. federal securities laws. The Fund believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions and can give no assurance that the Fund's expectations will be achieved. Forward-looking information is subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected.   The Russell/Nomura Small CapTM Index represents approximately 15% of the total market capitalization of the Russell/Nomura Total MarketTM Index. It measures the performance of the smallest Japanese equity securities in the Russell/Nomura Total MarketTM Index. As of August 31, 2018, there are 1,243 securities in the Russell/Nomura Small CapTM Index.

 

 

SHAREHOLDERS ACCOUNT INFORMATION   Shareholders whose accounts are held in their own name may contact the Fund’s registrar, Computershare Trust Company, N.A., at (800) 426-5523 for information concerning their accounts.

 

PROXY VOTING   A description of the policies and procedures that the Fund uses to vote proxies relating to portfolio securities is available (1) without charge, upon request, by calling toll-free 1-800-833-0018; and (2) on the website of the Securities and Exchange Commission (“SEC”) at http://www.sec.gov. Information about how the Fund voted proxies relating to securities held in the Fund’s portfolio during the most recent 12-month period ended June 30 is available (1) without charge, upon request, by calling toll-free 1-800-833-0018; and (2) on the SEC’s website at http://www.sec.gov. Additional information about the Fund’s Board of Directors is available (1) without charge, upon request, by calling toll-free 1-800-833-0018; and (2) on the website of the SEC at http://www.sec.gov in the Fund’s most recent proxy statement filing.

 

AVAILABILITY OF QUARTERLY SCHEDULE OF INVESTMENTS   The Fund files a schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Fund’s Forms N-Q are available on the SEC’s website at http://www.sec.gov. The Fund’s Forms N-Q may also be reviewed and copied at the SEC’s Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330.

 

FUND CERTIFICATIONS   In December 2017, the Fund filed its Principal Executive Officer Certification with the New York Stock Exchange pursuant to Section 303A.12(a) of the New York Stock Exchange Corporate Governance Listing Standards. The Fund’s Principal Executive Officer and Principal Financial Officer Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 were filed with the Fund’s Form N-CSR and are available on the SEC’s website at http://www.sec.gov.

 

SHARE REPURCHASES   Notice is hereby given in accordance with Section 23(c) of the Investment Company Act of 1940 that from time to time the Fund may repurchase shares of its common stock in the open market.

 

INTERNET WEBSITE   Nomura Asset Management U.S.A. Inc. has established an Internet website which highlights its history, investment philosophy and process and products, which includes the Fund. The Internet web address is http://funds.nomura-asset.com/japan-smaller-capitalization.

 

Japan Smaller Capitalization Fund, Inc.

FUND HIGHLIGHTS—AUGUST 31, 2018 (Unaudited)

 

KEY STATISTICS

 

MARKET INDICES

 

INDUSTRY DIVERSIFICATION

 

TEN LARGEST EQUITY HOLDINGS BY FAIR VALUE

 

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
JAPANESE EQUITIES SECURITIES
Banks
Fukuoka Financial Group, Inc.			383,000			$	2,048,836			$	2,150,115				0.6
General banking services
The Akita Bank, Ltd.			133,600				3,769,471				3,441,878				1.0
General banking services
The Bank of Okinawa, Ltd.			57,800				2,334,925				2,252,624				0.6
General banking services
The Keiyo Bank, Ltd.			467,000				2,137,401				2,003,082				0.5
General banking services
The Musashino Bank, Ltd.			73,100				2,389,043				2,121,036				0.6
General banking services
The Taiko Bank, Ltd.			99,400				2,015,073				1,834,388				0.5
General banking services
The Yamanashi Chuo Bank, Ltd.			477,000				2,066,789				1,715,008				0.5
General banking services
Total Banks							16,761,538				15,518,131				4.3
Chemicals
Adeka Corporation			223,600				3,404,149				3,705,343				1.0
Manufactures chemical and food products
C. Uyemura & Co., Ltd.			50,000				2,298,519				3,379,139				0.9
Plating chemicals
Fujikura Kasei Co., Ltd.			1,008,100				5,306,664				6,095,383				1.7
Specialty coating materials and fine chemicals
Koatsu Gas Kogyo Co., Ltd.			594,200				3,723,314				4,486,953				1.2
High-pressured gases and chemicals
Sakata Inx Corporation			673,600				9,856,744				8,971,217				2.5
Manufactures printing ink
Sekisui Jushi Corporation			245,400				4,201,881				4,862,668				1.4
Manufactures plastics and other resin materials
Shikoku Chemicals Corporation			103,600				1,106,452				1,364,841				0.4
Manufactures chemical products
Tenma Corporation			358,800				5,938,236				5,981,347				1.7
Manufactures synthetic resin products
T&K Toka Co., Ltd.			177,100				1,736,585				1,857,575				0.5
Manufactures specialized inks for printing applications
Yushiro Chemical Industry Co., Ltd.			232,600				3,114,911				3,125,088				0.9
Manufactures metalworking fluids
Total Chemicals							40,687,455				43,829,554				12.2

See notes to financial statements

 

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
Construction
Toenec Corporation			315,900			$	8,660,798			$	9,009,448				2.5
Construction of comprehensive building facilities
Totetsu Kogyo Co., Ltd.			245,900				7,452,451				6,609,774				1.9
Operates construction-related businesses
Yondenko Corporation			63,400				1,264,557				1,523,657				0.4
Construction of electrical distribution systems
Yurtec Corporation			275,600				2,171,354				2,195,363				0.6
Engineering company
Total Construction							19,549,160				19,338,242				5.4
Electric Appliances
Kitagawa Industries Co., Ltd.			255,600				2,656,123				3,388,040				0.9
Manufactures various industrial and consumer products
Koito Manufacturing Co., Ltd.			27,600				1,646,640				1,708,601				0.5
Manufactures lighting equipment
Mabuchi Motor Co., Ltd.			85,100				4,203,180				3,531,295				1.0
Manufactures small motors
Maxell Holdings, Ltd.			77,400				1,314,376				1,249,838				0.4
Manufactures media devices, batteries and electrical appliances
Nissin Electric Co., Ltd.			89,800				835,054				796,244				0.2
Manufactures electric equipment
Total Electric Appliances							10,655,373				10,674,018				3.0

 

See notes to financial statements

 

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
Financing Business
Hitachi Capital Corporation			135,000			$	3,145,386			$	3,758,955				1.0
General financial services
Ricoh Leasing Company, Ltd.			137,300				4,598,094				4,546,767				1.3
Leasing and financial services
Total Financing Business							7,743,480				8,305,722				2.3
Food
Kameda Seika Co., Ltd.			92,300				4,365,321				4,096,215				1.1
Manufactures confectioneries
Nichirei Corporation			77,900				1,997,228				1,959,872				0.6
Produces frozen foods and provides cold storage warehousing
Total Food							6,362,549				6,056,087				1.7
Information and Communication
NS Solutions Corporation			61,400				1,397,827				1,989,034				0.5
System consulting services and software development
OBIC Co., Ltd.			23,700				1,433,390				2,229,583				0.6
Computer system integration
Okinawa Cellular Telephone Company			235,500				7,047,085				9,167,470				2.6
Telecommunications
Otsuka Corporation			49,900				1,402,809				1,809,845				0.5
Computer information system developer
Total Information and Communication							11,281,111				15,195,932				4.2
Iron and Steel
Chubu Steel Plate Co., Ltd.			240,900				1,205,605				1,458,751				0.4
Manufactures steel-related products
Mory Industries Inc.			41,600				692,828				1,103,585				0.3
Manufactures steel tubing products
Nichia Steel Works, Ltd.			1,970,000				5,751,581				5,716,062				1.6
Manufactures steel-related products
Osaka Steel Co., Ltd.			475,600				8,927,831				8,631,299				2.4
Manufactures steel-related products
Total Iron and Steel							16,577,845				16,909,697				4.7

 

See notes to financial statements

 

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
Machinery
Hisaka Works, Ltd.			362,000			$	3,064,596			$	3,725,199				1.0
Manufactures heat exchangers and other machinery
Miura Co. Ltd.			73,700				1,501,567				2,068,714				0.6
Manufactures boilers and related products
Nippon Pillar Packing Co., Ltd.			106,300				1,094,027				1,525,892				0.4
Manufactures mechanical seals
Nitto Kohki Co., Ltd.			159,100				3,423,152				3,479,484				1.0
Manufactures machine tools and motor pumps
Oiles Corporation			486,080				8,481,529				10,490,305				2.9
Manufactures bearing equipment
Shibuya Corporation			15,400				266,744				572,426				0.2
Packing plant business
Star Micronics Co., Ltd.			12,200				215,758				220,419				0.1
Manufactures machinery, electronic components, and precision parts
Yamashin-Filter Corporation			50,000				78,982				459,563				0.1
Manufactures filters
Total Machinery							18,126,355				22,542,002				6.3
Metal Products
Dainichi Co., Ltd.			246,100				1,771,026				1,632,167				0.4
Manufactures oil heating equipment
Neturen Co., Ltd.			424,400				3,258,127				3,885,473				1.1
Manufactures steel bars and induction heating equipment
NHK Spring Co., Ltd.			304,300				3,000,470				3,221,919				0.9
Manufactures automobile-related products
Piolax, Inc.			142,400				2,595,549				3,123,240				0.9
Manufactures automobile-related products
Rinnai Corporation			51,500				4,529,998				3,837,846				1.1
Manufactures heating appliances and components
Shinpo Co., Ltd			1,800				12,441				23,016				0.0
Manufactures smokeless roasters
Total Metal Products							15,167,611				15,723,661				4.4

 

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
Other Products
Fuji Seal International, Inc.			24,500			$	658,292			$	865,420				0.2
Packaging-related materials and machinery
Komatsu Wall Industry Co., Ltd.			21,500				378,202				407,623				0.1
Manufactures various partitions
Nishikawa Rubber Co., Ltd.			185,200				2,980,383				3,469,527				1.0
Manufactures rubber automobile parts
Pigeon Corporation			43,600				1,541,911				2,109,772				0.6
Manufactures baby care products
The Pack Corporation			204,400				5,691,328				5,801,847				1.6
Manufactures paper and chemical products
Total Other Products							11,250,116				12,654,189				3.5
Precision Instruments
Nakanishi Inc.			103,200				1,451,970				2,077,484				0.6
Manufactures dental instruments
Total Precision Instruments							1,451,970				2,077,484				0.6
Real Estate
Daibiru Corporation			176,200				1,827,926				1,838,609				0.5
Real estate leasing and building management
Sanyo Housing Nagoya Co., Ltd.			282,200				2,772,605				2,832,807				0.8
Designs and constructs housing
Starts Corporation Inc.			79,300				1,651,684				1,805,017				0.5
Construction, leasing and management of real estate
Total Real Estate							6,252,215				6,476,433				1.8

 

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
Retail Trade
ABC-Mart, Inc.			103,100			$	5,677,305			$	5,629,971				1.6
Retail sales of shoes
AIN Holdings Inc.			2,700				102,793				206,803				0.1
Operates pharmacies and drug store chains
Amiyaki Tei Co., Ltd.			227,900				8,482,669				9,025,641				2.5
Operates barbecue restaurant chains
Cosmos Pharmaceutical Corporation			26,600				5,227,769				5,577,671				1.6
Operates drug stores
Create SD Holdings Co., Ltd.			221,100				5,486,994				5,142,231				1.4
Operates pharmacies and drug store chains
Daikokutenbussan Co., Ltd.			198,800				8,393,601				7,685,082				2.1
Operates supermarkets
Don Quijote Holdings Co., Ltd.			69,700				2,777,218				3,391,575				1.0
Operates discount stores
Hiday Hidaka Corp			114,133				2,081,638				2,314,028				0.7
Operates restaurant chains
Izumi Co., Ltd.			38,500				1,976,880				2,307,051				0.6
Operates shopping centers, real estate, and credit card services
Japan Meat Co., Ltd.			105,900				1,779,185				2,065,038				0.6
Supermarket business and operation of eating-out stores
JINS Inc.			30,700				1,254,265				1,579,608				0.4
Retail sales of eyewear and fashion accessories
Kura Corporation			14,700				678,465				871,602				0.2
Operates a sushi restaurant chain
Kusuri No Aoki Holdings Co., Ltd.			25,700				1,347,946				1,878,144				0.5
Operates drug stores
NAFCO Co., Ltd.			74,200				1,180,301				1,226,916				0.3
Operates a chain of home and furniture retail outlets
Saint Marc Holdings Co., Ltd.			70,900				1,962,716				1,664,928				0.5
Operates restaurant chains
Saizeriya Co., Ltd.			468,500				12,086,392				9,414,328				2.6
Operates restaurants
San-A Co., Ltd.			153,000				7,027,544				7,141,608				2.0
Retail sales of home goods
Seria Co. Ltd.			77,300				3,353,909				3,169,317				0.9
Discount retail sales
Start Today Co., Ltd.			13,600				330,661				469,367				0.1
Operates retail E-commerce websites
Sundrug Co., Ltd.			24,900				963,700				895,256				0.3
Operates pharmacies and drug store chains
Yossix Co., Ltd.			12,100				177,119				305,621				0.1
Operates restaurant chains
Total Retail Trade							72,349,070				71,961,786				20.1

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
Services
EPS Holdings, Inc.			73,800			$	1,014,150			$	1,504,928				0.4
Performs contract medical research services
H.I.S. Co., Ltd.			114,300				3,423,230				3,759,360				1.0
Travel business
Nihon M&A Center Inc.			31,200				581,165				817,849				0.2
Provides merger and acquisition brokerage services
Nippon Air Conditioning Services Co., Ltd.			371,200				2,244,651				2,685,953				0.8
Provides maintenance and management of building facilities
Step Co., Ltd.			152,200				1,583,825				2,127,166				0.6
Operates preparatory schools
Tear Corporation			67,700				510,460				603,337				0.2
Funeral business
Total Services							9,357,481				11,498,593				3.2
Textiles and Apparel
Seiren Co., Ltd.			320,500				4,557,797				5,467,056				1.5
Manufactures synthetic fibers and textile products
Total Textiles and Apparel							4,557,797				5,467,056				1.5

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
Transportation and Warehousing
Alps Logistics Co., Ltd.			244,800			$	1,365,590			$	1,852,958				0.5
General logistics services
Japan Transcity Corporation			789,600				2,824,948				3,685,630				1.0
General logistics services
Meiko Trans Co., Ltd.			385,400				3,912,768				4,170,898				1.2
Marine logistics services
Trancom Co., Ltd.			35,800				1,835,794				2,435,594				0.7
General logistics services
Total Transportation and Warehousing							9,939,100				12,145,080				3.4
Transportation Equipment
Hi-Lex Corporation			144,700				3,708,896				3,334,065				0.9
Manufactures control cables
Morita Holdings Corporation			75,700				1,244,638				1,633,033				0.5
Operates five business transportation segments
Nippon Seiki Co., Ltd.			4,200				78,308				78,153				0.0
Manufactures transportation equipment parts
Nissin Kogyo Co., Ltd.			49,900				778,506				835,901				0.2
Manufactures automobile brake systems
Total Transportation Equipment							5,810,348				5,881,152				1.6
Utilities
Keiyo Gas Co., Ltd.			97,200				2,465,637				2,440,182				0.7
Produces gas and energy products
The Okinawa Electric Power Company, Incorporated			173,477				2,409,005				3,493,770				1.0
Produces thermal energy products
Total Utilities							4,874,642				5,933,952				1.7

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

		Shares				Cost				Fair Value				% of Net Asset
Wholesale Trade
Ai Holdings Corporation			31,900			$	857,640			$	720,642				0.2
Information and security equipment
Kanaden Corporation			314,200				2,751,177				3,335,234				0.9
Factory automation business
Kohsoku Corporation			357,400				3,358,444				3,925,845				1.1
Food and industrial packaging materials
Kondotec Inc.			59,200				522,906				563,860				0.2
Manufactures construction materials
Matsuda Sangyo Co., Ltd.			335,100				4,148,825				4,677,359				1.3
Precious metals, electronic materials, and food
Nagaileben Co., Ltd.			6,500				169,328				151,818				0.0
Medical wear business
Paltac Corporation			39,900				879,825				2,171,624				0.6
Cosmetics and daily necessities
Ryoden Corporation			792,700				11,203,634				11,871,749				3.3
Purchases electronic and electrical devices
SIIX Corporation			627,100				9,006,467				12,612,635				3.5
Parts procurement, logistics, and manufacturing of electronics
Sugimoto & Co., Ltd.			255,000				2,956,445				4,301,509				1.2
Machine tools and measuring instruments
Techno Associe Co., Ltd.			388,100				3,862,492				4,630,272				1.3
Screws and nonferrous metal products
Total Wholesale Trade							39,717,183				48,962,547				13.6
TOTAL INVESTMENTS IN JAPANESE EQUITY SECURITIES						$	328,472,399			$	357,151,318				99.5

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF INVESTMENTS — (Continued)

AUGUST 31, 2018
(Unaudited)

 

Portfolio securities and foreign currency holdings were translated

at the following exchange rate as of August 31, 2018.

 

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

SCHEDULE OF ASSETS AND LIABILITIES

AUGUST 31, 2018
(Unaudited)

 

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

STATEMENT OF OPERATIONS

FOR THE SIX MONTHS ENDED AUGUST 31, 2018
(Unaudited)

 

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

STATEMENTS OF CHANGES IN NET ASSETS

 

See notes to financial statements

Japan Smaller Capitalization Fund, Inc.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

 

 

Japan Smaller Capitalization Fund, Inc. (the “Fund”) is registered under the Investment Company Act of 1940, as amended (the “Investment Company Act”), as a non-diversified, closed-end management investment company. The Fund was incorporated in Maryland on January 25, 1990 and investment operations commenced on March 21, 1990. The Fund’s investment objective is to seek long-term capital appreciation through investments primarily in smaller capitalization Japanese equity securities.

 

The accompanying financial statements have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) and are stated in United States dollars. The Fund is an investment company that follows the accounting and reporting guidance in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 946 Financial Services Investment Companies. The following is a summary of the significant accounting and reporting policies used in preparing the financial statements.

 

The net assets of the Fund are presented at the exchange rates and fair values on August 31, 2018. The Fund does isolate that portion of the results of operations arising as a result of changes in the foreign exchange rates on investments from the fluctuations arising from changes in the market prices of securities held at August 31, 2018. Net realized gains or losses on investments include gains or losses arising from sales of portfolio securities and sales and maturities of short-term securities. Net realized gains or losses on the foreign currency transactions arise from sales of foreign currencies, currency gains or losses realized on securities transactions between trade and settlement date, and the difference between the amounts of dividends, interest, and foreign withholding taxes recorded on the Fund’s books and the U.S. dollar equivalent of the amounts actually received or paid.

Japan Smaller Capitalization Fund, Inc.

NOTES TO FINANCIAL STATEMENTS — (Continued) (Unaudited)

 

Distributions from net investment income and net realized capital gains are determined in accordance with Federal income tax regulations, which may differ from U.S. GAAP. To the extent these “book/tax” differences are permanent in nature (i.e., that they result from other than timing of recognition—“temporary”), such accounts are reclassified within the capital accounts based on their Federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net realized capital gains for financial reporting purposes, but not for tax purposes, are reported as distributions in excess of net realized capital gains.

 

Pursuant to a securities lending agreement with Brown Brothers Harriman & Co., the Fund may lend securities to qualified institutions. It is the Fund’s policy that, at origination, all loans shall be secured by collateral of at least 102% of the value of U.S. securities loaned and 105% of the value of foreign securities loaned. It is the Fund’s policy that collateral equivalent to at least 100% of the fair value of securities on loan must be maintained at all times (when applicable). Collateral is provided in the form of cash, which would be invested in certain money market funds. The Fund is entitled to receive all income on securities loaned, in addition to a portion of the income earned as a result of the lending transaction. Although each security loan is fully collateralized, there are certain risks. On November 21, 2008, the Fund suspended its participation in the securities lending program. The Fund may resume its participation in the future. During the fiscal year ended February 28, 2018 and the semi-annual period ended August 31, 2018, the Fund did not earn fees from lending Fund portfolio securities, pursuant to the securities lending agreement.

 

Japan Smaller Capitalization Fund, Inc.

NOTES TO FINANCIAL STATEMENTS — (Continued) (Unaudited)

 

Under Japanese tax laws, a withholding tax is imposed on dividends at a rate of 15.315% and such withholding taxes are reflected as a reduction of the related revenue. The withholding tax rate of 15.315% was reduced to 10% upon the submission of Form 17 — Limitation on Benefits Article. There is no withholding tax on realized gains.

 

In accordance with U.S. GAAP requirements regarding accounting for uncertainties in income taxes, management has analyzed the Fund's tax positions taken or expected to be taken on federal and state income tax returns for all open tax years (the current and the prior three tax years), and has concluded that no provision for income tax is required in the Fund's financial statements. The Fund recognizes interest and penalties, if any, related to uncertain tax positions as income tax expense in the statement of operations. During the current year and for the prior three tax years, the Fund did not incur any interest or penalties.

 

Japan Smaller Capitalization Fund, Inc.

NOTES TO FINANCIAL STATEMENTS — (Continued) (Unaudited)

 

 

Nomura Asset Management U.S.A. Inc. (“NAM-USA” or the “Manager”) acts as the Manager of the Fund pursuant to a management agreement. Under the management agreement, the Manager provides all office space, facilities and personnel necessary to perform its duties. Pursuant to such management agreement, the Manager has retained its parent company, Nomura Asset Management Co., Ltd. (“NAM”), as Investment Adviser to the Fund.

 

As compensation for its services to the Fund, the Manager receives a monthly fee at the annual rate of 1.10% of the value of the Fund’s average weekly net assets not in excess of $50 million, 1.00% of the Fund’s average weekly net assets in excess of $50 million but not exceeding $100 million, 0.90% of the Fund’s average weekly net assets in excess of $100 million but not exceeding $175 million, 0.80% of the Fund’s average weekly net assets in excess of $175 million but not exceeding $250 million, 0.70% of the Fund’s average weekly net assets in excess of $250 million but not exceeding $325 million, 0.60% of the Fund’s average weekly net assets in excess of $325 million, but not exceeding $425 million and 0.50% of the Fund’s average weekly net assets in excess of $425 million. Under the management agreement, the Fund incurred fees to the Manager of $1,615,940 for the six months ended August 31, 2018. Under the investment advisory agreement, NAM earned investment advisory fees of $711,117 from the Manager, not the Fund, for the six months ended August 31, 2018. At August 31, 2018, the management fee payable to the Manager by the Fund was $260,913.

 

Certain officers and/or directors of the Fund are officers and/or directors of the Manager. Affiliates of Nomura Holdings, Inc. (the Manager’s indirect parent) did not earn any fees in commissions on the execution of portfolio security transactions for the six months ended August 31, 2018. The Fund pays each Director not affiliated with the Manager an annual fee of $30,000. In addition, the Fund pays each Director not affiliated with the Manager $3,000 per meeting attended, $2,000 per telephone meeting attended, and Director expenses related to attendance at meetings. The Chairman of the Board, presently Rodney A. Buck, is paid an additional annual fee of $8,000. The Chairman of the Audit Committee, presently David B. Chemidlin, is paid an additional annual fee of $4,000. Such fees and expenses for unaffiliated Directors aggregated $109,431 for the six months ended August 31, 2018.

 

 

Purchases and sales of investments, exclusive of foreign currency and investments in short-term securities, for the six months ended August 31, 2018 were $48,790,049 and $48,160,864, respectively.

 

 

Japan Smaller Capitalization Fund, Inc.

NOTES TO FINANCIAL STATEMENTS — (Continued) (Unaudited)

 

 

As of February 28, 2018, net unrealized appreciation on investments, exclusive of foreign currency, for federal income tax purposes was $71,615,567, of which $72,927,809 related to appreciated securities and $1,312,242 related to depreciated securities. The cost of investments, exclusive of foreign currency of $1,882,474, at February 28, 2018 for federal income tax purposes was $324,259,788.

 

At February 28, 2018, the components of accumulated earnings on a tax basis consisted of unrealized appreciation on investments and foreign currency transactions of $71,632,940, undistributed long-term capital gains of $28,085,599, and undistributed ordinary income of $8,479,938. The differences between book basis and tax basis for unrealized appreciation on investments and foreign currency transactions are attributable to the tax deferral of losses on wash sales and the tax treatment of passive foreign investment companies.

 

The Fund paid an ordinary income distribution of $18,113,858, which represents $0.6393 per share and a long-term capital gains distribution of $35,054,692, which represents $1.2372 per share to shareholders of record as of December 15, 2017. The distribution was paid on December 21, 2017.

 

The Fund paid an ordinary income distribution of $11,418,559, which represents $0.4030 per share and a long-term capital gains distribution of $15,104,798, which represents $0.5331 per share to shareholders of record as of December 19, 2016. The distribution was paid on December 23, 2016.

 

 

In accordance with U.S. GAAP, fair value is defined as the price that the Fund would receive to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP also establishes a framework for measuring fair value, and a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability. Inputs may be observable or unobservable and refer broadly to the assumptions that market participants would use in pricing the asset or liability. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Fund. Unobservable inputs reflect the Fund’s own assumptions about the assumptions that market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. Each investment is assigned a level based upon the observability of the inputs which are significant to the overall valuation. The three-tier hierarchy of inputs is summarized below.

 

 

At August 31, 2018, all of the Fund’s investments were determined to be Level 1 securities.

 

During the six months ended August 31, 2018, there were no transfers between Level 1, Level 2 or Level 3 securities.

 

During the six months ended August 31, 2018, the Fund did not hold any instrument which used significant unobservable inputs (Level 3) in determining fair value.

 

Japan Smaller Capitalization Fund, Inc.

 

FINANCIAL HIGHLIGHTS

 

For a share of common stock outstanding throughout each period: