Japan is a country that remains steeped in tradition and ritual, even as it embraces and leads advanced technologies such as factory automation, semiconductor production equipment and high-speed trains. Staid practices such as invoicing expenses via fax machines, saving data on floppy disks and even signing documents with physical ink stamps continued unabated until the pandemic forced a wholesale rethink.

Historical context: System integrators

Japanese companies’ approach towards IT infrastructure differs fundamentally from their American and European counterparts. In the 1960s, the Japanese government was concerned about IT competitiveness against American behemoths, IBM and Intel. Therefore, the government funded the development of IT national champion NTT, as well as three other IT groups, Fujitsu and Hitachi, NEC and Toshiba, as well as Mitsubishi Electric and Oki. It also awarded these groups public projects over the decades since. By the 1980s, the private sector saw the spinoff of consulting subsidiaries, specializing in the IT needs of service sectors such as e-commerce and finance. These consultants became known as System Integrators (SIs).

Competitive advantage: Talent monopsony

SIs coordinate software vendors, hyperscalers, subcontractors and non-tech companies’ IT departments to meet their clients’ IT needs. SIs’ customer stickiness is strong because clients desire customization but can’t secure the top IT talent because of customers’ comparatively low salaries. Local companies’ IT workers are generalists who don’t know how to effectively procure hardware, manage software or even develop an IT strategy. Gartner found that 67% of such companies blamed « talent scarcity » as a major obstacle to IT upgrades (vs. 38% globally). With growing IT labour shortages and few students pursuing tech degrees, SIs’ core role between the key parties is what leads to higher margins, enabling companies to hire top SI talent.

Industry outlook: Long growth runway

IDC estimated that Japan’s $180 billion in annual general IT spend would grow at 6.4% CAGR into 2029E. Mordor Intelligence estimated that cloud spending would grow significantly faster than general at 17% CAGR into 2031E. According to Gartner, in 2021 31% of Japanese companies stored data on the cloud, with cloud comprising only 4.3% of total IT spend (vs. 14.4% North America, 9.7% Europe, 6.4% China). As of 2023, according to the Information Technology Promotion Agency, large Japanese firms with more than 1,000 employees had already drawn even with large American firms with ~63% of them noting that they had dedicated digital transformation (DX) departments (vs. ~64% for large American firms). In contrast, smaller Japanese firms with fewer than 1,000 employees were lagging behind with just ~12-41% reporting dedicated DX departments (vs. ~39–66% for smaller American firms). Smaller capitalization SIs serve small customers.

Gen-AI: More opportunity than threat

While software-as-a-service (SaaS) company stocks have sold off across America, Europe and Japan year to date, we expect strong demand for cybersecurity and infrastructure to continue, benefiting SIs. This is because declining software development costs amid AI-led coding and fiercer price competition against AI agents reduce overall software package costs. While lower prices hurt SaaS supplier margins, they boost customers demand.

SIs are crucial to the integration of software packages with hardware and networks, all safeguarded by cybersecurity. Japanese companies’ core IT systems were built by the SIs themselves in complex layers based on evolving business needs and characteristics. This makes it hard to standardize processes, a necessary precursor to an AI-first automated approach. Rather, our SIs will even benefit from rising demand for limited IT system standardization as companies seek to deploy agentic AI. Admittedly, agentic AI has the potential to replace end-user applications in enterprise resource planning, but we believe that SIs will retain their crucial role in maintaining infrastructure by offering cybersecurity.

DX favours smaller SIs

Mentioned above, DX refers to the implementation of digitalization through efforts such as transitioning data to the cloud to avoid reliance on onsite physical data storage and, more recently, rolling out gen-AI models to boost productivity. The term captures the shift in approach from treating IT as peripheral toward recognizing its centrality. As IT competitiveness and DX continue in Japan, the next leg of growth should be led by DX service providers that focus on smaller firms.

Simplex Holdings

Simplex Holdings Inc. (4373 JP) was founded in 1997. In 2001, it began offering banks with solutions like IT consulting, systems development, and operations and maintenance. Over the decades, it expanded into FX brokerages, equity, futures, options platforms, insurers and crypto. In 2013, it conducted a $211 million buyout with Carlyle. Carlyle later sold its equity stake upon Simplex’s September 2021 relisting on the Tokyo Stock Exchange. We feel that Simplex is well positioned to benefit from this trend.

* all dollar amounts referenced in this article are in USD.

Chile’s 2025 presidential election marked a meaningful political inflection, with markets interpreting the outcome as a shift toward a more pro-business, market-oriented policy framework focused on restoring economic growth and encouraging private investment. The incoming administration has emphasized fiscal discipline, regulatory clarity and the strategic importance of export-oriented sectors – particularly copper – in driving medium-term economic expansion.

For the mining sector, this shift points to clearer permitting processes, a more pragmatic stance toward private capital and improved project visibility, all of which are especially relevant for long-life assets requiring sustained investment. Against a backdrop of structurally rising global copper demand – driven by electrification, grid expansion and the energy infrastructure needed to support AI-related data centre growth – this political realignment strengthens the case for selective exposure to high-quality copper producers.

Capstone Copper Corp. (CS TSE) is well positioned to benefit from this environment, with approximately two-thirds of consolidated copper production generated in Chile, providing direct leverage to a more constructive domestic policy backdrop. The company is executing a district-scale growth strategy targeting a ~70% increase in annual copper production to approximately 400 ktpa, driven by long-life Chilean assets and capital-efficient brownfield expansions. Near-term growth is led by the Mantoverde Optimized expansion, expected to deliver an incremental ~20ktpa of copper with declining unit costs, while the fully permitted Santo Domingo project represents a transformational medium-term opportunity with a sanctioning decision expected in H2 2026. Supported by more than $1 billion in available liquidity and net leverage of approximately 0.9x EBITDA (TTM), Capstone is well positioned to translate a supportive policy environment into improved execution, cash flow growth and valuation upside.

Global copper demand is poised for significant growth over the coming decades, with BHP projecting a roughly 70% increase to more than 50 million tonnes annually by 2050, up from around 31 Mt as of 2021.

Copper demand projected to grow ~70% through to 2050…
(Copper demand by key theme, Mt)

Source: “BHP Insights: how copper will shape our future,” BHP

This surge is driven by a combination of traditional economic expansion, as developing economies electrify and improve living standards, and newer demand sources tied to the energy transition and digitalization. Technologies such as electric vehicles, renewable power infrastructure and data centres – all of which are copper-intensive – are central to this trend, fueling higher material requirements even as substitution and efficiency improvements evolve.

…an average of 2% per year*
(Copper demand by end-use sector, indexed to 2021)

Source: “BHP Insights: how copper will shape our future,” BHP

These dynamics favour producers with scalable assets, permitted growth projects and balance sheet flexibility. In this context, Capstone Copper is well positioned to benefit from supportive domestic policy and increased demand for copper, with an opportunity to increase valuation and sustain cash flow through disciplined execution.

Retail brokers have benefited immensely from the impact of retail investors on financial markets since the onset of COVID. Robinhood is now a familiar name to most Americans, but virtually all the brokerages globally have benefited from the rising tide of retail investors’ enthusiasm for investing and trading. In this note, we examine some of the mega-trends that have helped European brokerages outperform the market since COVID emerged in 2020.

1. Retail participation and retail financial product availability.

Since the 2008 recession, retail investors have gained access to a multitude of new products like index ETFs, crypto, fractional shares, robo-advisors, IPOs and even private markets. This led to an explosive growth in retail investment, especially since 2020 and the dawn of COVID. Digital and mobile platforms, along with significantly reduced commission costs, have made it easier than ever for a younger demographic to access the markets. The vast majority of onboarded customers over the last decade have not lived through the trauma of the 2008 recession and see any market pullback as an opportunity to double down on their favourite stocks.

2. Increase in cross-border trading.

It is well documented that investors, including retail, have historically had a strong home bias in their asset allocations. But the US stock market outperformance since 2009, along with the disproportionate share of tech mega-cap attention, has led to consistent inflows into the US market. It has also created a larger level of familiarity with US companies that are more covered/discussed by pundits. All this has led to a higher level of cross-border trading in non-US brokerages that is typically much more lucrative as they usually pocket a large spread on foreign exchange transactions.

3. Digitalization and banks losing market share.

Over the last decade, brokerages have been able to consistently gain market share from large banks, thanks to a less-bloated corporate structure and a tech stack that could be built from scratch and not built on legacy bank structures. This has allowed them to be in a position to compete more aggressively on fees, transaction costs and overall value proposition as retail brokerage fees remain a minuscule proportion of mega-banks’ revenue and don’t garner a lot of attention from a strategic perspective.

4. Increase in share of income from NII.

Although net interest income (NII) has been declining for European brokers since the end of 2023, decreasing with the ECB rates, it remains at a more attractive level than pre-COVID and is expected to remain as such for the foreseeable future. Additionally, most brokers have been able to increase NII since 2023 thanks to client gains and account cash balance more than compensating for the lower rates.

Brokers have also been more efficient at increasing the spread between the amount they pay on deposit and the amount they get paid (known as net interest margin or NIM). Having managed deposit pass-through well on the way up and down, brokers are now better structurally positioned to benefit from deposit growth.

5. Benefit from macro volatility.

A key feature of brokerages’ stocks in a portfolio is their positive skew to market volatility. Because they make money from the number of trades, they are agnostic to market direction, as long as it causes participants to trade more. Just over the last year or so, events such as the US election, Liberation Day, the French budget and now the Venezuela situation have all been positive tailwinds mentioned by various brokerage CEOs.

It’s worth noting, however, that brokerages are not immune to long periods or volatility or market drawdown, all of which would lead customers to reduce their equity exposure.

We gained exposure to the retail brokerage space in one of our strategies through Nordnet (SAVE SS), a Swedish brokerage firm with a banking licence. It has exposure primarily to the Nordics with a top-two position in all markets and is slowly working on building a presence in Germany. It derives a bit more than half its revenue from commission and the rest from interest income.

Sweden is one of the countries with the highest savings rate globally, and financial literacy is also higher than the Europe average. Finland, Norway and Denmark also rank highly but are less penetrated and less competitive than Sweden. All have been a strong source of growth for Nordnet, which has consistently been among the top names in the space for customer satisfaction.

Given its diversified product offerings that include a full suite of investments, savings, pension and banking products, as well as its best-in-class technology platform (releases an update every 2.5 days on average and with a 99.9% platform uptime), Nordnet is able to maintain a customer acquisition cost of SEK790 – which is below the vast majority of peers – and its small social media platform has been able to generate a strong media presence and customer engagement.

Here is where Nordnet stands on the brokers mega-trends:

1. Financialization: Sweden is one of the countries in Europe with high financial literacy. Other Nordic countries rank above average as well.
2. Cross-border trading: Between 2022 and 2025, share of cross-border trading increased from 27% to 31.5% and is one of the primary contributors to the increase in income per transaction increasing from SEK31 to SEK39 over that same period.
3. Digitalization and market share gains: Both Nordnet and its close competitor, Avanza, have gained tremendous market share over the last decade and now rank second and first respectively by trading activity. This is despite still being behind Sweden’s largest four banks on savings capital. They both rank top of their class on user experience surveys.
4. Net interest income: NII was as low as 20% of overall revenue in 2021 and is now steadying at 42% of total revenue after peaking at 58% in 2023. We expect the share of NII to remain structurally higher than pre-COVID.
5. Macro volatility: Nordnet benefited from large macro events such as the US election and Liberation Day. In Q2 2025, following Liberation Day, Nordnet reported a 22% year-over-year (YoY) increase in trading volume. As for the US election in 2024, it saw a 14% YoY increase in trading volume.

Despite the volatility of their operational performance, brokerage firms provide a unique type of exposure to a diversified portfolio, one that is very different to how you would think of typical insurance and bank financials. There are reasons to believe brokers will continue to outperform the overall market and will continue to look for opportunities to participate.

The past year was yet another eventful one for sustainability investors and the broader Environmental, Social and Governance (ESG) landscape. 2025 was marked by a succession of extreme weather events, a near-record global temperature average and significant international policy developments, including the EU’s Omnibus simplification package and further amendments to greenwashing claims under Canada’s Competition Act. Importantly, the average global temperature for the three-year period from 2023 to 2025 likely exceeded the 1.5°C threshold above pre-industrial levels for the first time – a milestone that underscores the growing urgency for governments, companies and investors to reassess how climate risks are managed and priced.

In this commentary, we highlight five ESG trends set to shape the year ahead, revealing both challenges and opportunities for investors and businesses alike.

1. From climate mitigation to climate survival

With the 1.5°C threshold now effectively behind us, the focus is shifting from climate mitigation alone to climate adaptation and resilience. Markets are increasingly pricing physical climate risks – from flooding and heat stress to water scarcity – into valuations, insurance costs and credit risk. At the policy level, governments are directing more capital toward adaptation priorities such as resilient infrastructure, water systems, food security and disaster preparedness, with several countries announcing a major increase in adaptation finance, aiming to triple it to $120 billion annually by 2035. For investors, exposure to climate resilience is becoming critical. We believe that companies enabling societies to withstand and adapt to physical climate impacts are likely to play an increasingly important role in long-term portfolios.

2. ESG returns to its financial roots

After surging in prominence during the pandemic years, ESG has faced political pushbacks and skepticism in parts of the market. This recalibration is now forcing a clearer definition of what ESG truly represents: financially material business issues. Labour practices, supply-chain resilience, governance failures and environmental liabilities matter because they can directly affect cash flows, valuations and license to operate – and indirectly shape the long-term sustainability of economic growth. In 2026, we believe ESG will be re-anchored to its original purpose: identifying risks and opportunities that are financially relevant to investors.

3. ESG integration is also becoming mainstream

ESG is no longer a niche strategy or a product label. Sustainability considerations are increasingly embedded across investment processes, from equity and credit analysis to portfolio construction and risk management. In Canada alone, ESG integration is used by 96% of investors, representing 87% of AUM. Whether or not a fund is explicitly marketed as “ESG,” these factors are becoming part of standard due diligence, and therefore increasingly a core component of the investment infrastructure. We believe this trend will continue in the new year and accentuate in many markets around the world as countries like Japan, China and India are increasingly adopting ESG initiatives.

4. The redefinition of “responsible” capital

Energy security, defence, critical infrastructure and industrial resilience are being re-examined through an ESG lens. Investors are increasingly debating when exclusion gives way to responsibility, and whether financing defence capabilities, transition metals or strategic industries is incompatible with – or essential to – long-term sustainability. This shift reflects a more pragmatic approach to ESG, recognizing that social stability, security and resilient supply chains are foundational to sustainable development. We believe that 2026 will be marked by further discussions and guidance around how to invest responsibly in previously deemed harmful sectors, with workgroups such as the Principles for Responsible Defence Investment (PRDI) initiative.

5. AI and data-driven ESG analysis

Artificial intelligence (AI) and advanced data analytics are transforming how most sectors operate. ESG is no different. From climate modelling and supply-chain monitoring to controversy detection and impact measurement, AI is enabling more timely, granular and forward-looking ESG analysis. The competitive edge is moving away from simply having ESG data toward better understanding of the data, as well as interpreting signals faster and more effectively than the market. As AI capabilities continue to advance, we believe ESG will increasingly become more dynamic, data-driven and integral to enhance risk management, uncover emerging opportunities and improve long-term investment decision-making.

Final thoughts

At Global Alpha, it’s never been about chasing ESG trends, but remaining disciplined and consistent in our investment processes. ESG has always been about financial risk mitigation and long-term value creation – doing what is right for our clients by identifying material risks and opportunities in a rapidly changing world. From climate resilience and supply-chain stability to governance quality and data-driven analysis, ESG considerations have long been embedded in how we assess risk and opportunity across portfolios.

As the ESG landscape continues to evolve, our philosophy remains unchanged: identifying and managing material risks, while allocating capital to businesses positioned to create durable value in a rapidly changing world.

As we close out another year, we acknowledge it has been a difficult one for fundamental investors focused on quality companies.

How does Global Alpha define “quality”?  We mean companies with:

• Revenue growth with a high portion of recurring revenues
• Healthy profit margins
• Strong balance sheet
• Dividend paying
• Fair valuation, ideally below the market multiples

Instead of quality, the market has been fixated on size (the bigger, the better), liquidity (the more liquid, the better) and momentum (what goes up will continue to go up).

In other words, it’s a very speculative market.

Are we in a bubble?

Ruchir Sharma, Chair of Rockefeller International, asked that exact same question in his piece in Financial Times – The four ‘O’s that shape a bubble. He described four characteristics that define a bubble, “four Os”: overvaluation, over-ownership, overinvestment and over-leverage. In our view, today’s market checks all four boxes.

Overvaluation

Consider the S&P 500 price-to-sales ratio. It is currently at an all-time high, well above the peak reached during the tech bubble in 2000. The market is paying record prices for each dollar of revenue.

Source: Bloomberg

Over-ownership

US household stock ownership, as a share of financial assets, is also at record levels. According to Gallup, about 165 million Americans – roughly 62% of US adults – own stocks, an all-time high.

On top of that, foreign investors now hold a record share of US equities. The market has rarely, if ever, been this “crowded.”

Source: Federal Reserve

Sources: Federal Reserve, Macrobond, Apollo Chief Economist

Overinvestment

Technology investment has recently surpassed 6% of US GDP, eclipsing the previous record set in 2000. But the ultimate return on these investments is still uncertain, and there are signs that adoption is slowing rather than accelerating.

Over-leverage

We often hear about the enormous cash balances of the “Magnificent Seven.” However, much less attention is paid to the other side of their balance sheets: liabilities.

Amazon, Meta, and Microsoft are now net debtors, and they are increasingly financing capital expenditures with debt.

So, all four Os suggest a bubble. But who are we to know?

Surely, this time, it’ll be different! Right?

We recently looked at some assumptions underpinning the current enthusiasm and valuations.

The general consensus is that global semiconductor sales will grow at an annualized rate in the mid- to high-20% range over the coming decade.

During the strongest period until now – the 1990s, with the advent of the personal computer and the internet – annualized growth in semiconductor sales was about 15%.

Once again, the narrative is that “it’s different this time.”

What could deflate this bubble?
If we had to name one catalyst, it would be Nvidia, now the largest company in the world by market value, the most owned and traded stock globally, and the poster child for the AI wave.

What could go wrong with Nvidia?

In a word: Competition. More competition would likely mean lower market share, lower prices and lower profit margins.

Lessons from Novo Nordisk

The chart below shows the stock price of Novo Nordisk, which was the largest European company by market value just over a year ago. As a leader in GLP-1 “miracle drugs” used for weight loss and other health benefits, Novo Nordisk became the market’s favourite story.

As competition intensified and prices came under pressure, Novo Nordisk experienced a dramatic shift: its market value has dropped by 68% since its peak in June 2024.

What happened to this market leader?

Simple: more competition and lower prices. In 2024, Novo Nordisk earned €24.48 per share, up 29% from 2023. By mid-2024, analysts were expecting earnings of €30 per share in 2025, implying another 23% growth.

Source: Bloomberg

Source: Bloomberg

Instead, according to Bloomberg consensus estimates, earnings for 2025 will be around €23.38, a decline of approximately 4.5%, with a further decline expected in 2026. Novo Nordisk remains a great company, investors have just overpaid for it.

Lessons from Cisco

At the peak of the dot-com era, Cisco Systems was the company that defined the Internet age. It was the most valuable company in the world at the start of 2000, supplying the routers needed to handle internet traffic that was doubling every few months.

Despite that dominant position, Cisco’s stock only just regained its 2000 peak price last week – more than two decades later.

Source: Bloomberg

Looking at past trends, we do not expect Nvidia to maintain the market share and pricing power implied in current analyst forecasts. In our view (shaped by history that competition, regulation and changing narratives eventually catch up with even the most celebrated leaders), it is more prudent to diversify and pivot back to high-quality, reasonably valued companies with durable earnings and strong balance sheets

Lastly, we encourage you to read our previously published piece on quality: Time to take out the trash – Why high ROE matters in the long run. We breakdown how quality outperforms in the long-run and why it matters as an allocator.

We wish you a happy holiday season to you and your loved ones.

May 2026 bring peace and happiness to the world.

Of the five senses, vision is regarded as the most important as it allows us to navigate our environment, recognize the faces of our loved ones and read and watch to learn and entertain. But a good number of us do not have healthy eyes. According to the World Health Organization (WHO), at least 2.2 billion people globally suffer from near or distant vision impairment. The organization recognizes myopia as a significant public health concern given its rising prevalence around the world. A review of 276 studies (involving more than 5.4 million children from 50 countries across six continents) by the British Journal of Ophthalmology revealed that global prevalence of myopia among children and adolescents increased from 24% in 1990 to 36% in 2023 – one in three of all children and teens are nearsighted today. What is even more concerning is that myopia is starting earlier in children than before.

Prevalence of myopia by age group in 2000 vs. 2050, % of world population

Source: American Academy of Ophthalmology, BofA Global Research

The study predicted that approximately 740 million children and teens (more than half globally) will be myopic by 2050. American Academy of Ophthalmology in its 2016 article forecasted that by 2050, myopia would affect nearly half of global population. A more conservative projection this year puts the number at ~40% of global population – but it is clear that the world 25 years from now will have more than the 2.2 billion people in need of corrective lenses today.

Prevalence of myopia is not even across the world. Asia sees a higher prevalence (close to 40%) that is two to four times higher than that of other regions. East Asian countries – China, Taiwan, South Korea, Japan and Singapore – see much higher myopia rates, exceeding 80–90%, in their adolescent populations.

Source: ScienceDirect, Global perspectives on myopia and pathologic myopia: From environmental drivers to precision medicine

Primary drivers of myopia are genetics, near-work activities and lack of outdoor activities. A recent article in Progress in Retinal and Eye Research journal linked the high prevalences in the East Asian countries to educational systems characterized by intense academic competition, prolonged school hours and substantial homework assignments which significantly reduce opportunities for outdoor activities.

The WHO estimated that vision impairment cost the global economy an estimated USD411 billion in productivity loss, with only 36% of people with myopia having access to an appropriate intervention. Shanghai Conant Optical Co. Ltd. (2276 HK) in our Emerging Markets Small Cap Strategy seeks to address this global myopia pandemic. SCO, a sub-USD3 billion market cap company, is the second largest resin (plastic) optical lens maker in the world after EssilorLuxottica in terms of production volume. At its manufacturing locations across China and Japan, the company produced 209 million pieces to serve customers in over 90 countries around the world in 2024.

We believe SCO’s customer value proposition of value for money is especially effective in the product category of optical lenses. SCO’s high-index lenses (such as 1.74 and 1.67) are approximately half the price of comparable lenses from EssilorLuxottica, Hoya and Zeiss whilst providing the same level of vision correction. On product quality, SCO is an ODM (original design manufacturer) for all the previously mentioned global brands with various lens-coating options available. For the brand-conscious, it is “fortunately” very difficult to tell which brand of lens one is wearing. We are not surprised that the company is especially seeing strong demand in developing countries where its customer value proposition would be stronger. As a person who has been wearing glasses for the past three decades, I have found myself switching from the expensive Hoya and Nikon to much more affordable brands (including Asahi-Lite which is now owned by SCO), which have provided an identical visual experience – I have not looked back since.

China offers a significant room for growth, having entered the world’s largest short-sighted country in 2018, two decades after the company was established. Over 700 million people or roughly half the population in China are diagnosed with myopia. The prevalence of myopia is especially high in school-aged children – roughly 40%/70%/80% of students in elementary/middle/high school suffered from myopia according to a 2022 study published in Investigative Ophthalmology & Visual Science. Laser eye surgery is not an option for these youths, and they must rely on glasses for vision correction until they are older. SCO’s sales in China focus on higher-index lenses where competition is more limited and penetration is lower, and 80% of those sales are of its own brand. The company’s growth in China has been margin accretive given the higher mix of own brand and higher-index lenses.

The company is also involved in the development of AI/AR glasses with leading technology companies in North America and China. SCO as a partner to the technology companies makes sense, given SCO’s scale and cost competitiveness. We appreciate that SCO is trying to solve the problem of the global myopia pandemic, but do not doubt that AI/AR glasses offer the next leg of growth for the company.

After the “meme stock” frenzy of 2021 and a bruising surge of volatility in 2022, many investors assumed retail traders had finally stepped back. The story was neat: higher rates, tighter liquidity and fading stimulus would restore rationality to equity markets. We were not convinced and argued in February 2023 that speculative behaviour was more likely to adapt than disappear.

Fast forward to today, and the data suggest retail participation has not only persisted, it has become a defining force in short‑term market moves. Across the small‑ and mid‑cap universes, trading volumes in lower‑priced, lower‑quality names have surged, with roughly a quarter of daily volume now concentrated in stocks trading under $5, a share last seen at the peak of 2021’s speculation. This renewed activity has driven a striking rotation beneath the surface: low ROE and even unprofitable companies have periodically outpaced their higher‑quality, high‑ROE peers over short horizons.

In this weekly, we want to address two questions:

1. Why does high ROE – the best proxy for quality – matter when investing? And,
2. What does history tell us about the performance of companies with high ROE versus those with low or negative ROE?

What ROE really measures

Return on equity (ROE) is net income divided by shareholders’ equity; it tracks how efficiently a business converts owners’ capital into earnings. In practical terms, it tells you how many dollars of profit a company generates for every dollar of equity on its balance sheet. Conceptually, ROE links back to basic valuation logic: for a given starting multiple, a firm that can earn and reinvest at higher rates should grow intrinsic value and future dividends faster over time. A company that compounds book value at 15–20% per year for a decade ends up in a very different place than one compounding at 5%, even if both start at the same size and valuation.

High – and sustainably high – ROE typically reflects one or more durable advantages: strong pricing power, an advantaged cost position, valuable brands or networks, or business models that require relatively little capital to grow. This is why investors often group high-ROE companies under the broader “quality” or “profitability” factor. In other words, ROE is not just a ratio; it is often a shorthand for underlying business quality.

Why high ROE wins over time

History is clear: profitability and quality matter far more over multi-year horizons than they do over six month “junk” episodes. Portfolios tilted toward companies with high and persistent profitability have historically delivered higher average returns than portfolios concentrated in low profitability or unprofitable names, even after controlling for size and valuation.

There are three main reasons for this:

1. Compounding of retained earnings: High-ROE companies can reinvest a larger portion of each dollar of earnings at attractive rates. Over time, this drives faster growth in earnings per share and intrinsic value without requiring fresh capital from shareholders.
2. Resilience through cycles: Businesses that earn high returns on capital usually have competitive advantages that help them sustain margins and cash flows during downturns, which tend to show up as shallower drawdowns and faster recoveries.
3. Better capital allocation options: Management teams leading high-ROE franchises often have more flexibility: reinvest in the core, expand into adjacencies, pay dividends or buy back shares. Lower-quality companies, in contrast, often need to issue equity or debt simply to survive, diluting existing shareholders.

Short periods of outperformance by low-quality stocks can be sharp and uncomfortable, but they have historically been transient, while compounding fundamentals tend to dominate over longer horizons.

When you think about it, the lesson for long-term investors couldn’t be clearer: real wealth comes from investing in companies that steadily compound capital at high rates, not from jumping on every fleeting speculative surge. The junk rallies fade and quality compounding lasts.

Time to take out the trash – What really is a “junk rally”?

In a universe of over 12,000 companies within global small caps, not every balance sheet is one to admire. Our job as active managers is to find real quality – the companies that actually make money and know how to grow it – and to avoid the companies that are overleveraged, poorly managed or structurally unprofitable. Many of those “junk” businesses feel more like ticking time bombs than investments. So, what happens when these so‑called junk companies rally and drive index performance? Do we simply throw in the towel and chase them?

A junk rally is a period when the lowest‑quality stocks – often those with excessive leverage, negative earnings, high beta or heavy short interest – significantly outperform the broader market, particularly higher‑quality names. These episodes tend to be most intense and momentum‑driven in small caps, where smaller market caps and thinner liquidity allow collective enthusiasm and buying pressure to move prices disproportionately.

Junk rallies often arrive with a burst of excitement – usually from retail investors – as they rush into stocks chasing a story and paying little attention to fundamentals. To spread these stories, investors turn to platforms like Reddit, X or Instagram, using viral posts and online communities to build momentum. As more buyers join in, the rally feeds on itself, with price action attracting even more attention.

Common terms around these episodes include:

• Diamond hands: Investors who refuse to sell, convinced that holding long enough will eventually make them rich.
• Short squeeze: When heavily shorted stocks rise sharply, forcing short sellers to buy back shares to cover positions, which drives prices even higher.
• FOMO (“fear of missing out”): The anxiety investors feel when they believe they might miss a big gain if they do not act immediately.
• Pump and dump: When prices are hyped up – often by coordinated online promotion and early movers sell into the frenzy, leaving late buyers exposed when prices fall back.

These phrases rarely appear in institutional memos, but the behaviours behind them very much exist in our universe and often bring sharp, sudden volatility to stocks whose fundamentals have not changed.

How junk rallies behave in practice

Over the past five years, we have seen several junk rallies – wild bursts where low‑quality stocks suddenly take off. Each time, two features have stood out. First, these rallies are typically parabolic and short‑lived; trying to jump on the bandwagon after the move is underway is almost always a poor risk‑reward trade‑off. Second, they almost always mean‑revert back toward the market, making them more about timing and positioning than about sustainable value creation.

Normally, we would pay limited attention to these episodes. However, because these lower-quality stocks sit in our benchmark, big, synchronized rallies in some low-quality pockets can cause us to lag temporarily. That is exactly what happened in 2020, 2023, and again in 2025, when risk on sentiment sent the lowest quality corners of the market flying while our quality growth names took a back seat. As the excitement faded and fundamentals reasserted themselves, excess junk gains unwound and quality leadership reemerged.

Proof that low quality doesn’t last

Even without decades of data, recent episodes make the point: high ROE remains a long‑run winner. In the 2022 low‑quality rally, high‑quality stocks temporarily lagged as low‑quality names spiked and then sold off, but by the end of that six‑month stretch, the high‑quality cohort had again moved ahead. You saw a similar pattern in the quality rally of summer 2024, which lost steam by early 2025, and more recently in the post‑Liberation Day rebound, where relief from macro fears and crowded positioning turbocharged the most speculative, lower‑ROE parts of the market.

Once low quality lost steam, high quality rebounded faster

Low quality was ahead, but high quality protected during Liberation Day market correction

In the immediate aftermath of Liberation Day, low‑quality stocks rallied because the market shifted violently from fear to relief: investors moved quickly from pricing in severe recession and trade dislocation to betting on a softer outcome, and that swing in sentiment tends to benefit the most beaten‑up, highly levered and high‑beta parts of the market first. Positioning and mechanics amplified the move, as many lower‑quality names were heavily shorted and under‑owned going into the shock, so even a modest improvement in the macro narrative forced short covering and factor rebalancing, turbocharging returns in exactly the sort of speculative companies that typically lead junk rallies.

The current junk rally is showing signs of losing momentum, with lower-quality names starting to lag

Don’t hate the player, hate the game

Now that we’ve defined what junk rallies look like, let’s examine how they affect active management. As noted above, the post-Liberation Day period – when the MSCI World Small Cap Index surged 34.3% (CAD) between April 8 and October 31, 2025 – marked one of the strongest low-quality rallies of the past decade. During this time, market leadership – particularly in the United States – was dominated by lower-quality companies across a range of sectors. The AI and data centre trade became the theme of the year, driving performance regardless of valuations or ROE.

What you’ll almost never hear an investor say is that they’re overweight “junk.” It’s rare for anyone to deliberately focus on low-quality companies. As a result, low-quality rallies usually lead to short-term periods where active managers struggle to generate alpha. Looking at year-to-date and one-year returns, we’re seeing exactly that type of environment. With the MSCI World Small Cap Index ranking in the middle-to-high second quartile, about 60% of active global small-cap managers haven’t added alpha over the past year. Additionally, these periods usually come with a wide dispersion in manager returns, as portfolios with even modest exposure to the most speculative names tend to outperform sharply, while quality-focused strategies are left behind.

As we can see below, over the 7- and 10-year periods, global small caps remains an inefficient asset class – with more than 50% of active managers outperforming the MSCI World Small Cap Index.

What we’re trying to argue is that when these short periods of low quality take over, don’t hate the player, hate the game. The small cap market can be dysfunctional for short stretches, but over the long run, high-ROE companies almost always outperform their low-ROE peers.

Our Emerging Markets team attended a series of corporate meetings at a technology conference in Taipei last week. During these meetings, one topic kept emerging: as semiconductors become more advanced and complex, the importance of testing them is growing rapidly. This theme appeared consistently across our meetings, including with companies involved in probe cards, system-level testing and metrology. As the current AI-driven arms race accelerates investment in high-performance computing, testing has become a foundation for semiconductor reliability.

For many decades, progress in semiconductors came from shrinking transistor size and fitting more of them onto each chip. But as Moore’s Law approaches its physical limits, chip designers are increasingly turning to advanced packaging to continue pushing performance forward. This approach helps sustain technological momentum but also introduces new challenges and more potential points of failure. That is why semiconductor testing matters more than ever.

Modern semiconductors must now be tested at several points during a complex fabrication process. At the wafer level, testing examines individual dies (individual chips on a wafer) to determine which are viable before sending the wafer to subsequent steps. This is critical because the packaging stage adds significant dollar value, and if a defective die is mislabeled as good, the cost of assembling it into an advanced package can be substantial.

Once a chip enters packaging, it undergoes final electrical and functional testing, which confirms that the packaged device is assembled correctly and works as intended. A growing number of AI accelerators also require burn-in testing, where devices are stressed under elevated temperature and voltage to screen for early-life failures.

Finally, system-level testing validates each device under real-world operating conditions. As AI processors draw more power and generate more heat, system-level testing has become one of the most critical stages of the entire test flow.

In a sense, modern chips now go through the semiconductor equivalent of an endurance triathlon: wafer-level tests, post-packaging reliability tests (including burn-in) and finally system-level verification. Each stage is designed to catch a different type of failure and skipping even one dramatically increases the risk of defects later in the cycle.

Importantly, the most advanced AI accelerators require far more testing, nearly doubling test time and test content relative to previous generations. It is also why AI chips are now 100% tested, unlike many consumer electronics where sample testing remains common. As one management team noted in a meeting, “reliability can no longer be assumed; it must be verified.”

The economics of chip failure have also changed dramatically. Today’s AI accelerators are among the most expensive devices ever produced. A single AI server rack powered by NVIDIA chips can cost around USD3.5 million. One faulty component can compromise the entire system. Meanwhile, testing typically represents only about 2-3% of total chip cost, yet it protects assets worth millions. This asymmetry also explains why switching test solution providers mid-generation is rare: the potential savings are small, while the risks are substantial. Robust testing has therefore become a form of value protection.

Taiwanese testing companies are uniquely positioned because they operate in close proximity to TSMC, which today manufactures virtually all of the world’s most advanced chips, and within a rich ecosystem of its partners. Supported by deep engineering expertise, this environment enables tight co-development of testing solutions aligned with the industry’s most advanced semiconductor processes.

Among the firms we met at the conference were two companies we own in our Emerging Markets portfolio, both of which illustrate how we leverage this theme in practice.

MPI Corporation (6223 TT)

MPI provides tools used for wafer-level testing, particularly probe cards with fine needle-like contacts that touch each die on a wafer to verify it functions before packaging. The company is a key supplier of customized, high-performance probe cards for ASICs (application-specific integrated circuits) used by hyperscalers.

As AI and advanced packaging increase chip complexity, wafer-level testing now requires more precise and specialized probe card designs. This is contributing to rising unit sales and higher prices for MPI’s solutions. The company has also been enjoying sustained market share gains, supported by its ability to offer superior customization, short lead times and close integration with customers early in the chip design process. These strengths position MPI well for structurally rising test intensity across next-generation logic and AI devices.

Chroma ATE Inc. (2360 TT)

Chroma complements the theme at the opposite end of the test flow. The company is a global leader in system-level testing, power-testing equipment and metrology tools. As chips become more power-hungry and thermally constrained, ensuring reliable performance under real operating conditions becomes essential. Chroma’s solutions support both the growing energy demands of data centres and the precision requirements of advanced packaging.

As semiconductor complexity rises and Moore’s Law slows, innovation is increasingly shifting to packaging, integration and system design. Testing is what bridges that complexity with reliable performance. MPI and Chroma play important roles in this ecosystem. As fundamental investors focused on quality and growth durability, we view testing as a structurally growing and increasingly critical part of the semiconductor landscape.

In our view, testing matters.

Japan’s equity market is undergoing a structural reset. In October, Japan experienced its strongest month in net equity inflow in at least two decades. Net purchases by foreign investors reached 3.44 trillion yen, largely beating the previous record of 2.68 trillion yen in April 2013. A few factors contributed to the rally:

1. Expectations of pro-growth stimulus under new leadership of Sanae Takaichi.
2. Optimism on AI-related stocks.
3. Normalization of policy interest rate to create a sustainable and wage-driven inflation.
4. Acceleration of Tokyo Stock Exchange’s (TSE) corporate governance reforms.

According to Bloomberg, net equity outflows during 2015–2022 were about 13 trillion yen. So, it is reasonable to think that there is plenty of room for more inflows in the future.

Political impact and AI sentiment can be volatile. At Global Alpha, we would rather focus on structural changes such as sweeping TSE reforms and normalization of policy interest rate for healthy inflation. These two factors have been the game changers of Japan equity market in the past three years.

Game changer #1: TSE reforms

The positive impact of the TSE reforms on the market is mainly reflected in higher dividends, share buybacks, return on equity (ROE) and price-to-book value (P/B). Since TSE’s initiative on increasing shareholder values in 2023, we have seen notable increases in dividend and share buybacks.

 Sources: Factset, Jefferies

In the global context, Japan still has a long way to go to improve its ROE and P/B. Currently, 47% of stocks in Japan Prime Index are trading below 1x P/B. In contrast, the percentage is 15% in MSCI Europe and 5% in S&P 500. Median ROEs during 2000–2024 for MSCI regions are 10.1% in Japan, 12.0% in Europe and 16.2% in the United States. Working toward global standards could be attractive opportunities for Japan equities.

Game changer #2: Normalization of policy interest rate

In March 2024, Japan exited its negative interest rate policy with the first hike in 17 years. Since January 2025, the rate has been stable at 0.5%. Bank of Japan (BOJ) expects core inflation to be around 2.7% for fiscal year 2025, slowing to 1.8% in fiscal year 2026 and returning to its 2% target in fiscal year 2027. Recent BOJ meeting summaries indicated a chance of further interest rate hikes.

Year to date, “banks” is among the top performing industry groups in the MSCI Japan Small Cap Index, up 46.8%. We have two holdings directly benefiting from both the rising interest rate cycle and improving corporate value.

• Yokohama Financial Group Inc. (7186 JP)
  • One of Japan’s largest regional banks, growing both organically and via M&As.
  • A key differentiator is that its main customer base is in Kanagawa prefecture, close to Tokyo, which has a stable population outlook and strong economic growth.
  • ROE has been consistently improving from 2.3% in fiscal year 2021 to 7.0% now.
  • P/B also increased from 0.45 in fiscal year 2021 to 1.0 now.
  • After the recent quarter results, the company upgraded its full-year guidance for earnings and dividends.
  • Further, it unveiled a share buyback program for up to 30 billion yen.

• Rakuten Bank Ltd. (5838 JP)
  • Japan’s first and largest digital bank by both customer accounts and deposit balances.
  • Its parent company Rakuten Group is the number one web brand in Japan with over 100 million members, which continues to benefit Rakuten Bank in customer acquisition and cross-selling.
  • The company is targeting roughly 25 million customer accounts and 20 trillion yen in deposits by fiscal year 2027.
  • Among the six digital banks in Japan, Rakuten Bank achieved the highest deposit growth in the past five years.
  • ROE has consistently been improving from 12.3% in fiscal year 2021 to 20.2%.