We present the Semi-Annual Report of Japan Smaller Capitalization Fund, Inc. (the “Fund”) for the six months ended August 31, 2015. The net asset value per share (“NAV”) of the Fund increased by 7.2% and the closing market price of the Fund increased by 3.9% for the six months ended August 31, 2015. The closing mar- ket price of the Fund on August 31, 2015 was $10.07, representing a discount of 14.4% to the NAV of $11.77. The net assets of the Fund totaled $333,488,541 on August 31, 2015. The Russell/Nomura Small Cap TM Index, the Fund’s benchmark (“Benchmark”), increased by 3.7% in United States (“U.S.”) dollar terms for the six months ended August 31, 2015. During the six months ended August 31, 2015, the Fund outper- formed the Benchmark by 3.5% on an NAV basis. The Tokyo Price Index (the “TOPIX”), consisting of all companies listed on the First Section of the Tokyo Stock Exchange (the “TSE”), decreased by 0.4% and the Nikkei Average Index (“Nikkei”), a price- weighted index of the 225 leading stocks on the TSE, decreased by 0.8% in U.S. dollar terms during the six months ended August 31, 2015. The Japan- ese yen (“Yen”) depreciated by 1.3% against the U.S. dollar during the six months ended August 31, 2015. For the quarter ended August 31, 2015, the Benchmark decreased by 1.6%, the TOPIX de- creased by 6.1%, and the Nikkei decreased by 6.1% in U.S. dollar terms. The NAV of the Fund in- creased by 0.2% and outperformed the Benchmark by 1.8%. The Fund’s share price decreased by 1.9% during the quarter. The Yen appreciated by 2.2% against the U.S. dollar during the quarter. The Portfolio Equity holdings represented 98.8% of the Fund’s net assets at August 31, 2015. The Fund held a diversified portfolio of 124 stocks, of which 98 were TSE First Section stocks, 20 were TSE Second Section stocks and 6 were other smaller capitalization stocks, comprising 83.4%, 11.8%, and 3.6%, respectively, of net assets on August 31, 2015. The Fund invests in undervalued stocks that offer fundamental strength and potential for im- provement. The Fund performs extensive funda- mental research to identify stocks that can create shareholder value. The Fund focuses on compa- nies that are leaders in certain niche markets, companies with large or expanding market shares, stocks with superior shareholder distribu- tion policies, and stocks that offer good growth prospects. In the Japanese small cap equity mar- ket, valuation anomalies do exist and can be ex- ploited through active management. There are several factors that the Fund considers when sell- ing an investment, including appreciation of the stock price, unexpected deterioration in earnings, a substantial loss that impairs the company’s net assets, or a stock’s diminishing potential given declining competitiveness due to a change of business environment or failure of business strat- egy. JAPAN SMALLER CAPITALIZATION FUND, INC. October 22, 2015 To Our Shareholders:
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9922 Japan Semi-Annual Report 9922 - Nomura Holdings2015. The Japanese equity market rallied follow-ing robust earnings prospects for Japanese com-panies and entered a range trading
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We present the Semi-Annual Report of JapanSmaller Capitalization Fund, Inc. (the “Fund”) forthe six months ended August 31, 2015.
The net asset value per share (“NAV”) of theFund increased by 7.2% and the closing marketprice of the Fund increased by 3.9% for the sixmonths ended August 31, 2015. The closing mar-ket price of the Fund on August 31, 2015 was$10.07, representing a discount of 14.4% to theNAV of $11.77. The net assets of the Fund totaled$333,488,541 on August 31, 2015.
The Russell/Nomura Small CapTM Index, theFund’s benchmark (“Benchmark”), increased by3.7% in United States (“U.S.”) dollar terms for the sixmonths ended August 31, 2015. During the sixmonths ended August 31, 2015, the Fund outper-formed the Benchmark by 3.5% on an NAV basis.The Tokyo Price Index (the “TOPIX”), consisting of allcompanies listed on the First Section of the TokyoStock Exchange (the “TSE”), decreased by 0.4%and the Nikkei Average Index (“Nikkei”), a price-weighted index of the 225 leading stocks on theTSE, decreased by 0.8% in U.S. dollar terms duringthe six months ended August 31, 2015. The Japan-ese yen (“Yen”) depreciated by 1.3% against theU.S. dollar during the six months ended August 31,2015.
For the quarter ended August 31, 2015, theBenchmark decreased by 1.6%, the TOPIX de-creased by 6.1%, and the Nikkei decreased by6.1% in U.S. dollar terms. The NAV of the Fund in-creased by 0.2% and outperformed the Benchmark
by 1.8%. The Fund’s share price decreased by1.9% during the quarter. The Yen appreciated by2.2% against the U.S. dollar during the quarter.
The Portfolio
Equity holdings represented 98.8% of theFund’s net assets at August 31, 2015. The Fundheld a diversified portfolio of 124 stocks, of which98 were TSE First Section stocks, 20 were TSESecond Section stocks and 6 were other smallercapitalization stocks, comprising 83.4%, 11.8%,and 3.6%, respectively, of net assets on August31, 2015.
The Fund invests in undervalued stocks that offer fundamental strength and potential for im-provement. The Fund performs extensive funda-mental research to identify stocks that can createshareholder value. The Fund focuses on compa-nies that are leaders in certain niche markets,companies with large or expanding marketshares, stocks with superior shareholder distribu-tion policies, and stocks that offer good growthprospects. In the Japanese small cap equity mar-ket, valuation anomalies do exist and can be ex-ploited through active management. There areseveral factors that the Fund considers when sell-ing an investment, including appreciation of thestock price, unexpected deterioration in earnings,a substantial loss that impairs the company’s netassets, or a stock’s diminishing potential givendeclining competitiveness due to a change ofbusiness environment or failure of business strat-egy.
JAPAN SMALLER CAPITALIZATION FUND, INC.
October 22, 2015
To Our Shareholders:
Performance
In terms of the sector allocation strategy, anoverweight position in the Retail Trade sector andunderweight positions in the Electric Appliancesand Machinery sectors generated the largest pos-itive contributions, although sector returns wereeroded by underweight positions in the MetalProducts, Iron and Steel, and Transportation andWarehousing sectors.
Stock attribution analysis shows that somestocks such as Toenec Corporation in the Con-struction sector, Create SD Holdings Co., Ltd. inthe Retail Trade sector, and Zojirushi Corporationin the Electric Appliances sector made positivecontributions to the relative performance. Mean-while, some stocks such as Sakai Chemical In-dustry Co., Ltd. in the Chemicals sector andNichicon Corporation in the Electric Appliancessector made negative contributions to the relativeperformance.
Market Review
The Benchmark appreciated by 5.0% in localcurrency terms for the six months ended August31, 2015. The Benchmark outperformed the broadJapanese equity market, measured by the TOPIXindex, which increased 0.9% in local currencyterms during the six months ended August 31,2015. The Japanese equity market rallied follow-ing robust earnings prospects for Japanese com-panies and entered a range trading phase givenglobal economic outlook concerns and solid earn-ings prospects for domestic companies. In Au-gust 2015, Japanese stocks followed othermarkets in a steep sell-off triggered by an equitymarket crash in China. Meanwhile, under thesecircumstances, the small cap stock index wasable to outperform the main large cap equity mar-ket given the relatively steady business perfor-mance of many smaller domestically orientedcompanies.
The Japanese equity market posted a strongrally from March to May of 2015, registering a fifthconsecutive monthly gain since the beginning ofthis year. Robust earnings for fiscal year 2015 is-sued by many Japanese companies helped tosustain the positive sentiment toward Japaneseequities. Moreover, expected growth in real wagesimproved the prospects for domestic demand.
In June 2015, Japanese equity markets de-clined when global market sentiment faltered inreaction to an expected debt default by Greeceand a steep correction in the Chinese equity mar-ket.
Following a setback in June 2015, the Japan-ese equity market staged a recovery in July 2015.During this period, there were persistent concernsabout the political and potential economic turmoilin the Eurozone over the bailout plan for Greece,the volatile equity markets, and slowing economicgrowth in China. However, stability in the Japan-ese economy and the corporate sector continuedto offer solid earnings prospects.
Turmoil in the global markets triggered a steepdecline in Japanese equity prices and the TOPIXindex declined by 7.4% in August 2015. Chineseequity markets extended their recent decline whenshare price support policies from the authoritiesproved ineffective, causing widespread marketdisorder.
Outlook and Strategy
While the Fund expects the U.S. economic re-covery to continue, the Fund has become morecautious towards the global economic outlookgiven the recent slowdown in China. Following thedevaluation of the Chinese yuan, Chinese stockmarkets have remained volatile. Chinese con-sumption appears to be steady but the Fund ex-pects a slowdown in capital expenditures tocontinue. The Chinese yuan’s weakening hascome to a standstill for the moment, but the
downward pressure could resume given the antic-ipated unwinding of overseas funding by Chinesecompanies.
The Chinese yuan depreciation could also leadto the weakening of other Asian currencies againstthe U.S. dollar, possibly causing economic down-turns elsewhere in Asia due to declining purchas-ing power as well as the slowdown in capitalexpenditures. Thus, the Fund expects the recov-ery in Japanese production to be sluggish giventhat exports to Asian regions including Chinashould remain weak.
As for domestic consumption, the Fund has yetto encounter the expected recovery in disposableincome. Therefore, the Fund expects the overalleconomic recovery in Japan to proceed at aslower pace.
Although corporate earnings results for the sec-ond quarter of 2015 were positive, earnings for thesecond half of 2015 could fall lower than ex-pected. Measures of equity valuations, such asprice earnings ratios, have declined during the re-cent market drop. As a result, the Fund believesthat current market prices already discount thepotential for weaker corporate earnings. It is still
too early to estimate the full extent of the earningsimpact. Japanese equity prices remain highly de-pendent on global political, economic and marketdevelopments.
The Fund appreciates your continuing support.
Sincerely,
Yutaka ItabashiPresident
DISCLOSURESSources: Nomura Asset Management U.S.A. Inc. and Bloomberg L.P. Past performance is not indicative of future results.
The net asset value price is adjusted for reinvestment of income dividends, ordinary income distributions, and capital gain dis-tributions. The New York Stock Exchange’s closing market price is adjusted for reinvestment of income dividends, ordinary in-come distributions, and 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 materialshould not be considered investment advice. Statements concerning financial market trends are based on current market con-ditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions, andeach 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 Benchmarkshould be considered in light of the Fund’s investment policy and objective, the characteristics and quality of the Fund’s in-vestments, the size of the Fund, and variations in the Yen/U.S. Dollar exchange rate. This report is for informational purposesonly. Investment products offered are not FDIC insured, may lose value, and are not bank guaranteed.
Indices are unmanaged. You cannot invest directly into an index.The Russell/Nomura Small Cap™ Index represents approxi-mately 15% of the total market capitalization of the Russell/Nomura Total Market™ Index. It measures the performance of thesmallest Japanese equity securities in the Russell/Nomura Total Market™ Index. As of March 31, 2015, there are 1,146 secu-rities in the Russell/Nomura Small Cap™ Index.
SHAREHOLDERS ACCOUNT INFORMATIONShareholders whose accounts are held in their own name may contact the Fund’s registrar, Computershare Trust Com-
pany, N.A., at (800) 426-5523 for information concerning their accounts.
PROXY VOTINGA 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 ExchangeCommission (“SEC”) at http://www.sec.gov. Information about how the Fund voted proxies relating to securities held in theFund’s portfolio during the most recent 12-month period ended June 30 is available (1) without charge, upon request, bycalling 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 statementfiling.
AVAILABILITY OF QUARTERLY SCHEDULE OF INVESTMENTSThe 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 web site at http://www.sec.gov. The Fund’s Forms N-Q may also be reviewedand copied at the SEC’s Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Roommay be obtained by calling 1-800-SEC-0330.
FUND CERTIFICATIONIn December 2014, the Fund filed its Chief 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 Chief Executive Officer and Chief 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 web site at http://www.sec.gov.
INTERNET WEBSITENomura Asset Management U.S.A. Inc. has established an Internet website which highlights its history, investment phi-
losophy and process and products, which include the Fund. The Internet web address is www.nomura.com.
End of period (including accumulated/undistributed net investmentloss of $546,432 and $1,370,691 respectively) . . . . . . . . . . . . . . . . . . . $333,488,541 $311,094,211
See notes to financial statements
1. Significant Accounting Policies
Japan Smaller Capitalization Fund, Inc. (the“Fund”) is registered under the InvestmentCompany Act of 1940, as amended, as a non-diversified, closed-end management invest-ment company. The Fund was incorporated inMaryland on January 25, 1990 and investmentoperations commenced on March 21,1990.
The accompanying financial statements havebeen prepared in accordance with UnitedStates (“U.S.”) generally accepted accountingprinciples (“GAAP”) and are stated in UnitedStates dollars. The Fund is an investment com-pany that follows the accounting and reportingguidance in accordance with FASB AccountingStandards Codification Topic 946. The followingis a summary of the significant accounting andreporting policies used in preparing the financialstatements.
(a) Valuation of Securities—Investmentstraded in the over-the-counter market are val-ued at the last reported sales price as of theclose of business on the day the securities arebeing valued or, if none is available, at the meanof the bid and offer price at the close of busi-ness on such day or, if none is available, the lastreported sales price. Portfolio securities whichare traded on stock exchanges are valued at thelast sales price on the principal market on whichsecurities are traded or lacking any sales, at thelast available bid price. Short-term debt securi-ties which mature in 60 days or less are valuedat amortized cost, which approximates fairvalue, if their original maturity at the date of pur-chase was 60 days or less, or by amortizing
their value on the 61st day prior to maturity iftheir term to maturity at the date of purchaseexceeded 60 days. Securities and other as-sets for which market quotations are notreadily available are valued at fair value asdetermined in good faith by or under the di-rection of the Board of Directors of the Fund.
(b) Foreign Currency Transactions—Transac-tions denominated in Japanese Yen (“Yen”) arerecorded in the Fund’s records at the prevailingrate at the time of the transaction. Asset and li-ability accounts that are denominated in Yen areadjusted to reflect the current exchange rate atthe end of the period. Transaction gains orlosses resulting from changes in the exchangerate during the reporting period or upon settle-ment of foreign currency transactions are in-cluded in results of operations for the currentperiod.
The net assets of the Fund are presented atthe exchange rates and market values on Au-gust 31, 2015. The Fund does isolate that por-tion of the results of operations arising as aresult of changes in the foreign exchange rateson investments from the fluctuations arisingfrom changes in the market prices of securitiesheld at August 31, 2015. Net realized gains orlosses on investments include gains or lossesarising from sales of portfolio securities andsales and maturities of short-term securities.Net realized gains or losses on the foreign cur-rency transactions arise from sales of foreigncurrencies, currency gains or losses realized onsecurities transactions between trade and set-tlement date, and the difference between theamounts of dividends, interest, and foreign
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS (Unaudited)
withholding taxes recorded on the Fund’s booksand the U.S. dollar equivalent of the amountsactually received or paid.
(c) Security Transactions, Investment Incomeand Distributions to Shareholders — Securitytransactions are accounted for on the tradedate. Dividend income and distributions arerecorded on the distribution payable date andinterest income is recorded on the accrual ba-sis. Realized gains and losses on the sale of in-vestments are calculated on a first-in, first-outbasis.
Distributions from net investment income andnet realized capital gains are determined in ac-cordance with Federal income tax regulations,which may differ from GAAP. To the extent these“book/tax” differences are permanent in nature(i.e., that they result from other than timing ofrecognition—“temporary”), such accounts arereclassified within the capital accounts basedon their Federal tax-basis treatment; temporarydifferences do not require reclassification. Divi-dends and distributions which exceed net real-ized capital gains for financial reportingpurposes, but not for tax purposes, are reportedas distributions in excess of net realized capitalgains.
Pursuant to a securities lending agreementwith Brown Brothers Harriman & Co., the Fundmay lend securities to qualified institutions. It isthe Fund’s policy that, at origination, all loansare secured by collateral of at least 102% of thevalue of U.S. securities loaned and 105% of thevalue of foreign securities loaned. It is theFund’s policy that collateral equivalent to at
least 100% of the market value of securities onloan must be maintained at all times (when ap-plicable). Collateral is provided in the form ofcash, which would be invested in certain moneymarket funds. The Fund is entitled to receive allincome on securities loaned, in addition to aportion of the income earned as a result of thelending transaction. Although each security loanis fully collateralized, there are certain risks. OnNovember 21, 2008, the Fund suspended itsparticipation in the securities lending program.The Fund may resume its participation in the fu-ture. During the fiscal year ended February 28,2015 and the semi-annual period ended August31, 2015, the Fund did not earn fees from lend-ing fund portfolio securities, pursuant to the se-curities lending agreement.
(d) Capital Account Reclassification — Forthe year ended February 28, 2015, the Fund’saccumulated net investment loss was de-creased by $3,131,168 and the accumulatednet realized gain on investments and foreigncurrency transactions was decreased by$3,131,168. These adjustments were primarilydue to the result of the reclassification of for-eign currency losses and the tax treatment ofpassive foreign investment companies. Theseadjustments had no impact on net assets.
(e) Income Taxes — A provision for U.S. in-come taxes has not been made since it is the in-tention of the Fund to continue to qualify as aregulated investment company under the Inter-nal Revenue Code and to distribute within theallowable time limit all taxable income to itsshareholders.
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS— (Continued) (Unaudited)
Under Japanese tax laws, a withholding tax isimposed on dividends at a rate of 15.315% andsuch withholding taxes are reflected as a reduc-tion of the related revenue. The withholding taxrate of 15.315% was reduced to 10% upon thesubmission of Form 17 — Limitation on BenefitsArticle. There is no withholding tax on realizedgains.
In accordance with U.S. GAAP requirementsregarding accounting for uncertainties in incometaxes, management has analyzed the Fund's taxpositions taken or expected to be taken on fed-eral and state income tax returns for all open taxyears (the current and the prior three tax years),and has concluded that no provision for incometax is required in the Fund's financial state-ments. The Fund recognizes interest and penal-ties, if any, related to uncertain tax positions asincome tax expense in the statement of opera-tions. During the current year and for the priorthree tax years, the Fund did not incur any inter-est or penalties.
(f) Use of Estimates in Financial StatementPreparation — The preparation of financialstatements in accordance with GAAP requiresmanagement to make estimates and assump-tions that affect the reported amounts and dis-closures in the financial statements. Actualresults could differ from these estimates.
(g) Concentration of Risk — A significant portion of the Fund’s net assets consists ofJapanese securities which involve certain con-siderations and risks not typically associatedwith investments in the U.S. In addition to thesmaller size, and greater volatility, there is often
substantially less publicly available informationabout Japanese issuers than there is about U.S.issuers. Future economic and political develop-ments in Japan could adversely affect the valueof securities in which the Fund is invested. Fur-ther, the Fund may be exposed to currency de-valuation and other exchange rate fluctuations.
(h) Indemnifications—Under the Fund’s orga-nizational documents, its officers and directorsare indemnified against certain liabilities arisingfrom the performance of their duties to theFund. Additionally, in the normal course of busi-ness, the Fund enters into contracts that con-tain a variety of representations which providegeneral indemnifications. The Fund’s maximumexposure under these agreements is unknownas this would involve future claims that may bemade against the Fund that have not yet oc-curred. However, based on experience, theFund expects the risk of loss to be remote andas such no additional accruals were recordedon the Statement of Assets and Liabilities.
2. Management Agreement and Transactions With Affiliated Persons
Nomura Asset Management U.S.A. Inc. (the“Manager”) acts as the manager of the Fundpursuant to a management agreement. Underthe agreement, the Manager provides all officespace, facilities and personnel necessary toperform its duties. Pursuant to such manage-ment agreement, the Manager has retained itsparent company, Nomura Asset ManagementCo., Ltd. (the “Investment Adviser”), to act asinvestment adviser for the Fund.
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS— (Continued) (Unaudited)
As compensation for its services to the Fund,the Manager receives a monthly fee at the an-nual rate of 1.10% of the value of the Fund’s av-erage weekly net assets not in excess of $50million, 1.00% of the Fund’s average weekly netassets in excess of $50 million but not exceed-ing $100 million, 0.90% of the Fund’s averageweekly net assets in excess of $100 million butnot exceeding $175 million, 0.80% of the Fund’saverage weekly net assets in excess of $175 mil-lion but not exceeding $250 million, 0.70% ofthe Fund’s average weekly net assets in excessof $250 million but not exceeding $325 million,0.60% of the Fund’s average weekly net assetsin excess of $325 million, but not exceeding$425 million and 0.50% of the Fund’s averageweekly net assets in excess of $425 million. Un-der the management agreement, the Fund in-curred fees to the Manager of $1,459,598 for thesix months ended August 31, 2015. Under theinvestment advisory agreement, the Manager in-formed the Fund that the Investment Adviserearned fees of $768,761 for the six monthsended August 31, 2015 from the Manager, notthe Fund. At August 31, 2015, the fee payable tothe Manager, by the Fund, was $250,997.
Certain officers and/or directors of the Fundare officers and/or directors of the Manager. Af-filiates of Nomura Holdings, Inc. (the Manager’sindirect parent) did not earn any fees in com-missions on the execution of portfolio securitytransactions for the six months ended August31, 2015. Through March 31, 2015, the Fundpaid each Director not affiliated with the Man-ager an annual fee of $12,000 plus $1,500 permeeting attended. Effective April 1, 2015, the
Fund pays each Director not affiliated with theManager an annual fee of $17,000 plus $2,000per meeting attended. In addition, the Fundpays each Director not affiliated with the Man-ager $1,000 per telephone meeting attended to-gether with such Directors’ actual expensesrelated to attendance at meetings. The Chair-man of the Board, presently Rodney A. Buck,who is not affiliated with the Manager, is paid anadditional annual fee of $5,000. Through March31, 2015, the Chairman of the Audit Committee,presently David B. Chemidlin, received an addi-tional annual fee of $1,000. Effective April 1,2015, the Chairman of the Audit Committee re-ceives an additional annual fee of $2,000. Suchfees and expenses for unaffiliated Directors ag-gregated $73,941 for the six months ended Au-gust 31, 2015.
3. Purchases and Sales of Investments
Purchases and sales of investments, exclu-sive of investments in foreign currency andshort-term securities, for the six months endedAugust 31, 2015 were $30,040,637 and$28,922,086, respectively.
4. Federal Income Tax
As of February 28, 2015, net unrealized ap-preciation on investments, exclusive of invest-ments in foreign currency, for Federal incometax purposes was $15,206,628, of which$25,794,325 related to appreciated securitiesand $10,587,697 related to depreciated securi-ties. The cost of investments, exclusive of in-vestments in foreign currencies of $3,653,816 at
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS— (Continued) (Unaudited)
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS— (Continued) (Unaudited)
February 28, 2015 for Federal income tax pur-poses was $291,549,699.
At February 28, 2015, the components of ac-cumulated earnings (deficit) on a tax basis wereas follows:
Undistributed ordinary income $2,122,957Undistributed long term capital
gains 4,939,911Unrealized appreciation on
investments and foreign currency transactions $15,142,911(a)
Total accumulated earnings $22,205,779
(a) The difference between book basis and tax basisunrealized appreciation is attributable to the tax de-ferral of losses on wash sales and the tax treatmentof passive foreign investment companies.
The Fund paid an ordinary income distribu-tion of $0.1194 per share ($3,383,067) and along term capital gains distribution of $0.0131per share ($371,174) to shareholders of recordas of December 22, 2014. The distribution waspaid on December 29, 2014.
The Fund paid an ordinary income distribu-tion of $0.199 per share ($5,638,445) to share-holders as of December 13, 2013. Thedistribution was paid on December 19, 2013.
The tax character of distributions paid duringthe fiscal years ended February 28, 2015 andFebruary 28, 2014 were as follows:
February-15 February-14Ordinary Income $3,383,067 $5,638,445Capital Gains $371,174 $0
On December 22, 2010, the Regulated In-vestment Company Modernization Act of 2010
(the “Act”) was enacted, which changed vari-ous technical rules governing the tax treatmentof regulated investment companies. Thechanges are generally effective for taxableyears beginning after the date of enactment.One of the more prominent changes addressescapital loss carryforwards. Under the Act, theFund will be permitted to carry forward capitallosses incurred in taxable years beginning afterthe date of enactment for an unlimited period.However, any losses incurred during those fu-ture taxable years will be required to be utilizedprior to the losses incurred in pre-enactmenttaxable years, which carry an expiration date.As a result of this ordering rule, pre-enactmentcapital loss carryforwards may be more likely toexpire unused. Additionally, post-enactmentcapital loss carryforwards will retain their char-acter as either short-term or long-term capitallosses rather than being considered all short-term as permitted under previous regulation.
The Fund utilized $12,817,862 of its accumu-lated capital losses against current year net re-alized gains. All of the Fund’s capital losseswere generated in pre-enactment years.
5. Fair Value Measurements
In accordance with GAAP, fair value is de-fined as the price that the Fund would re-ceive to sell an asset or pay to transfer a liabilityin an orderly transaction between market par-ticipants at the measurement date. GAAP alsoestablishes a framework for measuring fairvalue, and a three-level hierarchy for fair valuemeasurements based upon the transparency ofinputs to the valuation of an asset or liability. In-
JAPAN SMALLER CAPITALIZATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS— (Continued) (Unaudited)
puts may be observable or unobservable andrefer broadly to the assumptions that marketparticipants would use in pricing the asset or li-ability. Observable inputs reflect the assump-tions market participants would use in pricingthe asset or liability based on market data ob-tained from sources independent of the Fund.Unobservable inputs reflect the Fund’s own as-sumptions about the assumptions that marketparticipants would use in pricing the asset or li-ability developed based on the best informationavailable in the circumstances. Each investmentis assigned a level based upon the observabilityof the inputs which are significant to the overallvaluation. The three-tier hierarchy of inputs issummarized below.
• Level 1—quoted prices in active marketsfor identical investments
• Level 2—other significant observable in-puts (including quoted prices for similar in-vestments, interest rates, prepaymentspeeds, credit risk, etc.)
• Level 3—significant unobservable inputs(including the Fund’s own assumptions indetermining the fair value of investments)
The following table summarizes the valuationof the Fund’s investments by the above fairvalue hierarchy levels as of August 31, 2015.
Level 2 ................................... 43,342Level 3 ................................... -0- Total ...................................... $333,092,121$
* Please refer to the Schedule of Investments for break-down of the valuation by industry type.
During the six months ended August 31, 2015,there were no transfers between Level 1, Level 2or Level 3 securities.
As of August 31, 2015, the Fund held a Level 2security. The security was valued at the IPO par-ticipation price transacted on August 31, 2015.
During the six months ended August 31,2015, the Fund did not hold any instrumentwhich used significant unobservable inputs(Level 3) in determining fair value.
JAPAN SMALLER CAPITALIZATION FUND, INC.
FINANCIAL HIGHLIGHTS
Selected per share data and ratios for a share of common stock outstanding throughout each period.
@ Based on average shares outstanding.* Decrease is due to the rights offering.† Based on market value per share, adjusted for reinvestment of income dividends, ordinary income distribution, and
long-term capital gain distributions, and capital share transactions. Total return does not reflect sales commissions.** Annualized
For the SixMonths Ended For the Year Ended
August 31, 2015 February 28, February 29, February 28,(Unaudited) 2015 2014 2013 2012 2011
Net asset value, beginning of year . . . . . . . . $10.98 $9.85 $8.83 $8.85 $9.80 $8.44 Net investment income@ . . . . . . . . . . . . . 0.03 0.06 0.05 0.07 0.06 0.03Net realized and unrealized gain (loss)
on investments and foreign currency . . 0.76 1.20 1.17 (0.01) (0.50) 1.41 Total from investment operations . . . . . . . 0.79 1.26 1.22 0.06 (0.44) 1.44
The Board of Directors of the Fund (the “Board”) consists of five directors, four of whom are independentor non-interested directors (the “Independent Directors”). The Board considers matters relating to the Fund’smanagement and investment advisory agreements throughout the year. On an annual basis, the Board specif-ically considers whether to approve the continuance of these agreements for an additional one-year period. Thespecific agreements (the “Agreements”) consist of the Fund’s management agreement with Nomura AssetManagement U.S.A. Inc. (the “Manager”) and the investment advisory agreement between the Manager and itsparent, Nomura Asset Management Co., Ltd. (the “Investment Adviser”).
The Board, including the Independent Directors, most recently approved the continuance of the Agree-ments at a meeting held on August 20, 2015. In connection with their deliberations at that meeting and at aseparate meeting of the Independent Directors held on August 13, 2015, the Independent Directors receivedmaterials that included, among other items, information provided by the Manager regarding (i) the investmentperformance of the Fund, performance of other investment companies and performance of the Fund’s bench-mark, (ii) expenses of the Fund and the management fee paid by the Fund to the Manager and the advisory feepaid by the Manager to the Investment Adviser, (iii) advisory fees charged by the Manager and the InvestmentAdviser to comparable accounts and (iv) the profitability of the Agreements to the Manager and the InvestmentAdviser. Included in the materials was a report prepared by Broadridge Board Reporting and Compliance(“Broadridge”) for use by the Independent Directors in their consideration of the continuance of the Agreements(the “Broadridge Report”). Broadridge is an independent firm retained by many investment companies to pro-vide data with respect to investment company performance and expenses. The Broadridge Report containedinformation regarding the Fund and other closed-end funds not affiliated with the Manager that compared,among other items, the respective funds’ management fees and operating expenses.
The Independent Directors sought and received additional information from the Investment Adviser. TheIndependent Directors were advised by, and received materials (including a detailed memorandum reviewingthe applicable legal standards and factors taken into account by the Supreme Court and other relevant courtdecisions) from their independent counsel in considering these matters and the continuance of the Agreements.
In considering the continuance of the Agreements at the meeting held on August 20, 2015, the Board, in-cluding the Independent Directors, did not identify any single factor as determinative. Matters considered bythe Directors in connection with their review of the Agreements included the following:
The nature, extent and quality of the services provided to the Fund under the Agreements. The Board con-sidered the nature, extent and quality of the services provided to the Fund by the Manager and the InvestmentAdviser and the resources dedicated by the Manager and the Investment Adviser. These services included bothinvestment advisory services and related services such as the compliance oversight provided by the Manager.Based on its review of all of the services provided by the Manager and the Investment Adviser, the Board, in-cluding the Independent Directors, concluded that the nature, extent and quality of these services supportedthe continuance of the Agreements.
Investment performance. The Board considered performance information provided by Broadridge and theManager regarding the Fund’s investment performance over a number of time periods, including the one-year,three-year and five-year periods recently ended. In response to requests by the Independent Directors, theManager provided information about the performance of the Fund compared to the Fund’s benchmark index,data on the Fund’s expense ratio and components thereof, and comparative fee, expense ratio and perfor-mance information for other funds investing primarily in Japanese securities. The Broadridge Report also pro-
JAPAN SMALLER CAPITALIZATION FUND, INC.
Board Review of the Management and Investment Advisory Agreements
vided supplemental information relating to performance, expense ratios, and fees of U.S. investment compa-nies investing in equity securities of Asian and other non-U.S. issuers.
In connection with their review of investment performance, the Independent Directors noted that, follow-ing a series of discussions with management in 2012 and 2013 that focused on the Fund’s performance, theInvestment Adviser had installed a new management team as of July 1, 2013. The Independent Directors rec-ognized that, as contemplated at the time of the transition, the new portfolio managers had invested in a morediversified portfolio than the Fund had maintained in the past with an increased focus on value characteristicsevidenced by financial measurements. The Independent Directors also noted that the Fund’s comparative per-formance had improved since the transition and that the Fund’s performance for the year ended June 30, 2015ranked first of the six funds (including the Fund) identified by the Manager as having similar investment objec-tives. Based on their review, the Independent Directors concluded that the Fund’s performance supported thecontinuance of the Agreements.
The costs of the services to be provided and the profits to be realized by the Manager and its affiliatesfrom their advisory relationships with the Funds. The Board considered the fee payable under the Fund’s man-agement agreement in connection with other information provided for the Directors’ consideration. The Man-ager and its affiliates also act as advisers to additional investment companies registered under the InvestmentCompany Act of 1940 and the Board of Directors of the Fund compared the advisory arrangements and feesfor these companies. The Board also considered information provided by the Manager regarding fees chargedby the Manager and its affiliates to institutional accounts and other investment companies having investmentobjectives similar to the Fund’s investment objective, including Japanese retail unit trusts. The Board of Direc-tors of the Fund recognized that the nature of the services provided by the Manager and the Investment Ad-viser to other investment vehicles and separate accounts differed from the range of services provided to theFund.
The Manager also provided the Board with information prepared by the Manager and the Investment Ad-viser indicating the profitability of the Agreements to these respective advisers. This presentation included in-formation regarding methodologies used to allocate expenses in considering the profitability of the Agreementsto the Manager and the Investment Adviser. The Independent Directors reviewed this information with the Man-ager and requested and received certain supplemental information from the Manager about the expense allo-cation methodology utilized by the Investment Adviser.
After reviewing the information described above, the Independent Directors concluded that the manage-ment fee proposed to be charged to the Fund was reasonable and the profitability of the Agreement to the Man-ager and the Investment Adviser supported the continuance of the Agreements.
Economies of scale. The Board also considered whether the Manager realizes economies of scale as theFund grows larger and the extent to which any economies of scale are shared with the Fund and its share-holders. The Board noted that the management agreement contains six separate breakpoints in the manage-ment fee for net assets above $50 million, with the last breakpoint applicable to net assets in excess of $425million.
Based on an evaluation of all factors deemed relevant, including the factors described above and takinginto account information received throughout the preceding year, the Board, including each of the IndependentDirectors, concluded that each of the Agreements should be continued through August 31, 2016.
JAPAN SMALLER CAPITALIZATION FUND, INC.
Board Review of the Management and Investment Advisory Agreements (continued)
BOARD OF DIRECTORS
Rodney A. BuckDavid B. ChemidlinYutaka ItabashiE. Han KimMarcia L. MacHarg
OFFICERS
Yutaka Itabashi, PresidentHiromichi Aoki, Vice PresidentMaria R. Premole, Vice PresidentNeil A. Daniele, Secretary and Chief Compliance OfficerAmy J. Marose, TreasurerKelly S. Lee, Assistant Treasurer
MANAGER
Nomura Asset Management U.S.A. Inc.Worldwide Plaza309 West 49th StreetNew York, New York 10019-7316Internet Addresswww.nomura.com
INVESTMENT ADVISER
Nomura Asset Management Co., Ltd.1-12,1, Nihonbashi, Chuo-ku,Tokyo 103-8260, Japan
DIVIDEND PAYING AGENT, TRANSFER AGENT AND REGISTRAR
Brown Brothers Harriman & Co.50 Post Office SquareBoston, Massachusetts 02110-1548
COUNSEL
Sidley Austin LLP787 Seventh AvenueNew York, New York 10019
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
McGladrey LLP80 City SquareBoston, Massachusetts 02129
JAPAN SMALLER CAPITALIZATION FUND, INC.WORLDWIDE PLAZA309 WEST 49TH STREET NEW YORK, NEW YORK 10019-7316
This Report, including the Financial Statements, is transmitted to theShareholders of Japan Smaller Capitalization Fund, Inc. for their infor-mation. This is not a prospectus, circular or representation intended foruse in the purchase of shares of the Fund or any securities mentioned inthe Report.The accompanying Financial Statements, including the Schedule of Investments, have not been examined by the Fund’s independent ac-countants, McGladrey LLP, and accordingly, they express no opinionthereon.