For the second straight quarter, Daiwa Securities, Japan’s second-largest brokerage, was the largest contributor to performance. Continued talk of economic reform from Japan’s new government has led to a weakening of the yen and a rally in Japan’s stock market. These positive developments contributed to Daiwa’s strong quarterly results. Compared with the same quarter last year, retail revenues increased 10% and profits more than doubled, while asset management revenues were up 4% and profits were 50% higher. In addition, the wholesale unit realized its first profitable quarter since 2009, produced by higher trading profits and commissions, along with solid cost-cutting. Although Diawa’s stock price has more than doubled over the past six months, we continue to believe Daiwa has a significant upside and will remain a good investment for our shareholders.
Another large contributor to performance for the quarter was Olympus, a world leader in endoscopes and other medical equipment, which returned 22%. Its medical systems group designs and manufactures clinical analyzers and other imaging devices. Olympus also makes products such as binoculars, microscopes, measuring equipment, printers, barcode scanners and magneto-optical disk drives, as well as traditional cameras. The share price rallied early in the quarter after Bank of Japan Governor Masaaki Shirakawa indicated the central bank would pursue monetary easing, which stands to benefit export-oriented companies. Share prices also rallied after Olympus announced plans to cut interest-bearing debt by $100 billion (yen) during the next fiscal year, much more than the $70 billion (yen) target in the original plan.
The top two detractors from performance were European banks hurt by Eurozone instability: Intesa Sanpaolo and Banco Santander. While the latest quarterly results for Intesa Sanpaolo were mixed, the larger issue in the quarter was the disappointing Italian election results, which have left the country without a clear government. This has called into question whether Italy will continue on the austerity path set by the technocratic Monti government. Furthermore, the conditions of the Cypriot bailout have put pressure on banks in both Italy and Spain. Despite Italy’s disappointing electoral results, we continue to believe that Italy is in better long-term fiscal shape than many investors think and that it should not be lumped together with the other European Union periphery countries. We also continue to believe Intesa Sanpaolo is attractively valued and well-managed, and that it has the highest quality retail franchise in Italy.
Banco Santander also reported mixed results in its latest quarter. Although operating revenue and net interest income were lower than expected, operating costs were in line with expectations, and credit costs were less than anticipated. Santander’s balance sheet remains strong, as the company has continued to strengthen its liquidity, capital and non-performing loan coverage. Deposit growth was strong in Spain (+10%), which management attributed to customers seeking out quality banks as a result of the recent series of bank failures. In addition, certain banks are under scrutiny by the Bank of Spain for uneconomic deposit pricing. We believe that Banco Santander’s strength and quality will serve both its customers and its investors well.
We purchased one new stock during the quarter: AMP, the leading independent wealth management company in Australia and New Zealand. Australian law requires employers to contribute 9% of salary to employees’ retirement, and this number is expected to increase to 12% by 2019. This is in addition to member contributions, which have averaged 2-3% over the past few years. We believe AMP will benefit from the required contribution increase as well as expected wage growth in Australia.
Our geographical composition has changed since last quarter. Our European holdings increased to 69%, our Pacific Rim exposure decreased to 27% and our combined Latin America and North America (Canada) exposure remained at 3%. The remainder of the portfolio is invested in the Middle East.
Although many global currencies have weakened compared to the U.S. dollar, we continue to believe they are overvalued. As a result, we defensively hedge a portion of the Fund’s currency exposure, though all hedges in the portfolio were reduced last quarter. As of quarter-end, approximately 51% of the Australian dollar, 13% of the Japanese yen, 26% of the Swiss franc and 9% of the Swedish krona exposures were hedged.