Japanese stocks gained in the quarter in yen terms, although a decline in the currency reduced returns for overseas investors. Economic data suggested that Prime Minister Shinzo Abe's "three arrows" plan of economic reform was delivering positive results. Employment growth figures were robust, while core inflation reached its highest level in five years. Total monthly wages per regular worker rose, as did inflation expectations on evidence of a tighter labor market. In reaction to slowing growth in the third quarter due to a decline in private investment, policymakers put through an additional stimulus package. Business and consumer sentiment continued to strengthen during the quarter, with a measure of business confidence reaching a six-year high.
The Japan Fund returned 2.21% in the quarter compared with 1.95% for the TOPIX Index and 2.07% for the Lipper Japanese Funds Average. For the 12 months ended December 31, 2013, the fund returned 29.96% versus 27.03% for the TOPIX Index and 27.90% for the Lipper Japanese Funds Average. The fund's average annual total returns were 29.96%, 8.70%, and 4.26% for the 1-, 5-, and 10-yearperiods, respectively, as of December 31, 2013. The fund's expense ratio was 1.14% as of its fiscal year ended October 31, 2012.
We recently increased our exposure to the financials sector, which is now our second-largest overweight position. During the period, we took positions in insurance companies on cheaper valuations, as investors have shifted focus elsewhere. We believe these companies should deliver as core earnings improvements continue. We also reduced our underweight to health care, as we believe this sector should be a key beneficiary of Abe's "third arrow" of structural reform.
We see further scope for upgrades to earnings estimates, which are already trending above other regions. Overly conservative corporate forecasts have not fully accounted for yen weakness, and potential tailwinds from structural reform should also fuel an earnings upgrade cycle. Also, with margins and returns starting from a low base, we see ample room for expansion. Less well documented is the operating leverage that is inherent in many Japanese business models, potentially making sales growth a key driver of further profitability gains. From a valuation perspective, although it appears that the undervaluation of Japanese equities is being rectified, current valuations remain well below pre-crisis levels and should continue to provide medium-term support.
