Japanese equities endured a difficult quarter, lagging developed market peers and significantly underperforming emerging markets. Weak economic data and many other factors pressured stocks lower, but the Bank of Japan's decision to impose negative interest rates on banks' excess reserves appeared to weigh the most. The action prompted a precipitous decline in bank stocks and, counterintuitively, caused a strengthening of the yen, as investors interpreted the move as meaning that policymakers had exhausted all other resources. Chinese growth concerns and expectations that the Federal Reserve will delay the U.S. rate hiking cycle also fed yen strength. One bright spot came from companies continuing to buy back stock at unprecedented levels.
The Japan Fund returned 1.82% in the quarter compared with −5.86% for the TOPIX Index and −5.34% for the Lipper Japanese Funds Average. For the 12 months ended March 31, 2016, the fund returned 3.48% versus −4.85% for the TOPIX Index and −4.56% for the Lipper Japanese Funds Average. The fund's average annual total returns were 3.48%, 7.85%, and −0.25% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2016. The fund's expense ratio was 1.05% as of its fiscal year ended October 31, 2015.
Stock selection provided the largest boost to the portfolio's relative results in the quarter. Stock selection in machinery and IT services was particularly helpful, as was our overweight in the latter. We believe the fundamentals of many Japanese tech companies are improving, valuations are attractive, and the sector contains a number of companies with a competitive edge capable of generating strong profit margins. Financials weighed on absolute returns, but an underweight in banks was also helpful on a relative basis. We have been underweight the "megabanks" for some time, and we pared our holdings further in early 2015, based on rising challenges we perceived for the group, which already had elevated valuations.
We believe Japanese stocks may be poised for further volatility in the short term, as currency and other economic concerns linger. We remain optimistic that the market will regain its footing over the medium term, however. Corporate profits have improved notably in recent years, and we are encouraged by companies' growing focus on shareholder value. We believe such an environment will favor our emphasis on investing in durable and improving businesses capable of weathering economic turbulence.
