Moving to Overweight in Financials

• We moved to an overweight position in financials, adding banks with significant U.S. exposure, such as UBS and HSBC Holdings, and those benefiting from strong balance sheets and businesses, which include Nordea Bank and BNP Paribas.
• We further reduced our overweight allocation to the consumer discretionary sector on concerns that accelerating inflation might sap consumer confidence and affect retailers.

• Information technology, where our holdings are concentrated in the IT services and software industry, and telecommunication services, which are benefiting from corporate consolidation, are now our largest overweight allocations.
• We reduced our exposure to "bond proxy" sectors as bond yields rose in anticipation of higher interest rates. We moved underweight to utilities, selling holdings mostly in Spain and the UK, while investing in regulated Italian companies. We cut our exposure to real estate by eliminating our holding in French property REIT Gecina.
• Materials is now our largest negative allocation, after we sold out of Fresnillo, the UK-listed Mexican miner. The industry's business models tend not to fit our investment philosophy.

Moving to Overweight in Financials, Banks in Focus

We moved to an overweight position in financials, which is now by far our largest absolute position. Before the change in sentiment ignited by the U.S. election outcome, we had estimated that the low interest rate environment would crimp bank income and margins and undermine the sector. We added to our bank holdings after the election to take advantage of the new environment. We have invested in a number of banks either with a large U.S. exposure, such as UK-based HSBC Holdings and Switzerland's UBS, or with strong balance sheets and franchises-including France's BNP Paribas; Nordea Bank, the largest financial services provider in the Nordic region; and Dutch bank Abn Amro, which offers an attractive dividend yield and benefits from a strong private banking franchise in Europe.

We raised the funds for these investments from the sale of London Stock Exchange (LSE), a British stock exchange and financial information company, and KBC, a leading Belgian bank. The share price performance of LSE has been disappointing, and we also feel there is a strong risk that Brexit-related uncertainty may prompt regulators to oppose the proposed merger with its European counterpart Deutsche Boerse. KBC has performed strongly over the year, and we felt there were more attractively valued banks on the Continent after the U.S. election.

We are overweight in insurance, adding to our holding in Prudential, a large global British insurer. We also hold Germany-based Allianz and Switzerland-based Zurich Insurance. We believe Zurich's strong cash flow generation will lead to an improvement in returns in the medium term.

• We initiated a position in global mega-cap bank HSBC Holdings following Trump's election victory. Expectations for growth and inflation have moved higher, causing bond yields to rise and the yield curve to steepen, which benefits banks as they are able to increase net interest margins. The bank also generates a large amount of its profits in the U.S., which will benefit from the stronger U.S. dollar.

Information Technology Large Overweight

Information technology, where our holdings are concentrated in the IT services and software industry, is now one of our largest overweight allocations, along with telecommunication services. We favor companies with resilient business models, solid recurring revenues, and structural growth drivers. One of our largest bets within services is SimCorp, the Danish provider of investment management software and services to the global financial industry. We also own e-payment processing company Wirecard, which continues to generate solid organic growth in its core business and is well positioned for an increase in mobile payments, and UK-based Playtech, the online-gambling software company.

• We sold out of our position in Sweden-listed technology equipment company Hexagon after the chief executive officer (CEO) was detained by Norwegian police in an insider trading probe. CEO Ola Rollen was key to our investment thesis as he pioneered the turnaround in the company, and while we await the result of the charge, we believe that Hexagon no longer fits our philosophy of being a high-quality company.

Reducing Consumer Discretionary as Inflation Picks Up

Consumer discretionary is another overweight exposure, though we have recently reduced our retail holdings because of signs that inflation might be accelerating. We are also underweight exposure to luxury goods mainly because of continuing unfavorable conditions in end markets. Although we do not own any automobile manufacturers, we are overweight automobile components suppliers, including Plastic Omnium and Continental. We expect these multinational companies to benefit from the weaker euro while growing faster than the car industry due to the development of new products needed to meet changing regulation.

• We sold our position in Sweden-listed specialty retailer Hennes & Mauritz. We are concerned about the effect of inflation on consumer confidence and the impact this could have on footfall for retailers in the months ahead.

Moved to Underweight in Utilities

We moved to an underweight exposure to utilities and rebalanced our portfolio as bond yields have increased in anticipation of higher interest rates. We have reduced our holdings most recently in the UK and in Spain, selling our positions in UK power company SSE and the Spanish electricity companies Red Electrica and Endesa. We have reinvested the proceeds in regulated Italian companies, which stand to benefit from market consolidation and a more favorable legal regime, including multi-utility company Hera, which distributes gas, water, and energy and provides waste disposal services. We believe the company offers an attractive defensive profile, given the increased uncertainty in the European economy, and good dividend yield.

• We acquired a new position in Italgas following its demerger from Snam, the Italian natural gas infrastructure company. Italgas will focus on local gas distribution services within Italy, while Snam will focus on the regasification process on a national level. We added to our initial holding in Italgas following the weakness in the share price as investors sold out of "bond proxy" sectors.

Materials Biggest Underweight; Sold Fresnillo

Materials is now our largest negative allocation. Investors moved into sectors such as materials during the rally in cyclicals near the end of the year, yet the weak cash flow generation of companies in the sector, ongoing cost inflation, and structurally low commodity prices deter us from making investments. Traditionally, we have found that the industry's business models tend not to fit our investment philosophy.

• We further increased our underweight by selling our position in Fresnillo, the Mexican precious metals miner listed in the UK. We profited from this defensive holding during the pronounced market rotation earlier this year, but we now believe that the stronger U.S. dollar will likely weigh on the price of gold and reduce earnings.