The portfolio is strongly correlated with yen strength due to our quality bias. Our main TOPIX sector overweights are to IT and services and other, as well as to machinery. Our main underweights remain to banks, transportation and logistics, construction and materials, and automobiles and transportation equipment. As noted earlier in this report, the past quarter has seen a sharp rotation to value names since the U.S. election.

We apply a bottom-up, durable growth investment approach with a focus on fundamentals and, specifically, the power of compounding earnings growth over a long-term horizon. This approach has been out of sync with the aggressive rally that took place over the final quarter of 2016. A lot of this buying has been driven by foreign buyers through ETFs, which include index heavyweights such as Japanese banks and automakers. However, we believe that these large-cap sectors still face secular headwinds, and as a result, we remain underweight and retain our view that they are unattractive when compared with the other opportunities that exist in other sectors. Rather, we continue to favor businesses with real earnings and cash flow generation power.

Machinery Remains a Key Overweight and We Have Selectively Further Raised Our Exposure

Machinery remains the portfolio's second-largest relative sector overweight. Over the course of the fourth quarter, we modestly further increased the extent of our overweight to the sector through the purchase of Komatsu and Miura.

• Komatsu: We initiated a new position in a manufacturer of construction and mining equipment and industrial machinery. We believe the market is not taking into account that the mining equipment business, where we see significant growth potential, has bottomed. If the company can beat expectations on the mining equipment business, we believe outperformance could be strong.

• Miura: Miura is a manufacturer of efficient and more advanced boilers sold predominantly to factories-in particular, food and beverage producers and chemical and textile manufacturers. We further raised the size of our position over the quarter. The company enjoys a strong position domestically and has the opportunity for growth overseas, primarily in China and in South Korea and the Association of Southeast Asian Nations.

At the same time, we took profits in one of our holdings, which had performed strongly amid the global cyclical rally, eliminating our position in Nabtesco. The company is the world's number one precision and speed reduction gear supplier to industrial robots with a 60% market share. The stock performed very strongly over the course of 2016, and we decided to take profits as the outlook became less bullish on concerns about the dampened outlook for global growth.

Our key overweight positions within the machinery sector now include Hoshizaki, Miura, THK, and Kubota. The latter is a manufacturer of agricultural equipment, construction machinery, and diesel engines for which the mechanization of agriculture in Asia is a long-term driver of growth.

We Switched Some Positions Within Electric Appliances and Precision Instruments

We remain modestly overweight to the electric appliances and precision instruments sector. However, over the quarter, we switched around some of our exposure, eliminating our holding in Nikkiso and recycling some of the proceeds of this sale to initiate a position in Nidec Group.

• Nikkiso: Nikkiso engages in the manufacture and sale of medical equipment and industrial instruments. Despite being a small-cap name, the stock is more defensive in characteristics and therefore likely to lag more cyclical names should we see the higher growth world that the market expects. Given the shift in rates and expectations, we can find more attractive names at these levels.

• Nidec Group: A new position in the portfolio, this leading global air conditioning manufacturer has solid midterm growth potential driven by its exposure to the Americas, Europe, and Asia/China. We believe this is a quality asset with strong positions domestically and within China and scope to grow outside Japan following shrewd acquisitions in the U.S.

• We also trimmed some of our exposure to Mitsubishi Electric, a defensive cyclical with diversified industrials exposure to energy, elevators, and air conditioners following results that significantly beat guidance. We believed that guidance was too low and the company had scope to significantly beat these. Results were strong and the company has outperformed over the year so we took this opportunity to book profits.

We Initiated a Position Within Steel and Nonferrous Metals

We moved from a modest underweight to the steel and nonferrous metals sector to a modest overweight. This was through our initiation of a position in Sumitomo Electric.

• Sumitomo Electric: Previously the world's third-largest electric wire producer, Sumitomo Electric's main business today is wiring harnesses and connectors for the automotive industry. A recent cut in guidance by management means that expectations by analysts are now more in line with our expectations, and valuations are compelling at these levels. Longer term, we believe the company should benefit from growing adoption of aluminum instead of copper wiring harnesses.

We Moved Underweight Financials ex Banks

Having been broadly benchmark neutral at the start of the period, we are now underweight for stock-specific reasons as we eliminated our holding in Credit Saison.

• Credit Saison: We eliminated our position in this consumer credit and data processing company. The stock has rallied strongly along with other financials following the U.S. presidential victory of Donald Trump, with expectations that more growth and less regulation will result in higher interest rates globally. We now see less upside given this material move and, as a result, have eliminated the name and taken profits.

The Sell-Off in Defensive Sectors Led to Opportunities Within Pharma Names

The portfolio remains modestly underweight pharmaceutical names; however, the underperformance of defensive sectors in the fourth quarter has led some stocks to trade at more compelling valuations. As a consequence, we recently increased the size of our exposure to Chugai Pharmaceutical.

• Chugai is a pharmaceutical company with a high-quality asset base and growing earnings driven by a key pipeline asset that will transform the treatment of hemophilia. The existing assets are also well positioned, in our view, and the stock is a good value at these levels with a strong growth pipeline going forward.