Last quarter was the best for international equity markets in more than two decades. Investors stepped up bets on a quick recovery for the world economy, sending share prices to levels unseen since the early days of last year’s financial crisis. Value stocks outperformed growth stocks by a large margin, while the U.S. dollar traded lower against most major currencies. A rush of optimism invigorated Asian markets during the second quarter, sending stock prices to the highest level since early October. Japanese consumer confidence rose to a ten-month high, while industrial production increased 5.2%, the most in fifty-six years. European bourses rallied hard last quarter, slamming the door on six consecutive quarterly losses. The European Central Bank (ECB) dropped its benchmark lending rate to a record low 1% and announced it would begin buying assets backed by mortgages and public sector bonds. The MSCI EAFE Index gained for the quarter, moving it into positive territory for the year.

• The Allianz NACM International Growth Fund was up for the quarter but lagged the MSCI EAFE Index. The Fund’s relatively defensive positioning trailed the market, which was generally driven by an uptick in cyclical stocks such as Materials, Financials, and Industrials.
• From a country perspective, Brazil added most to performance, led by Materials and Energy shares. Examples of winners include Usinas Sider Minas, a large steel producer, and Companhia Vale do Rio Doce, the mining and iron ore giant. Japan was the bottom performer for the Fund, led predominantly by stock picks which did not keep pace with index performance. Nintendo, the video game hardware and software manufacturer, was the largest negative contributor.
• Looking at sectors, Energy was the best performer for the Fund, where stockpicking helped drive results. Saipem, an Italian energy services company, was the top pick for the quarter. An underweight to Financials was the largest deterrent to the portfolio as the sector was the best index performer in the second quarter. Not holding Banco Santander, a Spanish banking stock with a sizeable index weight that was up significantly, was the largest single reason for underperformance in the sector.

Stock Stories

• Standard Chartered was a solid quarterly performer for the Fund. The U.K.-based international banking company was up for the quarter. The stock benefited from a shift in global risk concerns and a resurgence in financial sector sentiment. Specifically, Standard Chartered continues to grow revenues, earnings, and book value per share. Their well-structured balance sheet enables the company to absorb losses should the current environment deteriorate. Both the wholesale and consumer banking divisions have been strengthening, thanks in part to a steepening yield curve. Market share gains, strong performance and wider margins suggest this stock may continue its recent run into the near future. Longer-term, the company’s unparalleled reach into Asia, Africa, and the Middle East further this opinion. We continue to hold shares of Standard Chartered.
• Shares of Roche Holdings, a Swiss pharmaceuticals and diagnostics company, did not perform as well for the quarter, with the stock off. The Healthcare sector in general did not actively participate in the recent market run, as this more defensive sector was the worst sector performer for the MSCI EAFE. While longer-term potential in Roche is very compelling, the market seems to have been pricing in better near-term opportunities in other stocks and sectors. Specifically, the company has the lowest generic exposure, one of the strongest late-stage pipelines among other global large-cap pharmaceuticals. The recent Genentech acquisition may have put a question mark on current execution, but all accounts show integration has been going quite smoothly. Roche has also been increasing spending on R&D as it looks to expand its oncology and cardio-metabolic pipeline, which is expected to add to results over time. Second quarter results are planned to be released in mid-to-late July, with investors keying on company guidance and comments on Tamiflu results given recent swine flu outbreaks. We hold Roche given the company’s industry leadership, strength of portfolio, and opportunity for margin expansion.

With global stock markets and commodities up sharply since March, investors are asking whether the worst is behind us. Certainly, authorities worldwide have pulled out all the stops, using monetary and fiscal policies and government balance sheets to thaw frozen credit markets. As a result, we have seen stabilization in the rate of economic decline around the world and the large contractions witnessed in 4Q08 and 1Q09 should not be repeated. Still, we would prepare for a prolonged period of below-potential growth. The de-levering of the American consumer, growth engine for international export markets, will probably take time. Unemployment will likely continue to rise in many countries, as it is usually a lagging indicator. We also expect higher tax rates, as we have already seen in the U.K. and proposed in the U.S., and higher government involvement in industries ranging from financial services to health care.