The NFJ International Value Fund reported a solid return for the third quarter of 2009, though this did not keep pace with the MSCI All Country World ex U.S. Index benchmark, which continued its rebound to record a gain.

The third quarter net underperformance resulted from positive individual stock selection being more than offset by negative contributions from sector allocation. The Fund’s sector underperformance can be attributed to an underweighting in the Financials sector and an overweight position in Energy in a continuation of the trends seen during the second quarter. The Financials sector was the single best performing sector in the benchmark, rising as banks and brokers successfully raised capital to stave off a collapse in the global banking system. The Financials sector is now up over the past two quarters. Likewise, the Energy sector trailed the broad market as oil prices remained flat for the quarter in the $70 range.

We added value in terms of issue selection during the quarter. In particular, selection was solid in the Financials sector. The Fund’s Financial holdings returned ahead of the already-strong return posted by the benchmark’s Financial names. Selection also created alpha in the Utilities and Telecomm Services sectors, in which the Fund’s holdings outpaced those in the benchmark. This was partially offset by weaker stock selection in the Consumer Staples and Health Care sectors, in which our gains did not keep up with those in the benchmark.

The greatest additions to performance in the Financials sector came from such holdings as AXA (AXA), Bancolombia SA (CIB), Australia & New Zealand Bank (ANZBY) and Banco Bilbao Vizcaya (“BBVA” or BBV), all of which rose from oversold levels. BBVA came out of the financial crisis relatively unblemished and actually surprised markets by reporting its largest ever quarterly profit. AXA was upgraded by a major broker after reporting better than expected solvency ratios, and continues to trade below book value. Utilities sector alpha came from a pair of Brazilian names, Companhia de Saneamento Basico (“Sabesp” or SBS) and Companhia Paranaense Energy (“COPEL” or ELP). Their returns underscore the fact that Brazil was one of the best performing markets during the quarter. The city of Sao Paolo, Sabesp’s largest customer, also recently approved a new long-term concession that reduces earnings uncertainty. Other top performers were Pearson (PSO) and Ingersoll-Rand (IR). Pearson reported strong first half earnings as the company’s textbook business proved resilient to the economy and gained share from financially-strapped rivals. Ingersoll raised its full-year cash flow outlook and appears poised to take advantage of pent-up demand for residential HVAC orders.

On the negative side, stock selection lagged in the Health Care sector. Key detractors were AstraZeneca (AZN) and GlaxoSmithKline (GSK), which ended the quarter up. AstraZeneca has faced patent threats to Crestor, although with analyst Sell ratings outnumbering Buy ratings by a two-to-one margin, we believe that these challenges are well accounted for by the current valuation. GlaxoSmithKline also suffered a drop in earnings due to generic competition, although the company has a vaccine portfolio that has it well positioned to help combat pandemics such as the H1N1 virus. Selection also trailed in the Consumer Staples sector, with Delhaize Group (DEG) declining almost. Delhaize’s earnings were pinched by unwinding food inflation, but the company has demonstrated its robust financial condition with its proposed purchase of BI-LO’s 214 U.S. stores under Chapter 11. Diageo (DEO) has seen sluggish demand for premium liquors. Finally, selection detracted in the Energy sector, in which Nexen Inc. (NXY) and Sasol Ltd. (SSL) posted lagging returns. Nexen has seen delays at its Long Lake oil sands project, but the current stock price attributes no value to this project, providing upside if oil prices remain at current strip levels. Sasol reduced its dividend due to lower year-over-year commodity prices, but still offers a yield and continues to trade below emerging market oils despite a better growth profile.

Regarding country exposures, the product benefitted the most from being underweight Japan and China relative to the benchmark. Japanese stocks faced a double-whammy of the first change in government in years, along with a strengthening yen, which hurts its export-oriented economy. After rebounding during the year’s first half and quickly pricing in a recovery, Chinese equities were actually down as investors showed concern of slowing bank lending. The Fund was also helped by its overweighting in the United Kingdom, which appears to be emerging from the same subprime mortgage issues that have hampered the U.S. Performance was hurt most by the Fund’s overweighting in Canada. Canadian stocks did well during the first half, as it is a resource rich economy that benefits from exports to Asia. However, returns in Canada slowed during the latest quarter on concerns that the Chinese recovery might not be sustainable. Underweightings in France and Germany also detracted from results.

In July, we sold BASF (BASF), which had been hurt by weaker chemical prices and lower margins.. We also felt that after its merger with Ciba, the dividend was at risk since the company has faced challenges earning its cost of capital. We rotated into Amcor (AMCRY), the Australian packaging company. The company had been hit by higher input costs in 2008 and customer destocking. However, the name should be fairly defensive among materials names since its end markets are heavily weighted toward health care and tobacco. We also sold Teekay Corp. (TK) to increase our position in Companhia Paranaense de Energia (“COPEL” or ELP). Teekay had rallied from its lows set back in March, while earnings forecasts had been reduced. We bought COPEL, a Brazilian electric utility. Whereas many Brazilian companies offer alternative ways to play to the Asian infrastructure boom due to the heavy concentration of natural resources like oil, iron ore and paper, COPEL is a means of taking advantage of Brazil’s growing middle class.

In August, we sold Suncor Energy Inc. (SU), a name we received after it acquired Petro-Canada (PCZ), which had been one of our largest holdings. We continued to hold Petro-Canada after the merger announcement due to strong momentum and valuation metrics, and the stock had been one of our best holdings. However, Suncor is a high-multiple stock with a minimal dividend, not fitting our value orientation. We also reduced HSBC Holdings (HBC) to increase our weighting in Australia & New Zealand Bank (“ANZ” or ANZBY). We maintain a 2% weighting in HSBC due to its solid dividend yield and book multiple, but sold it on a P/E valuation that had risen substantially. ANZ has been more conservative than its Australian peers and is gaining share in Asia. ANZ has been named “Most Sustainable Global Bank” by Dow Jones the past two years running. We also sold Ingersoll-Rand (IR) to buy Siemens (SI). Ingersoll-Rand had nearly doubled from its March lows; when combining this rally with its dividend reduction earlier in the year. Siemens was acquired.

Clients often ask where the Fund is finding value and how we are positioning ourselves by country. Currently, our greatest areas of variation from the MSCI All Country World Ex-U.S. benchmark are the Fund’s overweight positions of holdings in places like Brazil, Canada, Mexico and the UK, with underweightings in Japan, China, France, Switzerland and Germany. However, it is also instructional to observe the relative changes on the margin in these weightings this year to date.

By region, so far during 2009, we have lowered the Fund’s position in the Americas by 5%. This has resulted from reduced weightings in Canada, Mexico and Argentina. As stated above, we maintain substantial exposure to Canada and Mexico. The average Mexican security trades at just 12x earnings, while Canadian equities, with their heavy resource weighting, provide low-risk exposure to the infrastructure boom going on in Asia. However, much of the good news is beginning to be priced into Canadian equities, and some Mexican companies have suffered from lack of credit as the country’s financial liquidity has dried up.

We have slightly raised the Fund’s positions in Europe. Dividend yields in Europe are very attractive relative to bond yields on a historical basis, and forecast earnings growth is slightly better in Europe than in the U.S., even though on a purchasing power parity basis, the Euro may not be cheap. However, the composition of the Fund’s Europe holdings has changed this year. We have reduced the Fund’s holdings in Germany by 3% and the Netherlands by 2%, while increasing the UK by 3% and Spain 2%. Part of this shift has been on a more bottom-up basis of buying BBVA, which is attractive partially due to its superior capital position that was a side effect of the stringent financial regulations that prevented Spanish banks from taking on toxic financial instruments.

Finally, although we have only slightly increased the Fund’s weighting in Asia, there have also been moves within the region. Most notably, we have lowered the Fund’s position in Japan by 4%, while raising Australia by 4% and South Korea by 2%. While the pundits fret about the heavy levels of indebtedness in the U.S. relative to GDP, the figures are even more daunting in Japan, where years worth of government stimulus programs have run up massive deficits with little economic growth to show for it. Japan also faces an uphill demographic battle as its population is forecast to fall precipitously over the next forty years, leaving fewer workers to pay the eventual taxes required to reduce its public sector debts. By contract, when the Korean won collapsed last year, it had a stimulative impact on Korean exports relative to Japanese and Chinese competitors and has helped ignite the Korean economy.

We believe the NFJ International Value Fund, based on fund data, continues to represent excellent value. It remains broadly diversified across 22 countries and 35 industries, and with a weighted average market cap of $42 billion, emphasizes large companies that are particularly prone to benefit from the theme of globalization.