WASATCH FUNDS - Curian Clearing

WASATCH EMERGING MARKETS SMALL CAP FUND (WAEMX) — Management Discussion
MARCH 31, 2015 (UNAUDITED)
The Wasatch Emerging Markets Small Cap Fund is
managed by a team of Wasatch portfolio managers led by
Roger Edgley, Andrey Kutuzov and Scott Thomas.
Roger Edgley, CFA
Lead Portfolio Manager
OVERVIEW
Andrey Kutuzov, CFA
Associate Portfolio
Manager
Scott Thomas, CFA
Associate Portfolio
Manager
In the first quarter of 2015, the Wasatch Emerging Markets
Small Cap Fund gained 0.37% but underperformed its
benchmark, the MSCI Emerging Markets Small Cap Index,
which gained 3.59%. Emerging-market equity returns were
mixed but generally rose as the prospect of further policy
easing in China lifted Asian shares.
Comments from Central Bank Governor Zhou Xiaochuan
that China’s growth had slowed “too much” raised expectations
for new measures to support the Chinese economy.
China and Korea posted gains that helped the Index. Our
underweighting in those markets and the underperformance
of our holdings were headwinds for the Fund. Taiwan was
also a positive market. The Fund’s weight in Taiwan was
approximately equal to that of the benchmark and our holdings
outperformed those in the Index.
Several emerging-market currencies fell relative to the U.S.
dollar during the quarter. In Turkey, Brazil and Colombia,
currency depreciation impacted stock performance in the
benchmark and the Fund. Meanwhile, the dollar’s strength
helped the big exporting markets. India continued to provide
positive performance.
DETAILS OF THE QUARTER
It is worth commenting on China and the changes in
equity markets there, as well as the implications for
emerging-market investors. China is a significant part of the
emerging-market indices and it is likely to get much larger
given the size of the domestic Chinese equity market as well
as U.S.-listed Chinese names. While the Fund remains significantly
underweighted in China, we expect to increase our
Chinese holdings over time.
The difficulty for equity investors in China has been to
find high-quality names that are not state-owned enterprises
(SOEs) or connected to or controlled by SOEs (the capitalization
of SOEs is well over 70% of the market). That is part
of the reason China is a value market, though reforming
SOEs — which seems part of the Chinese government’s
agenda — may help to improve their valuations. The performance
of emerging-market SOEs has been substantially
worse than the market since 2008. At the present time,
China is opening up its equity market and the currency is
becoming liberalized. This is not a small market opening up.
The market capitalization of the domestic Chinese market is
over US$4 trillion.
For us as small-cap investors, our challenges in China
have been lack of scale in companies we see (in a large-scale
economy), hyper-competition, corporate governance and
unclear strategy. These challenges will not go away. However,
over time we believe companies and managements will
improve. We see progress in the “new areas” of the economy
(Internet, health care, technology). In addition to investing
in companies based in mainland China, we also expect to
invest in companies based in Hong Kong and Taiwan that
have shown they can be successful in China.
Elsewhere, India continued to see strength and the Fund
continued to be structurally overweight in India. Natco
Pharma Ltd. was one of the Fund’s top contributors. Natco’s
share price rose sharply in the first quarter on news it had
won approval to market a generic version of Gilead’s new
Hepatitis C drug, Sovaldi, in India and 90 other countries.
The Fund is still underweight in Korea, but we are increasingly
finding more attractive opportunities as dividends
increase, government regulation improves and labor productivity
gets better. Nevertheless, Korea was a source of
underperformance in the first quarter as our companies
overall did not keep pace with those in the benchmark.
Hanssem Co. Ltd., a manufacturer of kitchen and bath cabinetry,
was up over 50% and was the Fund’s top contributor
to performance. On the other hand, i-SENS, Inc. was down
over 20% and detracted from performance. i-SENS, one of
the world’s leading manufacturers of blood-glucose
monitoring systems, has one of the lowest costs of manufacturing
for blood-glucose strips. The company also has a
strong research and development pipeline.
Another large detractor was Qualicorp S.A., a firm offering
insurance and benefits packages to corporations and
affinity groups in Brazil. Qualicorp’s shares slumped on
speculation that the government is considering measures to
stimulate sales of individual health-insurance plans, which
could increase competition in Qualicorp’s industry.
OUTLOOK
Overall, we see a much better tone in emerging markets.
While gross domestic product (GDP) growth has been slowing
and U.S. dollar-denominated debt levels remain a concern,
we’re optimistic regarding the prospects for lower
interest rates and SOE reforms.
The outlook is clearly improving in the developed regions
of Europe and Japan. Emerging markets may be lagging, but
over time they may also benefit from the improvement in
developed markets. During the past four years, the MSCI
Emerging Markets Small Cap Index has essentially moved
sideways even as the earnings of its underlying companies
have increased. As a result, the broad emerging-market
universe has become more attractively valued. In addition,
the U.S. dollar’s recent climb to multi-year highs has made
emerging-market equities less costly for dollar-based investors.
Going forward, we anticipate lower oil prices will also
benefit many emerging markets.
We appreciate the support that shareholders have shown us.
Current and future holdings are subject to risk.
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