Wasatch Emerging Markets Small Cap FundTM (WAEMX) 

Q4 2014
Comparing the Investing Environments of Mexico and Brazil
by Roger Edgley, CFA, Andrey Kutuzov, CFA and Scott Thomas, CFA

“Emerging-market investors have generally liked the macroeconomic backdrop for Mexico, and along with a “scarcity” of stock opportunities, this has meant Mexico’s stock market is more highly valued than Brazil’s.”

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Investing in small or micro cap funds will be more volatile and loss of principal could be greater than investing in large cap or more diversified funds.
Investing in foreign securities, especially in emerging markets, entails special risks, such as currency fluctuations and political uncertainties, which are described in more detail in the prospectus.

For the period ended December 31, 2014, the average annual total returns of the Wasatch Emerging Markets Small Cap Fund for the one-, five- and since inception periods were 0.89%, 8.58%, and 4.59%, and the returns for the MSCI Emerging Markets Small Cap Index were 1.01%, 2.93% and 0.24%.  Expense ratio: Gross 2.06% / Net 1.95%.


Data shows past performance, which is not indicative of future performance. Current performance may be lower or higher than the data quoted. To obtain the most recent month-end performance data available, please click on the “Performance” tab of the individual fund under the “Our Funds” section. The Advisor may absorb certain Fund expenses, without which total return would have been lower. Investment returns and principal value will fluctuate and shares, when redeemed, may be worth more or less than their original cost.

Wasatch Funds will deduct a 2.00% redemption proceeds fee on Fund shares held 60 days or less. Performance data does not reflect the deduction of fees, including sales charges, or the taxes you would pay on fund distributions or the redemption of fund shares. Fees and taxes, if reflected, would reduce the performance quoted. Wasatch does not charge any sales fees. For more complete information including charges, risks and expenses, read the prospectus carefully.

Wasatch Funds are subject to risks, including loss of principal.


The Wasatch Emerging Markets Small Cap Fund declined -2.42% for the fourth quarter, and outperformed its benchmark, the MSCI Emerging Markets Small Cap Index, which was down -6.02%.

During the fourth quarter, the performance of the world’s small-cap markets varied considerably. While developed-market small-cap stocks in aggregate experienced positive returns for the quarter, performance was highly mixed. Small-cap stocks in Japan and a number of eurozone countries were in negative territory, while strong positive returns for U.S. small caps provided most of the offsetting gains. For the quarter, developed-market small-cap equities outperformed their emerging-market counterparts. Relative performance across countries was driven in large part by the impact of the precipitous decline in oil prices seen during the second half of 2014. In short, countries that are large importers benefit from lower oil prices, while countries that depend on oil exports for their economic well-being are hurt by falling prices. In this vein, a number of emerging markets with economies heavily reliant on oil exports experienced significant stock-price declines for the quarter. By contrast, the U.S. economy and financial markets benefited, as lower oil prices meant consumers had more money to spend on other things.

Oil prices were not the sole factor in the performance dispersion across countries. Fear of deflation weighed on eurozone markets for much of 2014. The eurozone’s outlook has been further clouded by the current difficulties of Russia, which is a substantial trading partner for the region. The quarter saw a collapse in the ruble, as Russia’s ongoing standoff with Ukraine over Crimea led the United States and the European Union to impose further economic sanctions against Russia, which is already suffering due to lower energy-export revenues.

The Fund’s outperformance of the Index for the quarter was driven by India, as our Indian holdings outperformed their benchmark peers and a substantially overweight position also helped. Oil importers, such as India, continue to benefit from the falling price of crude oil. If India’s newly elected government can deliver on key initiatives, we believe the country’s secular growth story may still be in its early chapters. So while the Indian stock market has already had a substantial advance in the past year, we continue to find many companies in India that we believe have excellent long-term prospects. Outperformance by our holdings in Taiwan was also additive. Our investments in Thailand and the United Arab Emirates underperformed those in the Index and detracted from our relative performance.

Details of the Quarter

The Fund continues to be broadly diversified across markets and sectors. However, the emerging-market landscape does not look as attractive to us as it did in prior years. As a result, we want to be more selective of countries and stocks. We still see many attractive areas of opportunity where we can identify long-term growth companies with outstanding return potential. The top-down, macroeconomic case for some countries is less compelling than it had been, but with such an extensive universe of companies from which to choose we are confident we can find innovative, quality management teams that can navigate a more difficult period. We continue to be excited by the companies in our small-cap universe. (Current and future holdings are subject to risk.)

We feel it is worth discussing and contrasting Brazil and Mexico as two major countries in Latin America, along with the implications of Brazil’s recent elections. The Fund has been overweight in Mexico for some years, and Brazil is one of the world’s major emerging countries. We are encouraged by the structural reforms that have been implemented in Mexico, which provide support for Mexican companies and our overweight position there. Brazil is not on such sound footing. A quote from the December 1, 2014 issue of the Financial Times sums up the situation in Brazil over the past four years, “Growth has collapsed, inflation has accelerated, deficits have widened, investor confidence has withered, credit ratings have been slashed and Petrobras, the state-controlled oil company, has become engulfed in a billion-dollar corruption scandal.” Brazil’s newly appointed Finance Minister, Joaquim Levy, a Chicago-trained Ph.D. economist, has his work cut out for him. Fixing the structural issues—including underinvestment, inflation, lack of reform, and wage growth—facing the country won’t be easy. In addition, he will have to deal with less reform-minded politicians and an underperforming economy.

Brazil has a population of just over 200 million people, with gross domestic product (GDP)†† per capita of roughly $12,000. Mexico, by contrast, has a population of nearly 125 million people, with per-capita GDP slightly below that of Brazil at around $11,000. Brazil has been investing around 16% to 18% of GDP back into the country. This is well below Mexico, which has been investing about 24% of GDP (India and China invest much more). The inflation picture is also very different between Brazil and Mexico. In the past nine years, wage growth in Brazil has been roughly double that of Mexico (8.7% versus 4.4%). In Brazil, the Consumer Price Index (CPI)††† for 2013 was 6.2% (it can be argued that this is understated), whereas Mexico’s CPI was at 3.7%. Consequently, interest rates are different by some 8.75 percentage points. In December, Brazil’s central bank raised the benchmark interest rate by half a percentage point to 11.75%, while in June Mexico’s central bank lowered its benchmark interest rate to 3%. The manufacturing outlook for Brazil is at a multi-year low (it has been declining since 2010), whereas Mexico’s is at a multi-year high.

GDP growth for Brazil is now forecast to be 0.25% for 2014 (1% for 2015). For Mexico, growth expectations are 2.3% for 2014 and 3.6% for 2015. It is also worth noting that Mexico is expected to run with much healthier current account deficit numbers (less than 2%). When we add Brazil’s growth picture to its inflation picture, we see that the country is at risk of stagflation, where given its historic lack of investment, Brazil’s economy overheats at low rates of growth.

On the debt side, household debt to GDP in Brazil is now at 46%. Household debt has doubled in the past nine years, leading to concern that if there were a recession (growth is under 1% for this year), Brazil could be subject to a more difficult credit cycle. For Mexico, household debt as a percentage of GDP is less than 10%. Credit penetration for Mexico is on the low side with room to safely grow. Mortgages as a percentage of GDP are at low levels for both countries (at around 11% for Mexico and 8% for Brazil). In the case of Brazil, higher mortgage interest rates make affordability a greater challenge (i.e., a mortgage costs 13% to 14%). In addition, Mexico’s sovereign debt is more highly rated by Standard & Poor’s than Brazil’s and is therefore deemed to carry less risk.

It is clear that Brazil needs structural reforms. One measure that illustrates the problem is the World Bank’s survey on ease of doing business—Mexico ranks 53rd, Brazil ranks 118th. Reforms we hope will be tackled by Brazil’s incoming finance minister include taxes, ease of doing business and investment-friendly reforms. Here again, Mexico is ahead having already enacted some of these types of reforms.

What does this mean for our investment strategy? Where are the growth opportunities given our top-down comments? Emerging-market investors have generally liked the macroeconomic backdrop for Mexico, and along with a “scarcity” of stock opportunities, this has meant Mexico’s stock market is more highly valued than Brazil’s. The Brazilian IBOV Index‡‡ trades at roughly 1.2 times book value (the MSCI Brazil Index‡‡‡ trades at 1.3 times) so it is a somewhat cheap market. Petrobras is 5.5% of the IBOV, with the stock down close to 30% year to date. Investor sentiment regarding Brazil is poor and has not been helped by the corruption scandal involving Petrobras. On the other hand, Mexico’s MEXBOL Index§ trades at around 2.4 times book value. In price-to-earnings (P/E)§§ terms, the MEXBOL has a P/E of about 15 to 16, well above the P/E of about 9 for Brazil. A risk of underinvesting in Brazil would be that investors have low expectations. If reforms are made and the macro situation improves, there is upside opportunity not unlike the scenario that played out in India following last year’s elections. 

Our Brazil investment strategy is somewhat defensive. Small-cap names in Brazil have had a tougher time this year as evidenced by the MSCI Brazil Small Cap Index,§§§ which underperformed the MSCI Brazil Index. High interest rates and slow growth have made for a difficult macro environment for small companies. Mexico has a better investment environment. In particular, we see opportunities in smaller banks and financial companies (which can compete against their large-cap peers unlike those in Brazil), in consumer names, as well as in infrastructure names such as airport operators. The opportunities in Mexico appear to be fairly broad across sectors.


This has been a difficult year for emerging-market investors with the growth picture becoming more mixed. We see the required investment strategy as being particularly selective of companies and countries. We see “narrower” markets as growth has become more challenging—especially for the BRICs (Brazil, Russia, India and China), excluding India. For many emerging countries the inflation picture has improved, helped by lower commodity and oil prices, which allows central banks to be more accommodative. Some of the key markets that benefit from lower oil prices are those with high oil import bills like India and Turkey. According to estimates, a $1 reduction in the price of oil takes a billion dollars off India’s current-account deficit, which is clearly positive for the domestic economy.

Overall, we do not see emerging markets as being as “broadly” attractive as they were in 2009 or 2010. Back then, corporate and country balance sheets were in good shape with growth clearly well above the more “impaired” growth of developed markets. Now, we need to be especially discerning when selecting countries and stocks. We still see many attractive areas of opportunity in emerging markets, notably in the ASEAN# markets, health care, automation in China and e-commerce. These are areas where we believe we can identify long-term growth companies with attractive return potential. The current emerging-market backdrop means we will need to find companies that are less reliant on “macro-driven” growth, and more driven by endogenous growth (e.g., technology) or shifts in the economy (toward more automation, for example, or more cinema attendance).

We continue to be excited by the changing landscape of emerging markets and the companies in our small-cap universe. The arguments for being allocated to the emerging-market asset class still hold. The capital markets of most emerging countries are becoming deeper and broader over time—this not simply a function of GDP growth—and it should mean a vibrant and growing set of public companies. Both the debt and equity markets in emerging countries are shifting to more openness. This, along with better allocation to investment in a given country, should lead to lower costs of capital. We have seen improved trends in emerging markets over the last 10 years that have led to stronger investment ratings. Stronger markets are not a given, they do have to be accompanied by improved legal systems and institutional arrangements, which is why reforms matter.

We wish our investors a good 2015 and thank you, as ever, for your support.


Roger Edgley, Laura Geritz and Andrey Kutuzov


The MSCI Emerging Markets and Emerging Markets Small Cap Indices are free float-adjusted market capitalization indices designed to measure the equity market performance of emerging markets. You cannot invest in these or any indices.

Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties or originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages. (www.msci.com)

CFA® is a trademark owned by CFA Institute.

The Wasatch Emerging Markets Small Cap Fund’s investment objective is long-term growth of capital.

††Gross domestic product (GDP) is a basic measure of a country’s economic performance and is the market value of all final goods and services made within the borders of a country in a year.

†††A Consumer Price Index (CPI) is often called a cost-of-living index. It is an inflationary indicator that measures the change in the cost of a fixed basket of products and services, including housing, electricity, food, and transportation.

Credit ratings are forward-looking opinions about credit risk. Standard & Poor’s credit ratings express the agency’s opinion about the ability and willingness of an issuer, such as a corporation, state, city or government, to meet its financial obligations in full and on time.

‡‡The Brazilian IBOV Index is the Ibovespa Brasil Sao Paulo Stock Exchange Index. It is a gross total return index weighted by traded volume and is comprised of the most liquid stocks traded on the Sao Paulo Stock Exchange.

‡‡‡The MSCI Brazil Index is designed to measure the performance of the large- and mid-cap segments of the Brazilian market. With 70 constituents, the index covers about 85% of the Brazilian equity universe.

§The MEXBOL Index is the Mexican Stock Exchange Mexican Bolsa IPC Index. It is a capitalization-weighted index of the leading stocks traded on the Mexican Stock Exchange.

§§The price-to-earnings (P/E) multiple, also known as the P/E ratio, is the price of a stock divided by its earnings per share.

§§§The MSCI Brazil Small Cap Index is designed to measure the performance of the small-cap segment of the Brazilian market. With 77 constituents, the index represents approximately 14% of the free float-adjusted market capitalization of the Brazil equity universe.

#The Association of Southeast Asian Nations (ASEAN) is an organization of countries in southeast Asia set up to promote cultural, economic and political development in the region.

The MSCI Emerging Markets and Small-Mid Cap Indexes are free float-adjusted market capitalization indexes that are designed to measure equity market performance in the global emerging markets.  

You cannot invest directly in indexes.

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