Wasatch International Growth Fund® (WAIGX)  Invest in this Fund 

Investor Class | Institutional Class
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1Q19
The Power of Compounding Can Work Magic in an Investment Portfolio
by Ken Applegate, CFA, CMT, Roger Edgley, CFA and Linda Lasater, CFA

“Although quarter-to-quarter swings in performance can be quite distracting, the important point we want to make is that the more you stay focused on the long term and the longer you stretch out the timeframe, the more the power of compounding can work for you.”

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For the period ended March 31, 2019, the average annual total returns of the Wasatch International Growth Fund for the one-, five- and ten-year periods were -8.51%, 4.47%, and 15.96%, and the returns for the MSCI AC World Ex-U.S.A. Small Cap Index were -9.49%, 3.26%, and 11.86%.  Expense ratio: Gross 1.45%.

 

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.

Overview

The Wasatch International Growth Fund—Investor Class gained 13.72% in the first quarter of 2019 outperforming the 10.26% return of the MSCI ACWI (All Country World Index) ex USA Small Cap Index.

Viewing quarterly Fund performance is just one piece of the overall puzzle and provides little insight with which to judge the success of an investment strategy. Astute investors know that wealth is created by focusing on the long term and letting the power of compounding work its magic. In the short term, many things, both positive and negative, can distract investors’ attention away from their long-term goals. During the first quarter of 2019, equity markets had a strong rally following a weak fourth quarter. If we look at the 2018 calendar year, the Fund outperformed the Index by over two percentage points. But this was due to strong performance for the first three quarters of 2018 when the Fund gained 7.32% compared to a loss of -4.41% for the Index. During the fourth quarter of 2018, the Fund declined -21.46% versus a loss of -14.43% for the Index. Although quarter-to-quarter swings in performance can be quite distracting, the important point we want to make is that the more you stay focused on the long term and the longer you stretch out the timeframe, the more the power of compounding can work for you. For example, the Fund’s average annual total return for the 10 years ended March 31, 2019 was 15.96% compared to 11.86% for the Index. In other words, if a shareholder hypothetically invested $100,000 in the Wasatch International Growth Fund 10 years ago on March 31, 2009, it would have been worth nearly $440,000 as of March 31, 2019, versus about $307,000 if one could have invested the same amount in the Index. This is power of compounding.

Details of the Quarter

The Wasatch investment team spent a week visiting companies in the U.K. during January and found that Brexit-related uncertainties continued to prevail. Most U.K. companies have been preparing for a hard Brexit scenario—the U.K. leaves the European Union without a deal—and weakness was evident in many domestic-facing companies. We heard stories of struggling small businesses, many of which are closing down. However, we also noted that the highest-quality companies have solid cash flows and balance sheets. These companies continue to invest for growth and have prepared to navigate the business environment regardless of the outcome of Brexit negotiations. As regular readers of our quarterly commentaries know, we reduced our exposure to U.K. domestic-focused companies following the referendum in 2016. Since then, the majority of our U.K.-listed portfolio companies derive a meaningful portion of their earnings and growth from outside the country.

An example is Fevertree Drinks plc, one of the Fund’s strongest contributors for the first quarter. Fevertree, based in London, provides premium tonics and drink mixers and is an innovative company disrupting the traditional way we consume spirits with a premium brand, driving choice and value for customers. After refining the Fevertree brand in the U.K., where the company now has 42% market share in the mixers category, it has been successfully expanding globally. The initial foray abroad was to Europe where Fevertree is now seeing strong growth. More recently, the company has been expanding throughout the U.S. Last year, Fevertree signed a national distribution agreement for 29 U.S. states with Southern Glazer’s Wine & Spirits, a preeminent U.S. beverage distributor. Fevertree reported yet another quarter of strong financial results, and we believe there is substantial upside potential in the years to come as the company continues to grow its earnings over the long term.

Another example of our long-term focus is Abcam plc, a U.K.-based global leader in the sale of antibodies for life-science research. International markets provide over 90% of Abcam’s revenues. The company has been positioning itself for the next growth phase by investing in its business to make it more scalable, adding new systems and addressing new markets. While business fundamentals remain strong, Abcam’s increased investments have caused a slowdown in earnings growth. This, combined with high headline valuation and overall market weakness, led to a decline of about -25% in Abcam’s share price for the fourth quarter of 2018. During the first quarter of 2019, Abcam’s share price gained “only” about 7%. Let’s put these two quarters into a longer-term context. We first bought shares of Abcam in May 2008. In the more than 10 years since we have owned Abcam, the stock has sold off by more than -15% nine different times. The fourth-quarter selloff was the third decline of -25% or more. So while Abcam’s recent investments into its business have weighed on short-term earnings, our focus remains on the long-term opportunity and we like the company’s historical track record of success. Since we first bought Abcam in 2008, the stock price has increased more than 10-fold. More importantly, the company’s sales increased from £56.8 million in 2009 to £245 million in 2018 and net income increased from £13.3 million to £70 million over the same time period. We believe Abcam will eventually sell the majority of antibodies used in research around the world through its online platform. Given its scalability, dominant market position and abundant growth opportunities, we’re optimistic about the company’s prospects.

The greatest detractor from Fund performance for the quarter was Metro Bank plc, as the stock sold off more than -50%. Metro Bank is a retail bank in the U.K. that has been disrupting the high street banking industry and winning new customers with its customer-first; employee-empowered strategy and culture. During the quarter, Metro had to raise its risk weightings on certain commercial-property loans and buy-to-let mortgages due to an internal misclassification. This required an additional £900 million in capital, a 12% increase over what analysts had expected. On the positive side, Metro was awarded a £120 million grant by Banking Competition Remedies Ltd., an independent body established to promote competition in banking services for small and medium-size enterprises. Despite the volatility in Metro’s stock price and short-term uncertainties, we believe in the company’s vision. Wasatch has a long-standing history with the founder and chairman, having been shareholders in his previous venture, Commerce Bank in the U.S. This was a successful long-term investment for Wasatch, and our research indicates an even bigger opportunity for Metro Bank in the U.K. If the company can execute its business strategy, we see significant upside potential for Metro Bank’s shares. 

Japan added the most to the Fund’s return and outperformance of the benchmark in the first quarter. Although the fourth quarter was difficult from a stock-price performance perspective, it provided us the opportunity to add to what we consider to be some of our highest-quality companies that we felt had been irrationally oversold. We were pleased to see rationality return to Japan’s market in 2019’s first quarter. Many of our Japanese stocks bounced back as investors realized that company fundamentals remain sound. Our investment team spent nearly two weeks in Japan during March. We met with 44 companies. In addition, we have been conducting conference calls with another 40 or so Japanese companies. Japan is the largest country weighting in the Fund, and we remain structurally positive on Japan’s small-cap market.

Nihon M&A Center, Inc. was one of the Fund’s stronger contributors during the first quarter. In 2018’s fourth quarter, we used stock-price weakness as an opportunity to add to our position. The company has seen business reaccelerate following a slowdown in deal flow last year. With business succession a growing issue in Japan, Nihon M&A helps small-business owners, often those nearing retirement, to find buyers for their companies. Nihon M&A is the clear leader in a market with a substantial opportunity. The company has partnerships with large banks that provide referrals, which makes it difficult for nascent competitors to gain traction. Nihon M&A continues to hire and invest, which we believe bodes well for future earnings growth.

Funai Soken Holdings, Inc. also contributed to the Fund’s performance, as earnings growth was stronger than expected. Many parts of the Japanese economy lag behind their global counterparts from a productivity perspective. But change is happening on the ground in Japan, and Funai Soken is one of the companies helping to ignite this change. Funai Soken has a unique platform where members, generally small and medium-size enterprises (SMEs), pay subscription fees to participate in study groups and seminars on the subject of industry best practices. Funai Soken also has the potential to benefit by upselling consulting services to its members. If the company is successful upselling, the SMEs pay subscription fees for recurring consulting services. We expect these recurring revenues to be quite steady and visible throughout the business cycle. In addition, Funai Soken launched a human resource development practice several years ago that has seen strong growth as it provides tools to help companies deal with Japan’s labor shortage. We expect this will continue to drive the consulting business for several years. Another exciting area is Funai Soken’s information-technology segment, which we believe can become a much bigger practice and drive long-term growth.

On the other side of the coin, shares of Pigeon Corp. were down as the company reported earnings below expectations due to weak sales in China. Our research indicates that this weakness is likely to be transitory. Pigeon is a leading provider of baby bottles, lotions and related products in Japan. We think the company is on track to be a global consumer staples success story. Pigeon continues to innovate and has two key product launches scheduled, which we believe will accelerate growth in years to come. We used Pigeon’s recent stock-price weakness to increase the size of the Fund’s position, and we intend to add more shares if near-term weakness persists. Pigeon is another of the Fund’s long-term holdings. We first bought shares for the Fund in 2013. Prior to this, we owned Pigeon as a micro-cap stock in the Wasatch International Opportunities Fund. We believe that one of the competitive advantages we have at Wasatch is that we actively research dynamic micro- and small-cap companies, and we often discover them much earlier in their evolution than other investors.

Turning to Europe, we sold our holding in Ipsen S.A., a specialty pharmaceuticals company based in France. This had been a strong-performing stock since we bought shares in 2015. However, we believe that a couple of Ipsen’s key drugs face an increased competitive threat. (Current and future holdings are subject to risk.)

Outlook

The Fund is underweight in continental Europe, with our holdings positioned across the Nordic countries (Denmark, Norway and Sweden) and the core continental European countries including Germany, Italy, France and Switzerland. While there are numerous headwinds in Europe—including weak economic data—valuations relative to other developed regions are becoming more compelling. One of the benefits of being bottom-up small-cap investors is that we find a lot of companies doing new and exciting things. In May, we will spend two weeks in Europe, where we see positive change occurring. We are scheduled to meet a handful of new companies and nearly a dozen companies that we haven’t visited for a few years. We will also meet with a number of current portfolio holdings.

The U.K. remains a challenging investment environment, but the country has a deep pool of high-quality companies. It just so happens that many of these companies generate the majority of their earnings outside of the U.K. This is a key reason the Fund is overweight in the U.K. versus the benchmark.

In Japan, it was encouraging to see small-cap stocks resume their outperformance of large-cap stocks during the first quarter. Quality stocks also outperformed. Despite being one of the largest developed economies in the world, Japan’s market is still inefficient and misunderstood by many investors, which provides opportunities for us to use our expertise and on-the-ground research to find companies with outstanding investment potential. We have generated strong returns in Japan over the last five years, and we are equally excited about the next five years.

From a sector perspective, we have slightly increased the Fund’s weighting in information technology (IT), where we have primarily added to our holdings in software and consulting companies. We are seeing increased levels of spending on IT following years of underinvestment by businesses in many countries, especially in Europe. Around the world, there are new innovative and disruptive IT companies that are changing the way things are done or helping companies to adapt to changing business landscapes by becoming more efficient and effective.

We remain confident in the ability of our companies across the globe to navigate turbulent environments by virtue of their experienced management teams, solid business models and strong competitive positions. These companies are also characterized by their strong balance sheets and cash flows, which allow them to invest throughout business cycles and take market share from competitors. We remain optimistic regarding their long-term prospects given recent meetings and calls with management teams, which point to continued investment in their businesses.

Thank you for the opportunity to manage your assets.

Sincerely,

Ken Applegate, Roger Edgley and Linda Lasater

 

 

 

**The MSCI ACWI ex USA Small Cap Index is an unmanaged index and includes reinvestment of all dividends of issuers located in countries throughout the world representing developed and emerging markets, excluding securities of U.S. issuers. This index is a free float-adjusted market capitalization index designed to measure the performance of small capitalization securities.

The MSCI World ex USA Small Cap Index is a free float-adjusted market capitalization weighted index designed to measure the equity market performance of developed markets, excluding the United States.

You cannot invest in these or any indexes.

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 indexes. 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 International Growth Fund’s investment objective is long-term growth of capital.

The Wasatch International Opportunities Fund’s investment objective is long-term growth of capital.

Brexit is an abbreviation for “British exit,” which refers to the June 23, 2016 referendum whereby British citizens voted to exit the European Union. The referendum roiled global markets, including currencies, causing the British pound to fall to its lowest level in decades.

Earnings growth is a measure of growth in a company’s net income over a specific period, often one year.

Valuation is the process of determining the current worth of an asset or company.

The MSCI World Ex U.S.A. Small Cap Index is an unmanaged index that measures the performance of stocks with market capitalizations between U.S. $200 million and $1.5 billion across 22 developed markets, excluding the United States.   The MSCI AC World Ex U.S.A. Small Cap Index is an unmanaged index and includes reinvestment of all dividends of issuers located in countries throughout the world representing developed and emerging markets, excluding securities of U.S. issuers. This index is a free float-adjusted market capitalization index designed to measure the performance of small capitalization securities.  

You cannot invest directly in indexes.

View the International Growth Fund’s most current Top 10 Holdings

Portfolio holdings are subject to change at any time. References to specific securities should not be construed as recommendations by the Funds or their Advisor.

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CFA® is a trademark owned by CFA Institute.