The International Opportunities Fund gained 5.22% for the quarter ended March 31, 2015, beating its benchmark, the MSCI All Country (AC) World Ex-U.S.A. Small Cap Index, which rose 3.93%.
European equities started the year off strong on the back of additional stimulus from the European Central Bank, despite ongoing negotiations between Greece’s government and Europe’s finance ministers over the country’s bailout agreement. While investors were hoping that low energy prices, low interest rates, and a weak currency would help get Europe on its feet again, economic concerns in emerging economies like Russia, China and Brazil continued to dampen global growth expectations.
The biggest change in the Fund and global markets over the past 12 months has been the resurgence of Japan. Japanese stocks have been benefiting from both bottom-up and top-down initiatives. We have increased the Fund’s weight in Japan considerably and are finding abundant investment opportunities in the land of the rising sun.
Details of the Quarter
“Every being that exists in the entire world is linked together as moments in time, and at the same time they exist as individual moments of time. Because all moments are the time being, they are your time being.” This is a quote from Zen Buddhist teacher Dogen Zenji. Uji means “time being” and Zenji’s quote was cited in Ruth Ozeki’s recent novel, A Tale for the Time Being, which connected characters across the sea in Japan, the United States and Canada. After more than 20 years of mending from a real-estate and economic bubble, we believe now—in economic and stock-market terms—is once again Japan’s time being. Of course, as a student of the country and a lover of Japan’s culture and scenery, I waited a long time for this to happen. I watched Japan shudder in the shadows of bigger, stronger time beings. Today, being a market’s time being might not be overly impressive. The competition of time beings—relevant and strong developed economies—is a pathetic set of debtor nations from the United States to China and many constituents of the European Union. However, we will endeavor to capitalize on this small relative strength for the Fund. We think Japan’s resurgence might have a longer duration than in the past. I’m encouraged by what I’m seeing from both Prime Minister Abe’s initiatives and from bottom-up analysis of Japanese corporations.
So why Japan? As many of our investors know, our research process involves screening a large set of micro-cap companies for the Fund, finding what we believe are the best as defined by quality, and then traveling the world to dig into the companies that we believe have the potential to be the best investments, assessing both micro and macro dynamics. Based on recent screening and deep due diligence, Japan has shown remarkable change from the bottom up. Japan is often a frustrating place for the Western mind. It is a country where what is done, not what is said, often holds greater significance. Many of the nation’s best novelists write tales that are incomprehensible to the Western reader. There is often little plot and little dialogue. It is snow falling on cedars, a subtle turn of the head in a Noh drama, the colors of a kimono. One must read between the lines and understand what is not said. Japan does not usually shout for attention. While there’s no such thing as a quiet American, the stillness of Japan is omnipresent. That’s why subtle changes in our DuPont models helped call our attention to Japan. Like the crescendo of the taiko drums (temple drums), we believe Japan’s changes are accelerating. We know this country well. Our stock-picking has been great over time here. Now, we have been increasing the Fund’s weight. On a bottom-up basis, Japanese corporations have been buying back shares, lifting wages, paying down debt, increasing dividends, and have been engaging in mergers and acquisitions. Best yet, Japan’s micro-cap stocks remain inexpensive on our metrics. We believe Japan is calling for attention—propelling its time being.
The markets of developed countries slightly outperformed those of emerging countries (+4.0% to +3.6%) in the Index during the quarter, but the Fund’s developed-country stocks gained 10.4% and crushed the benchmark returns. There were several reasons for this, primarily lack of exposure to Canada, which obviously struggled due to exposure to the energy and materials sectors (over 40% of the Canada component of the Index is tied to these two sectors, which were each down over -12% during the quarter).
Our holdings in Japan (+20.0%) also did even better than the strong performance of the Japan component of the Index (+9.1%). Our decision to add to our Japan weight during the quarter, which was based on attractive valuations‡ and improving momentum in a number of stocks that we feel are high quality, meant that we quickly closed the underweight gap relative to the Index. As of December 31, 2014, the Fund’s weight in Japan was a mere 9.8%, less than half Japan’s weight in the Index. By March 31, 2015, the Fund’s weight was 18.8%, which was 2.2 percentage points below the benchmark’s 21.0% weight.
In emerging markets, the Fund benefited from solid stock performance in Taiwan, but the overall performance of our emerging-market holdings was pulled down by a handful of stocks from struggling markets like Indonesia, Turkey and Nigeria, and by our failure to match the benchmark’s strong gain in Korea.
The consumer-discretionary sector was the biggest contributor to performance relative to the Index. The Fund’s 7.5% return nearly doubled the performance of the Index. Online travel service companies Ikyu Corp. (Japan) and Webjet Ltd. (Australia) led the way, returning nearly 57% and over 27%, respectively. Domino’s Pizza Enterprises Ltd., a franchise-license owner in Australia with operations around the world, was also up about 40%. Some of our larger emerging-market positions like Famous Brands Ltd., a South African food company, and Berjaya Food Bhd., a Malaysian restaurant operator that was one of the Fund’s top contributors over the last year, saw stock-price declines and detracted slightly from generally strong sector performance.
The next highest contributor to the Fund’s outperformance of the Index was energy, but primarily because we lacked exposure to this struggling sector. Our lone holding, oil/lubricants producer Hankook Shell Oil Co. Ltd. in Korea, was up 7.7%, while this sector in the benchmark was down over -10% during the quarter.
Information technology (IT) was another strong sector within the Fund, more than doubling the Index’s 7.2% return. IT and Internet service names EOH Holdings Ltd. of South Africa and My EG Services Berhad of Malaysia continued their strong performance from last quarter, and Xing AG, the “LinkedIn of Germany,” was up almost 55%.
The performance of the Fund’s materials sector was greatly aided by our lack of exposure to the metals and mining industry, which was down -3.8% in the benchmark. Performance was also aided by the strong gain of Indian plastic-goods manufacturer Supreme Industries Ltd., which was up over 21% during the first three months of the year.
At about one-third of the portfolio, our biggest sector weight is consumer staples. And because this was one of the better-performing sectors in the Index during the quarter, we gained a lot of relative performance from this overweighting. Gains in the stock prices of Japanese drug-store chain Kusuri No Aoki Co. Ltd. and Philippine Seven Corp. more than offset the decline of Singapore bakery chain BreadTalk Group Ltd., which reported disappointing results in China for the fourth quarter. Other standout performers in the consumer-staples sector for the quarter included Pigeon Corp., a Japanese company that produces baby-care products, and Karex Berhad, a Malaysian condom manufacturer. Finally, the Fund’s holdings in the beverages industry were down about -4.9% and failed to match the performance of their counterparts within the benchmark, which gained over 7%.
The Fund’s industrials companies gained 5.9% and outperformed their MSCI yardstick due to strength in names like Indian tile manufacturer Kajaria Ceramics Ltd. The Fund’s underweight relative to the Index in the sector did not have significant impact on performance.
The portfolio struggled a bit in the financials sector during the quarter and our holdings underperformed those in the benchmark. Insurer British-American Investments Co. Kenya Ltd. (Kenya) was the biggest detractor in the sector, but the Fund was also hurt by lack of exposure to the capital markets industry, which was up 11.6%.
Our pharmaceutical stocks were down -7.4%, while those in the Index gained 12.2%. This was the primary reason that, despite the strong performance of United Arab Emirates health-care provider NMC Health plc, the health-care sector detracted the most from performance relative to the Index. (Current and future holdings are subject to risk.)
We’ve spoken extensively about Japan. We are extremely positive on the potential resurgence of this market and our companies, and we will be traveling aggressively through the region to meet with companies’ management teams. With many people on Wasatch’s research team who know Japan well and a history of good stock-picking in the market, we feel we have the ability to execute well in this market.
Japan is not the only country with companies where we see positive changes. After several years of sluggish growth in China, we are seeing some corporations step up and cut expenses. This is critical in a slow-growth world where revenue expansion is hard to come by. Growth has to come from more creative methods like cost cutting, debt unwinding, share buy backs and dividends to shareholders who are willing to wait for the long-run story to unfold. This is what Japan is doing. Hence, I will save the story of China and Hong Kong for another time being.
With significant exposure to consumer companies that we consider to be high quality and that we anticipate will benefit from lower oil prices and input costs, we believe the Fund continues to be well-positioned for a global deflationary environment.
As we continue to scour the globe for high-quality micro-cap companies, we have been increasingly impressed with the valuations and momentum of companies in Asia, and Japan in particular. Likewise, we are cognizant of increasingly attractive valuations appearing across Europe. The list of names that we think are worthy of a position in the Fund continues to grow, which is why the Fund had 157 names at quarter-end. Given that there are over 7,000 micro-cap stocks globally in the universe, we feel there is still plenty of room for active management in this asset class. The harder we look, the more excited we get about the great opportunities we are uncovering around the world.
Thank you for allowing us to invest your hard-earned assets. It is a privilege we don’t take lightly.
Laura Geritz and Jared Whatcott
†The MSCI All Country (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.
††The MSCI World Ex-U.S.A. 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.
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The Wasatch International Opportunities Fund’s investment objective is long-term growth of capital.
‡Valuation is the process of determining the current worth of an asset or company.