Overview
The Wasatch International Growth (Trades, Portfolio) Fund—Investor Class outperformed its benchmark, the MSCI AC World Ex-U.S.A. Small Cap Index, returning 9.63%, while the benchmark was up 8.78%. The quarter was marked by a broad recovery across international markets. The expectation of pro-growth policies to reinvigorate the economy in the U.S., stabilization of the Chinese economy, and reflationary trends across Europe and Japan helped boost markets across the globe. Sector performance was mixed with more defensive sectors such as health care outperforming as did more cyclical sectors like industrials and information technology. Energy reversed course and underperformed following strong fourth quarter performance.
Details of the Quarter
During the quarter, health care and information technology were the strongest-contributing sectors for the Fund. We are overweight relative to the benchmark in health care. We own companies that we believe have strong positions in their domestic markets and are seeing growth opportunities through geographic expansion or levering their existing infrastructure to distribute new products or services in their core markets. Ipsen S.A. (XPAR:IPN, Financial) (France) was the Fund’s top contributor in the quarter. Ipsen is a pharmaceutical company with 75% of sales generated from specialty drugs. In the quarter, Ipsen announced that it would acquire the rights to Merrimack Pharmaceuticals’” ” pancreatic cancer treatment. In our view, this acquisition would expand Ipsen’s oncology assets, bolster its geographic reach and provide significant growth potential. Medytox, Inc., a South Korean producer of botulinum toxin and dermal fillers, and Abcam plc (United Kingdom), a leading online supplier of antibodies for life science research, were also among the top contributors to the Fund’s performance in the first quarter.
The Fund is also overweight in the information technology sector with companies like Silergy Corp. (Taiwan), a producer of high performance analog integrated circuits, and Melexis N.V., a Belgian manufacturer of advanced integrated semiconductors and sensors, being the top performers in the sector after both companies reported strong earnings growth.
From a country perspective, Japan and the United Kingdom (U.K.) were the largest contributors to the Fund’s performance. In Japan, Seria Co. Ltd., operator of a chain of 100-yen stores (equivalent to dollar stores in the U.S.), was our biggest contributor, followed by MonotaRO Co. Ltd., an online distributor of maintenance, repair and operations supplies. In the U.K., where many of our companies have global sales, IWG plc, a global provider of shared and temporary office workspace, Abcam, mentioned earlier, and ASOS plc, an online fashion retailer, were our top contributors.
It’s worth discussing why we believe Japan presents compelling investment opportunities in our space. During the quarter, we had three members of our investment team visit the country for two weeks. If you were to only read the headlines about Japan, a vast amount of the news highlights weak economic growth, deflation, poor demographics, weak corporate governance and excess savings. However, as we have dug deeper, we have found that for every headwind the country faces, there are companies that benefit from these trends by providing innovative products or services to help companies deal with these issues.
The headlines don’t completely reconcile with what we heard and saw during our visit to Japan. The streets are buzzing with shoppers and tourists at all hours. The restaurants are filled. At the most popular sweet shops, lines wrap around street corners. Business executives and managers are optimistic about the future and have been investing for growth. Japan’s unemployment at 3% is near 20-year lows. Many of the company management teams we spoke to have hired aggressively over the last few years and still have plans to hire hundreds of graduates next year. Companies are struggling to find good talent. Fund holding Dip Corp. (TSE:2379, Financial) is an online job portal disrupting the recruiting market and taking market share by offering better services for companies wanting to hire workers and job-seekers so both sides can find appropriate matches efficiently.
Tourism has flourished since the yen weakened and the government began its “Visit Japan” campaign. Stores are catering to foreigners, with increasing numbers of bilingual sales staff and more signs in English and Chinese. With China plagued by product scandals, Chinese tourists have been coming to Japan to fill their suitcases with high-quality, safe products like baby bottles and infant formula from portfolio holding Pigeon Corp. The boom is presenting new challenges and opportunities for restaurants and shops. Gurunavi, Inc., an online restaurant guide, is helping restaurants reach tourists by providing multi-language support and manage capacity with online reservations.
As the Japanese population ages, the country must find ways to drive health-care costs down. For example, Ain Holdings, Inc. (TSE:9627, Financial), a leading operator of pharmacies and drug stores, is gaining market share. The company has the scale to offset pricing pressure from increasingly available generic drugs and to provide medical services, which the government is moving from hospitals to bring down costs. Larger companies like Ain also have advantages in hiring and training pharmacists, which are in short supply. The industry is large and fragmented. It is in the early stages of consolidation, providing plenty of headroom for Ain to grow. M3, Inc. (TSE:2413, Financial) is another Japanese company that has flourished by helping pharmaceutical companies to more effectively deliver drug information to doctors online. Leveraging its doctor network and technology platform, M3 entered the contract research organization (CRO) space a few years ago and has become one of the top three CRO companies in Japan. The company’s platform automates and optimizes portions of the clinical trial process to help bring drugs to market faster and cheaper.
The Wasatch team also met executives at several companies that have had recent initial public offerings (IPOs). These companies have taken proven business models from companies in markets like the U.S. and the U.K. and have been replicating them in Japan. In the last 2.5 years, Japan has led the number of IPOs at 67 versus other developed international countries like the U.K. at 55, Australia at 49 and Sweden at 40. A healthy IPO market means that entrepreneurs are able to access an efficient way to capitalize their businesses and grow. We see Japan’s IPO market as providing a more dynamic small-cap universe and future investment opportunities for the Fund.
The biggest detractor from the Fund’s performance in the first quarter was NCC Group plc (LSE:NCC, Financial). The U.K.-based company, which provides security software and consulting services, issued a second profit warning and the CEO stepped down. Our conviction regarding the company’s long-term prospects has waned and we sold our shares. Domino’s Pizza Enterprises Ltd. (DPZ, Financial), a strong contributor to overall performance over the last several years, saw negative news headlines regarding franchise labor practices and profitability in Australia. We believe management has been forthright in discussing and addressing the issues and we remain positive on the long-term opportunity of the company.
Several of our emerging market companies also detracted from performance during the first quarter. The looming increase in excise taxes on automobiles in the Philippines weighed heavily on the stock of GT Capital Holdings, Inc. (PHS:GTCAP). The company owns 51% of Toyota Motor Philippines and this subsidiary contributes 46% to GT Capital’s earnings. However, for a typical auto loan, the proposed tax increase would only modestly raise a buyer’s monthly payment and in our opinion does not appreciably alter GT Capital’s long-term growth prospects. Nien Made Enterprise Co. Ltd. (TPE:8464), the world’s largest manufacturer of window coverings based in Taiwan, saw strong earnings but investors were concerned over price increases for raw materials and headlines highlighting growing protectionism around the globe. We remain positive on emerging markets and the Fund is slightly overweight relative to its benchmark. (Current and future holdings are subject to risk.)
Outlook
Economic trends across the globe appear to be strengthening, but the political environment in some countries adds uncertainty regarding policies, which will result in volatile equity markets. We have been finding investment opportunities across sectors and geographies. Within our investment universe, we believe we can find high-quality companies that can grow despite difficult political or economic environments. Periodic volatility often provides opportunities to invest in companies that meet our stringent criteria at more reasonable prices thus improving the upside potential of the Fund.
In Europe, indicators like business and consumer confidence, consumer spending, inflation and industrial activity have strengthened, but we remain cautious with upcoming elections in several core European Union countries. Like the U.K.’s vote to exit the European Union last year, if populist parties take power, the impact of election outcomes will remain uncertain for a long period of time. The Fund’s investments remain focused on core and northern European countries.
In addition, Japan provides a wealth of opportunities given the deep and broad universe of small companies. Improving trends in corporate governance also result in more companies meeting our strict quality standards. We continue to find innovative and disruptive Japanese companies that are shaking up their industries.
Our investment team is grateful for the opportunity to manage your assets.
Sincerely,
Roger Edgley, Ken Applegate, Linda Lasater and Kabir Goyal
For the period ended March 31, 2017, the average annual total returns of the Wasatch International Growth (Trades, Portfolio) Fund for the one-, five- and ten-year periods were 3.21%, 8.58%, and 4.94%, and the returns for the MSCI AC World Ex-U.S.A. Small Cap Index were 12.26%, 6.68%, and 3.04%. Expense ratio: Gross 1.48% / Net 1.48%.
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.
