Overview
The Wasatch International Growth (Trades, Portfolio) Fund—Investor Class continued to build on momentum from the first half of the year, returning 6.78% for the third quarter, which compares to the 6.90% return of its benchmark the MSCI ACWI (All Country World Index) ex USA Small Cap Index. The nine months through September 30, 2017 was a strong period for global stocks. The Wasatch International Growth (Trades, Portfolio) Fund rose 27.30% and the benchmark increased 23.54%.
Throughout the first nine months of 2017, investors continued to renew their focus on quality and growth stocks following last year’s outperformance of value stocks. This has been especially evident in countries like Japan where the quality focused JPX-Nikkei Mid and Small Cap Index increased 8.75% during the third quarter, outperforming the MSCI Japan Small Cap Index return of 6.31%. (These returns are in U.S. dollar terms.) The Nikkei Mid and Small Cap Index was launched on March 13, 2017, and includes companies that aim at “sustainably increasing corporate value.” As one might expect, to be included in this Index a company must meet quantitative measures, such as three-year average return on equity (ROE) and three-year cumulative operating profit. Interestingly, a company must also meet qualitative standards such as strong corporate governance. For example, a company must have appointed at least two independent outside directors and have disclosure of earnings information in English. These are actions that a company’s senior management and board of directors have more immediate control over and which can lead to improvement in the company’s quality.
Details of the Quarter
Three of our top five contributing stocks came from Japan. The Fund’s top contributor was Nihon M&A Center, Inc. (TSE:2127, Financial), a company that connects sellers and buyers of small businesses. Nihon M&A has been benefiting from the demographic trends of baby boomers retiring and looking to sell their businesses. It is one of the few firms servicing such small businesses, and management has enhanced the company’s market position by hosting informational seminars for sellers, and by building relationships with banks, accounting firms and other lead-generating sources. Nihon M&A also has a robust information-technology backbone, which allows multiple parties to submit information and leads, further enhancing its platform. MISUMI Group, Inc. (TSE:9962, Financial) was the Fund’s second-best contributor in Japan. MISUMI is the world’s largest manufacturer of dies, and also manufactures other items for factory floors such as bolts, nuts, etc. MISUMI manufactures nearly all parts in-house, and scale gives it a cost advantage versus competitors. With a heavy investment in rapid logistics between Japan, China and Vietnam, MISUMI has also entered the maintenance, repair and operations (MRO) business. Seria Co. Ltd., which operates a chain of 100-yen stores (essentially dollar stores), was also a top contributor as the company continued to generate strong earnings growth.
Japan Material Co. Ltd. (TSE:6055, Financial), whose primary business is to build and maintain the infrastructure for gases used in semiconductor manufacturing plants, and en-japan, Inc. (TSE:4849, Financial), which operates an online job site and provides recruitment agency services, are smaller weights in the portfolio, but both stocks were up more than 40% and contributed to the Fund’s return.
The fundamentals of the Japanese companies in which we have invested have been strong and their valuations seem reasonable to us. Contrary to what many headlines would lead one to believe, we have seen improvements in the investing environment in recent years. We believe that the macro environment in Japan is improving with unemployment near 20-year lows, wage inflation beginning to materialize, corporate governance improving and business confidence strong. While consumer spending is lagging, we are watching for improvements there too.
European stocks extended their gains from the first half of 2017 as corporate earnings and economic indicators continued to recover. Germany and France have been leading the pack. Both countries have held elections this year. The outcome of the election in Germany was somewhat predictable and benign. In France, the country’s voters opted to cast aside populism and support a president focused on economic growth. Emmanuel Macron’s pro-business plans include cutting taxes and reforming the labor market. We are encouraged that Macron has a lot of political support for his initiatives and is also supportive of the European Union (EU). To the extent economic activity improves, this could have a positive effect on the EU as a whole. Our investment team traveled to France and Germany during the third quarter and the outlook of company management teams we met with is one of optimism.
Of particular note is the outperformance of domestic facing cyclicals over global cyclicals within Europe, which indicates to us that performance is being driven more by Europe-centric factors than by improvement in the global economy. An example of a company benefiting from this dynamic is Maisons du Monde S.A. (XPAR:MDM, Financial), a furniture retailer based in France. The company focuses on the “affordable luxury” or “inspirational affordable” category. For years, management has embraced a true omni-channel approach, which they believe will be a winning business model over the long term. They have been extremely successful in France and have been expanding throughout Europe in recent years where online sales of home goods are underpenetrated. They are creating a network across the continent, which presents a significant barrier to entry for would-be competitors. In addition, we like the company’s clear strategic plan and growth focus.
Our investments in India took a breather in the third quarter following strong performance in the first half of 2017. We continue to believe that structural reforms implemented by the Modi government will be positive for our Indian holdings over the long term.
It was a tough quarter for our Australian holdings as both Domino’s Pizza Enterprises Ltd. (DPZ, Financial) and Technology One Ltd. (ASX:TNE) were a drag on performance. Domino’s has seen growth slow down in 2017 and also had negative press surrounding how some franchises pay their employees. Our investment team was in Australia during September and we remain impressed with the quality of Domino’s management and how innovative they are and how they use data and information technology to make their business better. We also met with a range of executives at Technology One, which gave us an even deeper understanding of the company’s culture and long-term growth aspirations. We have conviction in both companies over the long term and remain invested in both stocks.
Highlighting that we can find great companies in a variety of countries and sectors from around the world, other strong contributions during the quarter came from a technology company based in Singapore and a beverage company in the United Kingdom (U.K.). Venture Corp. Ltd. (SGX:V03) is a leading global electronics provider, offering an integrated range of electronic manufacturing services and original design manufacturing. While headquartered in Singapore, the company has global operations and has been remarkably stable and consistent within a fast changing industry. The stock benefited from improving trends for the company’s industrial and technology customers.
Fevertree Drinks plc (LSE:FEVR) is a premium drink mixers company, known most for its all-natural premium tonic. The company started in the U.K., but has had tremendous success expanding throughout Europe and in the U.S. In addition to geographic expansion, the company has been adding to its range of products with ginger ale and, more recently, cola. Strong earnings growth propelled Fevertree’s shares higher during the quarter. (Current and future holdings are subject to risk.)
Outlook
Emerging markets continued to perform well based on optimism over growth and returning investment. We have been seeing strength from the bottom-up as earnings are coming through at the company level. Emerging market currencies appear to have stabilized and are more competitive. Current account balances have improved for the majority of emerging markets and valuations are still below their long-term averages.
European corporate earnings have been recovering after years of underinvestment and economic indicators continued to improve. In the U.K., Brexit still clouds the future, though we remain optimistic regarding the prospects of our holdings in the country. A majority of our U.K. investments derive a meaningful portion of their revenue from outside the country, and so have been benefiting from increased global economic activity. We have seen signs that Brexit is weakening Britain’s domestic consumers, and since the referendum in June 2016, we have reduced our exposure to U.K. domestic focused companies.
We remain extremely positive on the investment outlook for Japanese small caps. We believe Japan is an inefficient market and remains misunderstood. We have seen improvements in the financial data from companies, and each time we visit Japan we return incrementally more positive. We believe the changes happening in Japan are positive and sustainable. We recently completed a research white paper titled Japan: Land of Generational Change, which explores our optimism for investing in Japan. Please visit our website to obtain your copy (www.WasatchFunds.com).
We have had a busy travel schedule this year. So we will spend the next few months in the office consolidating our thoughts, updating our models and screening the world for new and exciting investment opportunities. This will enable us to plan our research efforts for 2018. We already have research trips planned later in the fourth quarter to meet companies in the U.K., Europe and India. We are very excited about the future of investing internationally.
Thank you for the opportunity to manage your assets.
Sincerely,
Roger Edgley, Ken Applegate and Linda Lasater
