(07/23/13) Finding the World's Best Growth Stocks

Wasatch Advisors has been around since the mid-80s, and has had many periods of outstanding performance; its new Wasatch Emerging Markets Select Fund has excellent long-term potential, for several reasons, notes Walter Frank of MoneyLetter.

First, it is managed by a team of international investors, led by Ajay Krishnan and Roger Edgley. Krishnan joined Wasatch Advisors in 1994 and has been a manager of the firm’s Ultra Growth, Global Small Cap, Global Science and Technology, and Emerging India funds and strategies.

Edgley, the firm’s director of international research, has guided various Wasatch international funds, including Wasatch International Growth, to excellent performance.

Before joining Wasatch more than a decade ago, Edgley had a sterling tenure at Wanger Asset Management (the Acorn funds), where he also specialized in small foreign stocks.

Second, Emerging Markets Select Fund (WAESX) is less tied than most of its competitors to the state of the global economy. The typical emerging market stock fund focuses on large companies within large emerging countries—for which exports to the developed world account for significant portions of their economies.

Since such companies tend to be cyclical, the funds themselves are very dependent on global economic growth. Though economically, cyclical stocks account for more than half the fund, sensitive stocks recently represented less than 10%.

Defensive stocks recently comprised 37% of assets, with energy and materials stocks adding up to only 6.3%. Chinese and Taiwanese stocks were recently absent from the fund, while South Korean equities clocked—in at just 3% of assets.

While India, South Africa and Brazil accounted for 15.0%, 12.3%, and 11.5%, respectively, such smaller emerging markets as Indonesia, Thailand, Turkey, the Philippines, and Hong Kong, account for between 9% and 10% each, vs. 3% or less apiece in the index.

Third, the fund provides above-average exposure to growing consumer classes within specific emerging countries. The managers attempt to find companies that are likely to benefit from behavioral changes resulting from urbanization, and from the increasing purchasing power among consumers in the emerging markets with growing, upwardly mobile populations.

In particular, the managers emphasize high-quality consumer discretionary and staples companies, which recently combined for 45% of assets, vs. 17% for the benchmark.

Fourth, Emerging Markets Select also is more diversified than the typical emerging markets stock fund. Though it holds only 30 to 40 stocks (with a maximum position size of 6%), it seeks to exploit investment inefficiencies in smaller emerging markets, where Wall Street devotes few analytical resources, and stocks may be underrated.

By contrast, Wasatch employs three portfolio managers and seven equity analysts, devoted specifically to international investing.

The fund offers especially notable exposure to small and midsize companies located in countries with relatively high birth rates. Though these markets are subject to their own specific risks, Wasatch attempts to manage volatility by investing in countries and stocks with below-average correlations.

In fact, over its six-plus months of existence, the fund has lost considerably less than half as much as its benchmark (about 4.6%, vs. about 10.0%).

Across each of its internally managed stock funds, Wasatch seeks to find what it calls “The World’s Best Growth Companies.” These companies tend to possess sustainable competitive advantages, above-average earnings growth as compared to competitors, and relatively conservative balance sheets.

Wasatch seeks out companies that can sustain above-average growth in revenue and earnings for many years, and whose stocks trade at reasonable prices, given the expected growth.

Wasatch estimates the portfolio of Emerging Markets Select offers three-to-five year annualized earnings growth of 20%, vs. 13% for the benchmark, and profitability of about a third better.

While Wasatch is best known for small-cap funds, Emerging Markets Select can invest across the size spectrum. In fact, the fund counts several graduates among its holdings from the small-cap emerging market stocks in its other international and emerging market funds.

Because of increases in market capitalization, they no longer qualify for the small-cap funds, but may be excellent candidates for Emerging Markets Select, so long as they still appear to be fairly early in their growth trajectories.

While many of these stocks may have attained market leadership and heft in their home countries, they may still have considerable room to grow. As of March 31, the weighted average market capitalization of the holdings within the fund was $7.8 billion, vs. $45.8 billion for the MSCI Emerging Markets Index.

Because of its youth and the poor recent performance from emerging markets generally, Emerging Markets Select had only $23.3 million in assets at the end of June.

Though emerging markets may continue to suffer in the short-run, this could prove to be an excellent time for long-term investors with a contrarian mind-set, to build positions at a time of maximum flexibility for the managers.

Available directly from Wasatch and through most discount brokerages, the fund has a minimum initial investment of $2,000 and a subsidized expense ratio of 1.69%, which isn’t bad for an actively managed, multi-cap emerging market stock fund.