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This Emerging-Markets Fund Wins Big with Small Companies

The managers of Wasatch Emerging Markets Small Cap fund find opportunities to benefit from the growing middle class abroad.

While the developed world’s economies putter along, those of emerging markets zoom ahead. Deutsche Bank recently estimated that the gross domestic product of developing nations will increase 30% by the end of 2012 compared with just 5% for developed markets. By 2014, it said, emerging markets will account for 40% of the world’s GDP, up from 22% in 2000.

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A sense that emerging nations have put the recession well behind them has fueled a robust advance in the group’s shares. From the time most global stock markets bottomed on March 9, 2009, through July 29 of this year, Standard & Poor’s 500-stock index leaped an impressive 68%. But over the same period, the MSCI Emerging Markets index roared ahead 113%.

And proving that little guys can pack a big punch everywhere, small companies in emerging nations have performed even better. The MSCI Emerging Markets Small Cap index posted a spectacular 155% gain since the market’s bottom. Over the past year, the index returned 31% -- 8 percentage points more than the MSCI Emerging Markets index, 21 points more than the MSCI EAFE index (which tracks stocks in developed overseas markets) and 11 points more than the Russell 2000 index of U.S. small-company stocks.

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Wasatch Emerging Markets Small Cap (symbol WAEMX) is a good way to get in on the action. Over the past year, the fund returned 51%, beating its benchmark, the MSCI Emerging Markets Small Cap index, by 20 points and placing it in the top 1% of all diversified emerging-markets funds. It’s also tops in its category so far in 2010, with a 14% return.

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Although still just a toddler, the nearly three-year-old Wasatch fund has strong family roots. Co-managers Roger Edgley -- who also runs Wasatch’s International Opportunities (WAIOX) and International Growth (WAIGX) funds -- and Laura Geritz work closely with the three analysts and four other managers who are part of Wasatch’s international team. They also share ideas with Wasatch’s domestic managers and analysts.

In building the fund’s small-cap emerging-markets portfolio, Geritz and Edgley follow the same scrupulous stock-selection process that Wasatch has used at all of its funds over the past 35 years. The managers screen for companies with healthy balance sheets that are capable of financing growth in any part of the business cycle. They seek out capable management teams and often vet them in person (each manager spends about three months a year on the road). They also look for companies with a competitive advantage, such as a well-recognized brand name.

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It’s hard to find a more recognizable name than Colgate-Palmolive (CL), the big U.S. maker of toothpaste. So Geritz and Edgley have made Colgate-Palmolive India one of their fund’s biggest holdings. In addition to sporting a clean balance sheet and generating a lot of cash flow, Colgate-Palmolive India, which is 51% owned by its U.S. parent and trades on the Bombay stock exchange, should benefit from India’s rapidly growing middle class. In fact, says Geritz, 375 million residents of emerging markets are expected to achieve middle-class status over the next five years, and 90% of them will come from just three countries -- China, Indonesia and India. “One thing we don’t think about in the developed world is that a lot of people in the developing world don’t brush their teeth yet,” she says. So Colgate will have plenty of new customers bumping up sales of dental-care products.

In addition to India, the managers are excited about prospects in Egypt, Indonesia, Malaysia, Mexico and Thailand. “We think these markets are ignored by most investors,” says Geritz. “So we see great opportunities there.”

The fund’s largest holding at last report was Holcim Indonesia (HCMLY.PK), one of just three cement companies in the world’s fourth most-populous country. “Cement in the emerging world is not anything like it is in the developed world,” says Geritz. “In these countries, it’s a consumer good, so owning Holcim is like owning a retail stock.”

Keep in mind that both small companies and emerging markets carry above-average risks. So a fund that combines those two categories will likely take you on a bumpy ride. During the 2007-09 bear market, when the EAFE index plunged 59%, Wasatch Emerging Markets Small Cap tumbled 64%. Another downside: The fund’s annual expense ratio is a stiff 2.1%. Wasatch requires a minimum initial investment of $2,000.

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