Wasatch Emerging Markets Small Cap (ticker symbol WAEMX) is a mutual fund with approx. $1.8 billion in assets managed by Roger Edgley, CFA and Laura Geritz, CFA. Currently, Morningstar rates the fund Five Stars / Neutral in the US OE Diversified Emerging Markets category. The last Morningstar report on the fund, titled “Don’t forget about this closed fund’s risks or costs.” was published in January 2013. The fund is currently closed to new investors. Let’s take a look at the fund’s performance using the Alpholio™ methodology.

First, the total return chart, which includes a reinvestment of all distributions into the fund and each member of the reference portfolio, respectively:

Cumulative Return of WAEMX and Reference Portfolio

The chart shows three distinct phases:

  • In 2008, the fund underperformed its reference portfolio.
  • In 2009-10, the fund recovered.
  • From 2011 onwards, the fund’s performance roughly matched that of its reference portfolio.

This is further illustrated by the cumulative RealAlpha™ chart:

Cumulative RealAlpha™ for WAEMX

In the chart, the lag cumulative RealAlpha™ curve is permanently offset from the regular RealAlpha™ due to a large difference between the fund’s and reference portfolio’s returns in January 2008 (-10.7% vs. -5.2%). While by early 2011 the fund restored the cumulative RealAlpha™ it lost in 2008-09, its subsequent performance has been mixed.

The overall statistics further describe the fund’s unimpressive performance:

WAEMX Statistics

At over 29%, the fund’s volatility, measured by an annualized standard deviation of monthly returns in the entire analysis period, was very high compared to that of the overall stock market. The volatility of the reference portfolio, at about 22%, was significantly lower than that of the fund. The overall discounted annualized RealAlpha™ of the fund was just over 1%, which did not justify the elevated volatility.

The following chart demonstrates the use of smoothed RealAlpha™ to automatically generate a hypothetical trading signal for the fund:

Buy-Sell Signal for WAEMX (Smooth)

The analysis starts with an assumption that the investor initially bought the fund in early 2008 and intended to hold this investment indefinitely, i.e. at least through early 2013. The blue curve depicts the cumulative RealAlpha™ in that entire period. Since there is some degree of high-frequency oscillation in that curve, its longer-term trend can be elicited from a smoothed approximation, depicted by the green curve. Subsequently, a simple decision criterion is applied to determine whether the investment in the fund should be retained. As long as the fund generates positive monthly increments to cumulative RealAlpha™, the investment in the fund is considered beneficial. Conversely, if the fund’s cumulative RealAlpha™ begins to consistently decrease, the investment is no longer considered attractive.

The signal would allow an investor to avoid periods of the fund’s underperformance in 2008-09 and 2011-12.

The following chart shows the major investment “themes” of the fund over time:

Reference Weights for WAEMX

In the analysis period, the fund held equivalent equity positions in EWM (iShares MSCI Malaysia ETF; average weight of 41.2%), JKH (iShares Morningstar Mid-Cap Growth ETF; 22.1%), EWT (iShares MSCI Taiwan ETF; 14.6%), EWS (iShares MSCI Singapore ETF; 12.3%), EWZ (iShares MSCI Brazil Capped ETF; 4.7%), and FXI (iShares FTSE China Large-Cap ETF; 2.6%).

For clarity, smaller reference positions are collectively represented by the Other category in the chart. For example, this category includes an equivalent position in EZA (iShares MSCI South Africa ETF; average weight of 2.5%).

A recent article from Barron’s states that:

“Given the harder-to-parse valuations, lack of stocks traded on a U.S. exchange, and the illiquidity of many of these markets, it makes sense to use mutual funds. Investors looking for a purer play on this theme can look at the Wasatch Emerging Markets Small Cap fund, which has beaten 99% of its peers in the past three- and five-year periods…”

Given the results of this analysis (incl. the high volatility and unimpressive RealAlpha™), the fact that the fund is closed to new investors, and the high expense ratio of the fund (gross 2.13% / net 1.95% through 1/31/2014), investors may want to consider an alternative ETP portfolio.

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