Wasatch Ultra Growth Fund® (WAMCX)  Invest in this Fund 

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Q1 2018
Volatility’s Return Offered Opportunities as Well as Risks
by John Malooly, CFA

“By establishing new Fund positions in “beaten down” stocks, we were able to purchase what we believe are attractive growth companies at significant discounts to their recent valuations.”

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For the period ended March 31, 2018, the average annual total returns of the Wasatch Ultra Growth Fund for the one-, five- and ten-year periods were 30.39%, 15.05% and 10.65%, the returns for the Russell 2000 Growth Index were 18.63%, 12.90% and 10.95%.  Total Expense Ratio: Gross 1.35%.

 

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.

Wasatch Funds will deduct a 2.00% redemption proceeds fee on Fund shares held 60 days or less. Performance data does not reflect the deduction of fees, including sales charges, or the taxes you would pay on fund distributions or the redemption of fund shares. Fees and taxes, if reflected, would reduce the performance quoted. Wasatch does not charge any sales fees. For more complete information including charges, risks and expenses, read the prospectus carefully.

Wasatch Funds are subject to risks, including loss of principal.

Overview

U.S. equities got off to a rocky start in 2018, as several of the major averages finished lower during the first quarter. Growth stocks outperformed value stocks in a pattern that has held for most of the past five years. Small-company growth stocks did even better, with the benchmark Russell 2000 Growth Index rising 2.30%. The Wasatch Ultra Growth Fund gained 6.73% and surpassed its benchmark.

Rising interest rates and worries about a global trade war brought severe volatility to financial markets during February and March. While storms were raging on Wall Street, however, our portfolio companies were quietly generating solid earnings growth for the most part. Over the past year or so, we’ve been making subtle shifts to tilt the Fund toward higher-quality companies whose earnings are more predictable, while trimming companies whose prospects are especially difficult to evaluate. Those moves appear to have helped the Fund outgain its benchmark during a first quarter in which general uncertainty increased.

One of the factors adding to the market’s jitters was the narrowing spread between short-term interest rates and long-term interest rates. Because banks typically pay short-term rates of interest to obtain funds—which they then lend out at long-term rates—a “flattening” in yields tends to hurt the banks’ profitability. In addition, many investors consider a flat or inverted yield curve to be a harbinger of recession.

During periods of extreme turbulence in the market, stocks of companies that report disappointing news are often severely punished—sometimes unfairly so. We attempted to use that tendency to the Fund’s advantage in the first quarter. By establishing new positions in a small number of such “beaten down” stocks, we were able to purchase what we believe are attractive growth companies at significant discounts to their recent valuations.

We believe our intensive research and focus on the fundamentals of individual companies helps us identify companies with the potential to outperform. In addition to the strong showing of the Wasatch Ultra Growth Fund in the first quarter, the Fund outperformed its benchmark for the one-, three- and five-year periods ended March 31, 2018.

Details of the Quarter

Health care was by far the Fund’s largest source of outperformance relative to the benchmark in the quarter. The sector accounted for our two strongest contributors, Tandem Diabetes Care, Inc. (TNDM) and ChemoCentryx, Inc. (CCXI), respectively.

Tandem offers insulin-delivery systems for people with diabetes. The company’s flagship product is the t:slim X2 insulin pump, which integrates with Dexcom’s fifth-generation continuous glucose monitor (CGM). Sales in Tandem’s most-recently reported quarter were the strongest in the company’s history, as pump shipments increased 80% over the previous sequential quarter. In addition, Tandem’s recently completed equity raise has strengthened its balance sheet and appears to have removed a major source of investor uncertainty.

ChemoCentryx is a biopharmaceutical company developing orally administered therapeutics for autoimmune diseases, inflammatory disorders and cancer. Its lead drug candidate is avacopan, an orally-administered small molecule currently in late-stage clinical trials for the treatment of orphan and rare renal diseases. Shares of ChemoCentryx surged in January on news that its application for Conditional Marketing Authorization for avacopan had been accepted for regulatory review by the European Medicines Agency (EMA). ChemoCentryx also announced that the EMA’s validation of the application had triggered a milestone payment from the company’s partner in the drug’s development.

Software stocks were another area of first-quarter strength for the Fund. Business-software specialist Zendesk, Inc. (ZEN) was a notable contributor in the group. The company saw its stock price rise throughout the quarter amid continued investor optimism about the increasing number of large organizations using Zendesk’s platform. The company’s shares got another boost in February after Zendesk reported year-over-year quarterly sales growth of 39%, better-than-expected earnings results and a positive outlook for continued strong growth over the remainder of 2018.

The Fund’s greatest detractor from performance for the quarter was PDF Solutions, Inc. (PDFS). The company provides technologies for optimizing the design and manufacture of integrated-circuit chips. Though PDF reported revenues and earnings in February that surpassed expectations, the stock fell sharply after management lowered guidance in response to a product delay and more-difficult competitive conditions for PDF’s customers. On the plus side, PDF’s design-for-inspection initiative appears to be gaining momentum. This new technology seeks to change the current paradigm of visual chip inspection by incorporating proprietary electrical characterization directly into the chip’s design, which enables customers to detect previously unknown defects and to do so in a non-destructive manner.

Second-largest detractor Exact Sciences Corp. (EXAS) is a molecular-diagnostics company with an innovative test for colon cancer. Named Cologuard,® the test avoids the high cost and invasiveness of a colonoscopy by screening a stool sample for cancerous and precancerous cells. Shares of Exact Sciences tumbled in March after the company’s selection of celebrity endorsers disappointed investors who had been expecting a higher-profile figure. Concerns about a new blood test that might provide future competition for Cologuard also appear to have tempered the enthusiasm of some investors. We used the weakness to add to our position after having sold shares at higher prices in October and November.

Another weak stock in the Fund was Freshpet, Inc. (FRPT). The company sells fresh, refrigerated meals and treats for dogs and cats in the U.S., Canada and the United Kingdom. Shares of Freshpet declined in March after earnings in the company’s most-recent quarter fell short of expectations. Investors also seemed dissatisfied with management’s guidance for 2018, which included a healthy increase in advertising spending. We think the additional advertising will accelerate top-line growth at Freshpet and continue to own the stock in the Fund. (Current and future holdings are subject to risk.)

Outlook

Aside from a recently launched investigation into Facebook’s privacy practices and a handful of other high-profile stories, the first-quarter corporate-news flow tended to be more positive than negative. Rather than company-specific developments or macroeconomic problems, financial markets themselves seemed responsible for the difficulties they encountered during the quarter.

In particular, specialized exchange-traded funds (ETFs) that had bet against an increase in volatility faced mounting losses as volatility returned to the stock market. The forced liquidation of these funds increased volatility further. The proliferation of index ETFs also did not help, as the frequently one-sided trading in index funds dragged the indexes and their component stocks along for the ride.

The flattening of the yield curve for U.S. Treasury securities presents something of a conundrum for investors. The Federal Reserve (Fed) has signaled its intention to raise its short-term interest rate to around 2.5% to 2.75% by 2019. With the 10-year interest rate ending the first quarter at approximately 2.74%, likely possibilities suggest either a significant increase in long-term rates or a continued flattening of the yield curve. Because either one of these developments seem likely to spook investors, financial markets appear to be hoping that the Fed will back away from its targets.

We think companies taking market share and growing revenue will continue to be dear assets in the market and we like where the Fund is positioned, however, we also expect value stocks to come back into favor at some point. While we are sticking with our growth mandate, we expect to continue our defensive shift toward companies we view as being among the highest quality in our universe. We think those types of companies may help to reduce risk in the Fund during future periods of market volatility.

Thank you for the opportunity to manage your assets.

Sincerely,

John Malooly

 

 

**The Russell 2000 Growth Index measures the performance of those Russell 2000 Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell 2000 Index is an unmanaged total return index of the smallest 2,000 companies in the Russell 3000 Index. The Russell 2000 is widely used in the industry to measure the performance of small company stocks.

You cannot invest directly in these or any indexes.

Frank Russell Company is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. This is a presentation of Wasatch Advisors, Inc. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. Frank Russell Company is not responsible for the formatting or configuration of this material or for any inaccuracy in Wasatch Advisors, Inc.’s presentation thereof.

CFA® is a trademark owned by CFA Institute.

The Wasatch Ultra Growth Fund’s primary investment objective is long-term growth of capital. Income is a secondary objective, but only when consistent with long-term growth of capital.

Earnings growth is a measure of growth in a company’s net income over a specific period, often one year.

An Exchange-Traded Fund (ETF) is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on a securities exchange. ETFs experience price changes throughout the day as they are bought and sold.

Valuation is the process of determining the current worth of an asset or company.

The yield curve is a line on a graph that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares three-month, two-year, five-year and 30-year U.S. Treasury securities. This yield curve is used as a benchmark for other interest rates, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.

The Russell 2000 Growth Index measures the performance of the Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.   Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. 

You cannot invest directly in indexes.

View the Ultra Growth Fund’s most current Top 10 Holdings

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CFA® is a trademark owned by CFA Institute.