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

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Q3 2017
Small Caps Extended Year-to-Date Gains
by John Malooly, CFA

“We’re always trying to gain a better understanding of our management teams, as their decisions drive the success or failure of our portfolio companies.”

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For the period ended September 30, 2017, the average annual total returns of the Wasatch Ultra Growth Fund for the one-, five- and ten-year periods were 22.13%, 14.29% and 6.86%, the returns for the Russell 2000 Growth Index were 20.98%, 14.28% and 8.47%.  Total Expense Ratio: Gross 1.43%.

 

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

Stocks of small growth companies extended their year-to-date gains, with the benchmark Russell 2000 Growth Index rising 6.22% for the third quarter. The Wasatch Ultra Growth Fund slightly outperformed the benchmark with a gain of 6.55%.

U.S. equities pushed higher in what was a fairly uneventful quarter for financial markets. After pulling back modestly during the first half of the period amid rising political tensions on the Korean peninsula, stocks staged a six-week rally that recaptured and surpassed earlier gains.

News that the Federal Reserve (Fed) will begin winding down its quantitative-easing program in October was met with limited market reaction. Though the announcement raised concerns about the impact of tighter monetary conditions, the perception that the Fed may be signaling stronger economic growth boosted cyclical stocks.

Stock selection in health-care and information-technology was one of the major reasons the Fund surpassed its benchmark. Our significant holdings in these areas reflect the substantial growth opportunities we have been finding in them. Innovative companies in health care and information technology are generating rapid revenue and earnings growth by disrupting their industries and taking market share from their competitors. Although we don’t have target sector weightings, health care and information technology have provided fertile ground for applying our growth-oriented, bottom-up investment discipline to prospective holdings.

The Fund’s real-estate stocks produced a solid gain and outperformed their benchmark peers. While none of these holdings were among the Fund’s top individual contributors, as a group they made a strong contribution to outperformance relative to the benchmark.

The Fund’s holdings in the financials sector underperformed their benchmark peers during the quarter, but we continue to believe their growth prospects are attractive. Within the sector, small banks in particular have at times struggled in recent years, as sluggish loan demand and low long-term interest rates pressured lending revenue. Better prospects on the interest-rate and housing fronts offered the possibility of improved business conditions for the banking industry.

Details of the Quarter

The strongest contributor to the Fund’s performance for the quarter was Sangamo Therapeutics, Inc. (SGMO). A clinical-stage biopharmaceutical company, Sangamo specializes in the treatment and cure of single-gene disorders. The company saw its stock price jump in early August after management reported better-than-expected financial results for the company’s most-recent quarter. Shares of Sangamo surged again later in the month when management announced the first patient infusion in its clinical trial of SB-525, an investigational gene therapy for the treatment of Hemophilia A. Despite its sharply higher stock price, we think Sangamo offers attractive value with significant upside potential for the Fund.

The Fund’s second-best contributor was Exa Corp. (EXA), a developer of simulation software that enables manufacturers to model aerodynamics, thermal management, fluid flow and other properties of their products. The company’s stock price soared in late September after management agreed to a competitor’s offer to acquire the company at a substantial premium to its then-current stock price.

Exact Sciences Corp. (EXAS), the third-largest contributor, is a biotechnology 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. Those benefits are resonating with patients, producing better-than-expected top- and bottom-line results in the company’s most-recent quarter. Management raised its full-year guidance for Exact Sciences and said it now hopes to sell 550,000 tests in 2017, up from 244,000 last year.

The greatest detractor from the Fund’s performance was Kornit Digital Ltd. (KRNT). An Israeli company, Kornit sells digital-printing machinery for the textile-printing industry. Kornit’s share price declined sharply after the company’s preliminary third-quarter results fell short of previous guidance. Management attributed the disappointment to a delay in permitting that prevented a key customer from taking delivery of a larger order. We view this as a temporary setback and expect the sale to proceed once the necessary permits are obtained. Because Kornit’s machines shorten supply chains and lead times for retailers, we think the company should benefit from current retail trends.

Genocea Biosciences, Inc. (GNCA), a developer of T cell-directed vaccines and immunotherapies to treat infectious diseases and cancer, was the second-largest detractor. Genocea’s stock price tumbled in September when management announced that the company was pivoting away from its lead candidate for the treatment of genital herpes to focus on cancer vaccines. Executives also said that Genocea’s staff would be cut by 40%. Considering the serious challenges we believe Genocea now faces, we sold the stock to seek better opportunities elsewhere.

The Fund’s third-largest detractor was Ultimate Software Group, Inc. (ULTI). The company provides cloud-based human resources software to businesses in the U.S. and Canada. Earnings topped Wall Street forecasts in its most-recent quarter, but revenues fell short of expectations. Citing longer implementation times in its backlog, management also lowered recurring-revenue guidance for the second half of 2017. Although investors reacted negatively to the news, we consider the revenue shortfall to be primarily a timing issue. Given our confidence in Ultimate Software’s highly respected management team, we continue to view the company as an attractive holding for the Fund. (Current and future holdings are subject to risk.)

Outlook

In recent years, advances in modern science have created a revolution in our understanding of human biology and the causes of disease. The resulting progress in our ability to treat diseases at a fundamental, curative level has produced functional cures and potential cures for a variety of afflictions.

In evaluating the investment potential of health-care companies seeking to develop new therapies, we consider three main aspects: science, management team, and market potential. We want companies with compelling science that addresses an important medical need. We consider the origin of the technology and how the company plans to translate scientific breakthroughs into treatments for humans.

The management team in some ways is more difficult to assess than the science. Because running a public company engaged in health-care research is a complex task even under the best of circumstances, recovery from missteps often proves difficult. In our experience, the best management teams contemplate a wide range of outcomes and develop appropriate contingency plans. We’re always trying to gain a better understanding of our management teams, as their decisions drive the success or failure of our portfolio companies.

The final element is the market potential for a new treatment or cure. Solving an unmet medical need generally creates high barriers to entry for would-be competitors and generates substantial cost savings for the health-care system and society. Looking forward, a growing risk for investors is that biotechnology companies in particular may become “victims of their own success.” That is to say, the variety of ways being developed to treat diseases may produce a corresponding variety of competing solutions. As a result, unmet medical needs may be harder to find in the future, which would be very good for society.

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.

Quantitative easing is a government monetary policy used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

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. 

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