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

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1Q19
Equities’ Recent Gains Call for Cautious Expectations
by John Malooly, CFA

“While the current investment environment demands modest expectations with respect to short-term returns, we believe our investment approach retains its appeal over appropriately longer horizons.”

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For the period ended March 31, 2019, the average annual total returns of the Wasatch Ultra Growth Fund for the one-, five- and ten-year periods were 23.17%, 13.92% and 19.96%, the returns for the Russell 2000 Growth Index were 3.85%, 8.41% and 16.52%.  Total Expense Ratio: Gross 1.25%.

 

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

The Wasatch Ultra Growth Fund gained 18.90% during the first quarter of the year and outpaced its benchmark, the Russell 2000 Growth Index, which rose 17.14%. Equity prices moved higher amid signs of easier U.S. monetary policy and hopes for a speedy resolution to the trade dispute between the U.S. and China.

Economic data released during the quarter showed a U.S. economy that was beginning to slow. According to a report from the Commerce Department in March, gross domestic product (GDP) grew just 2.2% during the fourth quarter of 2018—down from 3.4% in the third quarter—and the U.S. Federal Reserve (Fed) projected slower growth for 2019. Citing the slowdown, Fed officials signaled no interest-rate hikes this year. In the days following the announcement, safe-haven demand sent the yield on the 10-year Treasury note below the yield on the three-month Treasury bill for the first time since 2007. The so-called yield-curve inversion heightened fears of a coming U.S. recession.

As bottom-up investors, we don’t make macroeconomic or political forecasts—and we certainly don’t allow them to drive our investment approach. Instead, we take events and data as they come, factoring them into our assessments of individual companies and industry exposures. In addition to considering the effects of an inverted yield curve on small banks, we continually reassess the near-term risks and earnings profiles of our companies as they relate to macro issues such as their trade exposure to China. Generally speaking, corporate earnings face more difficult year-over-year comparisons in 2019 after benefiting from a tax cut that slashed the corporate rate to 21% last year.

With the economic outlook appearing more uncertain, growth stocks outperformed value stocks during the first quarter. A mainstay for growth investors, information-technology (IT) led the advance in equities and was the Fund’s largest source of outperformance relative to the benchmark. Our IT stocks outgained the IT positions in the benchmark, and our overweight position was a tailwind to performance.

Consumer discretionary was another source of strength relative to the benchmark, driven by the strong performance of our holdings across the sector and outsized gains in a few individual holdings. Areas of weakness against the benchmark were few and largely insignificant, as the Fund’s contributors offset detractors in most sectors of the market.

Details of the Quarter

The strongest contributor to Fund performance for the quarter was Paylocity Holding Corp. (PCTY). The company provides software for payroll and human-capital management using the software-as-a-service business model. Paylocity saw its stock price rise in concert with the stock of a competitor after the other firm agreed to be acquired at a premium by a private investor group. Incidentally, we also owned the competitor that was acquired—Ultimate Software Group, Inc. (ULTI). We think Paylocity stands to benefit as Ultimate adjusts to the influences of its new owners. Private equity firms excel at attracting value, but creating value is a more challenging endeavor. For Paylocity, better-than-expected revenues, earnings and forward guidance also helped push its stock higher during the first quarter.

Tandem Diabetes Care, Inc. (TNDM) was the second-best contributor. The company offers insulin-delivery systems for people with diabetes. Shares of Tandem jumped in February on better-than-expected quarterly results and strong guidance for 2019. Total pump shipments surged 133% versus the year-ago quarter, sending revenues 89% higher and pushing earnings into the black sooner than analysts had been expecting.

Tandem provides a good example of the role that research, discipline and conviction can play when investing in small companies. Tandem’s stock price tumbled in 2016 after the unexpected approval of a competitor’s next-generation insulin pump caused patients to postpone their purchases of pumps until the newer model became available. Compounding the company’s woes was its need to raise additional capital at prices that severely diluted the interests of existing shareholders. Nevertheless, we believed the superiority of Tandem’s product would either result in the company’s acquisition at a premium or enable the management team to right the ship. Our assessment proved correct and the stock price increased 35-fold in less than 18 months.

Another strong stock in the Fund was Wayfair, Inc. (W), a rapidly growing e-commerce retailer of home goods. The company has become a major player in online sales of furniture and home furnishings in the U.S., and has also begun expanding in Canada and Europe. Wayfair’s share price soared in February after the company reported a 40% year-over-year increase in revenues in its most-recent quarter and a narrower-than-expected loss. Although we typically avoid companies in head-to-head competition with Amazon, Wayfair’s well-established niche and competitive advantage in shipping large items make the stock an attractive holding in our view.

The greatest detractor from Fund performance for the quarter was Metro Bank plc. One of the so-called challenger banks established in the U.K. after the financial crisis, Metro is noted for its superior customer experience. Metro’s shares plunged in January after the bank disclosed that it had applied an incorrectly low risk weighting to parts of its loan book. The stock fell again in February on news that Metro will have to raise about $464 million of additional equity in order to put more capital behind the misclassified loans. The bank now faces the prospect of having to issue stock at prices that are highly dilutive to the ownership stakes of existing shareholders.

Events at Metro Bank have raised concerns about the bank’s internal controls and the credibility of its management team. Management’s shifting account as to how the errors were discovered has served only to make investors more uneasy. Metro’s regulator also wants to understand the situation. Meanwhile, the bank’s ambitious growth plans have been impacted until the equity raise has been completed. We continue to hold the stock but are watching it closely.

The Fund’s second-largest detractor from 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. Investors reacted negatively in February to interim results from an early-stage study using the company’s zinc-finger gene-editing technology for the treatment of Hurler syndrome. However, we think it’s too early to draw conclusions until results from the study’s high-dose subjects have been released. Moreover, Sangamo has already developed a second-generation zinc-finger technology designed for greater editing efficiency. The company expects to begin clinical trials for the newer version later this year. It’s worth noting that, just after quarter end, Sangamo provided an unscheduled positive clinical-trial update and its stock rose almost 30%.

Healthcare Services Group, Inc. (HCSG) was also a significant detractor. HCSG provides outsourced housekeeping and nutritional services for hospitals, nursing homes and other health-care institutions. HCSG shares fell sharply in early March after the company disclosed that it would file its 2018 10-K report 15 days late. Management revealed the company had received a letter from the Securities and Exchange Commission in November 2017 seeking information about the way HCSG calculates and reports its earnings per share. The company also disclosed it received a subpoena from the commission concerning the matter in March 2018. With little else to go on, investors assumed the worst and sold the stock. We continue to monitor the situation for further developments.

Another weak stock in the Fund was NV5 Global, Inc. (NVEE). An engineering and construction-services firm, NV5 saw its stock price fall sharply in March after the company reported disappointing operating results and issued lower forward guidance. Also, management revealed that accounting oversights at NV5 had resulted in the company’s failure to enforce escalator clauses in some of its contracts. Despite these negatives, the stock was down less than -3%. We like NV5’s business prospects and expect robust global demand for infrastructure to sustain the company’s future growth. (Current and future holdings are subject to risk.)

Outlook

One of the main principles behind the Wasatch investment approach is the thesis that in the long run, earnings drive stock prices. Simply put, we believe companies that can compound their earnings at favorable rates over time will generate attractive long-term investment returns. Even so, fluctuations in expectations can have an outsized impact over shorter periods. We think the currently high levels of uncertainty provide good reason for investors to be cautious.

It has long been said that the stock market must climb a wall of worry. In the current environment, there is no shortage of macroeconomic worries for stocks to surmount. However, the wall-of-worry concept is based on the confidence that the worries will eventually be resolved and stock prices will rise. It’s also a good reminder that down markets correct imbalances and set the stage for future returns.

Regardless of the near-term outlook, our disciplined investment approach keeps us squarely focused on the growth prospects of individual businesses over long periods of time. We look for dynamic, innovative companies that can take market share and grow even in unfavorable economic environments. Interestingly, those types of companies tend to be the ones investors seek most during an economic downturn. While the current investment environment demands modest expectations for short-term returns, we believe our investment approach retains its appeal over appropriately longer horizons.

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.

The Wasatch Ultra Growth Fund has been developed solely by Wasatch Advisors, Inc. The Wasatch Ultra Growth Fund is not in any way connected to or sponsored, endorsed, sold or promoted by the London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). FTSE Russell is a trading name of certain of the LSE Group companies.

All rights in the Russell 2000 Growth Index vest in the relevant LSE Group company, which owns the Index. Russell ® is a trademark of the relevant LSE Group company and is used by any other LSE Group company under license.

The Index is calculated by or on behalf of FTSE International Limited or its affiliate, agent or partner. The LSE Group does not accept any liability whatsoever to any person arising out of (a) the use of, reliance on or any error in the Index or (b) investment in or operation of the Wasatch Ultra Growth Fund or the suitability of the Index for the purpose to which it is being put by Wasatch Advisors, Inc.

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.

As of March 31, 2019, the Wasatch Ultra Growth Fund was not invested in Amazon.com, Inc.

Earnings per share or EPS is the portion of a company’s profit allocated to each outstanding share of common stock. EPS growth rates help investors identify companies that are increasing or decreasing in profitability.

Gross domestic product (GDP) is a basic measure of a country’s economic performance and is the market value of all final goods and services made within the borders of a country in a year.

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

Portfolio holdings are subject to change at any time. References to specific securities should not be construed as recommendations by the Funds or their Advisor.

Read our Holdings Release Policy and why we have one.

CFA® is a trademark owned by CFA Institute.