Wasatch Strategic Income Fund® (WASIX)  Invest in this Fund 

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Q1 2018
The Quarter Was Full of Sound and Fury
by Sam Stewart, CFA

“Long experience has taught me that the key to successful investing is to strike a balance between being ‘frozen at the wheel’ and making so many zigs and zags that there’s a risk of going off the road.”

Strategic Income
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The Fund has a concentration in the financials sector. Investing in concentrated funds can be more volatile and loss of principal could be greater than investing in more diversified funds. The financials sector can be significantly affected by various market factors, which are described in more detail in the prospectus.
With respect to the Fund’s assets invested in fixed income securities, you are subject, but not limited to, the same interest rate, inflation and credit risk associated with the underlying fixed-income securities owned by the Fund. Return of principal is not guaranteed.
Investing in small or micro cap funds will be more volatile and loss of principal could be greater than investing in large cap or more diversified funds.
Investing in foreign securities, especially in emerging markets, entails special risks, such as currency fluctuations and political uncertainties, which are described in more detail in the prospectus.

For the period ended March 31, 2018, the average annual total returns of the Wasatch Strategic Income Fund for the one-year, five-year, and 10-year periods were 7.45%, 7.48%, and 7.10%, the returns for the S&P 500 Index were 13.99%, 13.31%, and 9.49%, and the returns for the Barclays Capital U.S. Aggregate Bond Index were 1.20%, 1.82%, and 3.63%.  Expense ratio: Gross 1.58% / Net 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.

A NOTE REGARDING PROPOSED CHANGES TO THE WASATCH STRATEGIC INCOME FUND

According to an announcement made subsequent to the end of the quarter, it is planned that portfolio manager Sam Stewart will leave Wasatch Advisors to join Seven Canyons Advisors, LLC, an SEC-registered investment advisor recently established by members of the Stewart family. In addition to his departure, the Wasatch Funds Board of Trustees approved a plan to merge the Wasatch Strategic Income Fund into a new fund with similar objectives and strategies to be managed by Sam at his new family-owned firm. The Wasatch Funds Board of Trustees approved the merger plan, concluding it’s in the best interest of the Fund’s shareholders.

Overview

Unlike most recent quarters, the quarter ended March 31, 2018 was “full of sound and fury,” but possibly, as Macbeth noted, “signifying nothing.” 

Or, perhaps the shift in the market environment from tranquility to volatility does reflect a shift from a one-way market to a two-way market. The one-way up market we enjoyed for over a year was driven by improving business conditions and prospects for a tax cut. Since the tax cut has been realized, its anticipation can no longer drive the market. Further improvement in the economy is somewhat problematic as it is running so close to capacity. The fluctuations of February and March may signify that we are now in a more normal two-way market.

DETAILS OF THE QUARTER

The volatility of February and March took the market down from its January peak. The market ended the quarter just about flat with our S&P 500 Index benchmark showing a slight loss of -0.76%. The Wasatch Strategic Income Fund didn’t do quite as well, ending with a decline of -1.67%, which was also slightly worse than the -1.46% decline of our Bloomberg Barclays US Aggregate Bond Index benchmark. 

Over the past year, I worked our precautionary cash balance down in order to participate in a market that was moving virtually straight up. However, when the market changed from a one-way market to a two-way market at the beginning of February, I raised cash back to the 20% level, which helped to make the Fund’s performance less volatile than that of the S&P 500 for the rest of the quarter. Reflective of this lower volatility is the Fund’s beta of 0.71.

Herbalife Ltd. (HLF) and Mastercard, Inc. (MA) each contributed over half a percentage point to the Fund’s return during the quarter. Herbalife’s earnings were better than expected as it demonstrated that its business would not be adversely affected by the Federal Trade Commission’s tightened rules regarding direct-marketing companies. Mastercard’s strong performance was likely due to an increasingly digitized economy moving away from cash toward electronic payments.

Unfortunately, during the quarter, both Comcast Corp. (CMCSA) and Magellan Midstream Partners L.P. (MMP) subtracted more than half a percentage point from performance. Comcast, the Fund’s largest position, spooked investors by announcing a bid for Sky plc, a United Kingdom-based satellite television company. Investors feared this was a backward-looking, empire-building move as the number of video subscribers continues to decline. Comcast argued that Sky is not significantly comparable to United States-based satellite companies as it produces a substantial amount of original content. In addition, Sky would provide Comcast’s NBC unit with improved access to foreign markets. I decided to trim our position, but the Fund still maintains a substantial holding in Comcast.

Magellan’s decline was in part due to fears of being adversely affected by a Federal Energy Regulatory Commission (FERC) ruling that Master Limited Partnerships (MLPs), such as Magellan, would no longer be permitted to recover an income-tax allowance in their cost of service. However, as Magellan expects minimal to no impact from the FERC policy change, we continue to hold our full position.

For the 12 months ended March 31, 2018, the Fund produced a return of 7.45%, which is on target between the 13.99% return of its S&P 500 stock benchmark and the 1.20% return of its bond benchmark. Further, it is spot on our high single-digit return goal. As noted above, for 10 of the past 12 months the market went virtually straight up. Our large cash position proved to be unneeded ballast, which in hindsight, served as a drag on performance. However, during the final two months of the 12-month period, the ballast demonstrated that it could be very useful as the Fund was not only less volatile than the S&P 500, but it also outperformed.

For the year, Visa, Inc. (V) joined Herbalife and Mastercard in contributing more than one percentage point to the Fund’s return. Mastercard itself contributed nearly two percentage points. Fortunately, for the year no stock subtracted more than one percentage point. (Current and future holdings are subject to risk.)

OUTLOOK

Looking forward, I will continue to search for companies with both the ability and willingness to pay a growing stream of dividends. I believe that holding such companies over long time periods will allow for the compounding effects that such a growing stream of dividends provides. As I noted at the outset, we may have shifted into a tougher market environment. I will continue to navigate cautiously as I believe that preservation of capital is important to the Fund’s shareholders. 

Sincerely,

Sam Stewart

 

**The S&P 500 Index includes 500 of the United States’ largest stocks from a broad variety of industries. The Index is unmanaged and is a commonly used measure of common stock total return performance.

The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, mortgage-backed securities (MBS) (agency fixed-rate and hybrid adjustable-rate mortgage [ARM] pass-throughs), asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS) (agency and non-agency).

You cannot invest directly in these or any indexes.

CFA® is a trademark owned by CFA Institute.

The Wasatch Strategic Income Fund’s primary investment objective is to capture current income. A secondary objective is long-term growth of capital.

††The 30-day current net (“SEC”) yield is calculated by dividing the net investment income per share for the 30 days ended on the date of calculation by the maximum offering price per share on that date. The figure is compounded and annualized.

Bloomberg Barclays US Aggregate Bond Index covers the U.S. investment grade fixed rate bond market, including government and corporate securities, agency mortgage pass-through securities, and asset-backed securities. To be included in the index the security must meet the following criteria: must have at least one year to final maturity, regardless of call features; must have at least $100 million par amount outstanding; must be rated investment grade or better by Moody’s Investors Service, Standard & Poor's, or Fitch Investor's Service' must be fixed rate, although it can carry a coupon that steps up or changes to a predetermined schedule' must be dollar-denominated and nonconvertible. All corporate and asset-backed securities must be registered with the SEC and must be publicly issued.  The S&P 500 Index represents 500 of the United States’ largest stocks from a broad variety of industries. The Index is unmanaged, and a common measure of common stock total return performance. 

You cannot invest directly in indexes.

View the Strategic Income 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.

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CFA® is a trademark owned by CFA Institute.