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

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Q2 2018
Rapid Growth of Our Companies’ Dividends Suggests a Bright Future
by Sam Stewart, CFA

“I’ve used some of our cash anchor to add to our holdings of companies that have exhibited both the ability and the willingness to pay a growing stream of dividends.”

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 June 30, 2018, the average annual total returns of the Wasatch Strategic Income Fund for the one-year, five-year, and 10-year periods were 8.61%, 8.23%, and 7.85%, the returns for the S&P 500 Index were 14.37%, 13.42%, and 10.17%, and the returns for the Barclays Capital U.S. Aggregate Bond Index were -0.40%, 2.27%, and 3.72%.  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 during 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

The Wasatch Strategic Income Fund enjoyed a strong 3.42% return for the quarter ended June 30, which essentially matched the 3.43% gain of the S&P 500 Index (our stock benchmark) and which was well above the -0.16% loss of the Bloomberg Barclays US Aggregate Bond Index (our bond benchmark). If we were to annualize the Fund’s quarterly return, we would have been in double-digit territory—well above our high single-digit return goal.

Over the past year ended June 30, the Fund’s actual 8.61% return was spot-on our high single-digit return goal. That return was also on target in between the S&P 500 Index’s 14.37% gain and our bond benchmark’s -0.40% loss.

I’m pleased our Fund did well during the more volatile market environment of recent months in spite of my reducing our stabilizing cash anchor from about 20% to around 10%. As a reminder, I increased our cash position to about 20% in response to the market’s sharp decline from its January peak as a precautionary measure. As it’s become apparent that the selloff wasn’t an immediate precursor to economic woes, I’ve used some of our cash anchor to add to our holdings of companies that have exhibited both the ability and the willingness to pay a growing stream of dividends.

DETAILS OF THE QUARTER

Given the relative weakness of overseas markets, I’ve found several interesting companies to add to our portfolio. The primary business of Photo-Me International plc is a chain of internet-connected photo booths capable of producing photos that meet the qualifications for government IDs—easing the process of obtaining passports, driver’s licenses and identity cards. To investors, Photo-Me offers a 7% yield and has grown its dividend at more than a 5% annual rate over the past five years.

Warsaw Stock Exchange is another recent addition offering a dividend yield of 5.5% and growing its dividend at a more than 20% annual rate over the past five years. Poland, along with other Central European countries, has excellent growth prospects due to much cheaper labor than neighboring Germany.

While these new additions don’t offer quite as much yield as Alcentra Capital Corp. (ABDC) and Medley Capital Corp. (MCC), which are holdings I sold, I believe that Photo-Me and Warsaw Stock Exchange’s dividend-growth prospects more than offset their relative yield shortfall. Both Alcentra and Medley are business-development companies, which are required to pay out almost all of their earnings as dividends—so they have limited ability to grow their dividends. In fact, one of the reasons I sold both Alcentra and Medley was that these two companies recently cut their dividends.

Looking at the companies we currently own in the Fund, they’ve grown their dividends at a 9.5% rate over the past year. While their average dividend yield of approximately 2.3% may seem somewhat skimpy, the rapid growth of our companies’ dividends suggests a bright future.

I look forward to a time when one of our holdings generates an annual dividend that exceeds the per-share price that we paid when we first purchased the stock. In that regard, Home Depot, Inc. (HD) seems to be the closest to the target. The company’s $4.12 dividend, while only a 2% yield on Home Depot’s current stock price, represents more than a 20% yield on our original sub-$20 per-share purchase price. Granted, the $4.12 dividend still has a long way to go before it reaches $20. But it’s more than four times the $0.90 dividend that Home Depot was paying when we first bought the stock.

Higher oil prices propelled Suncor Energy, Inc. (SU), a leading oil-shale producer, into the top spot among the Fund’s quarterly contributors to performance. Magellan Midstream Partners L.P. (MMP) was our second-largest contributor. My energy strategy has evolved over the years into holding only these two companies at large enough weights to match the benchmark weight. Suncor is akin to a manufacturer in that the company has a very large supply of shale, which can be converted into oil at a relatively fixed cost. This is in contrast with many energy companies that continually have to search for new oil as their wells tend to have short lives. Suncor offers a 2.5% yield and has grown its dividend over the past five years at an annual rate of almost 20%.

Magellan is very different in that it’s a pipeline company that mostly depends on volume-related fees. Volume is somewhat helped by “take or pay” contracts, which require users to pay for capacity on the pipeline. Most of Magellan’s pipelines connect reliable supply sources to refiners, which convert raw oil into usable products like gasoline. Unlike many energy companies, Magellan is more affected by energy volume—which tends to be relatively steady compared to more volatile energy prices. Magellan offers a yield over 5%, and over the past five years has grown its dividend at an annual rate of more than 10%.

MasterCard, Inc. (MA) was a leading contributor for the past year, and Visa, Inc. (V) was not far behind. Both companies were also among the leading contributors for the quarter. These companies have been benefiting from the replacement of cash by credit cards and other means of digital payment.

A somewhat new holding, BE Semiconductor Industries N.V. was the largest detractor from the Fund’s performance. It’s disappointing to me that BE Semiconductor’s price has moved down from our purchase price as doubts have crept in about the semiconductor cycle. The most recent news from BE Semiconductor was that the company’s contract to supply equipment to a smartphone maker was canceled. We continue to own BE Semiconductor, as I believe it’s a top-quality company. Furthermore, BE Semiconductor’s rapidly growing dividend now provides more than a 10% yield, in part due to the decline in the stock price. (Current and future holdings are subject to risk.)

OUTLOOK

While President Trump’s trade-war continues to unsettle the market, I believe that economic fundamentals are solid. The economy is growing, and inflation is contained. I’m always on the lookout for signs of a potential accident, but I believe our Fund is positioned to cope with adverse economic changes.

As mentioned at the beginning of the commentary, I will be leaving Wasatch Advisors to join Seven Canyons Advisors, a recently-established SEC-registered investment advisor. 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, which I plan to manage at Seven Canyons.

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.

Dividend yield is a company’s annual dividend payment divided by its market capitalization, or the dividend per share divided by the price per share. For example, a company whose stock sells for $30 per share that pays an annual dividend of $3 per share has a dividend yield of 10%.

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.