Wasatch Core Growth Fund® (WGROX)  Invest in this Fund 

Investor Class | Institutional Class
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2Q19
Long-Term Methodology Bolstered by Patience and Mindfulness of Valuations
by JB Taylor, Paul Lambert and Mike Valentine

“Stock selection clearly matters. The Fund hasn’t just benefited from a rising tide of “beta” that lifts all boats. We seek innovative growth companies tied to secular themes that are resilient to uncertain regulatory and macro developments.”

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For the period ended  June 30, 2019, the average annual total returns of the Wasatch Core Growth Fund for the one-, five- and ten-year periods were 7.79%, 12.46% and 16.28%, the returns for the Russell 2000 Index were -3.31%, 7.06%, and 13.45%, and the returns for the Russell 2000 Growth Index were -0.49%, 8.63%, and 14.41%. Total Expense Ratio: 1.18%.

 

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

Building on strong performance in the first quarter, the Wasatch Core Growth Fund—Investor Class gained 7.61% during the second quarter and surpassed its primary benchmark, the Russell 2000 Index, which rose 2.10%. The Fund also exceeded its secondary benchmark, the Russell 2000 Growth Index, which increased 2.75%.

During the second quarter, U.S. stocks continued to exhibit heightened volatility. The market retrenched in May as the U.S.-China trade dispute heated up. Then, in June, the market recovered despite concerns about economic weakness, which were highlighted by statements from the Federal Reserve (Fed).

Growth stocks sustained their edge over value names during the quarter. Additionally, the outstanding performance of the industrials sector—both in the Fund and in the Russell 2000 Index—was a notable turnaround considering the negative sentiment regarding the sector that was prevalent at the end of 2018.

Another sector that contributed significantly to the Fund’s return was health care, where our company selections surpassed the Index constituents by a wide margin. When investing in health care, we seek innovative companies that are embracing technology to offer better products and services—often more cost effectively—than the competition.

The Fund’s outperformance of its primary benchmark during the second quarter was a direct result of advantageous stock selection across all the sectors in which we’re invested. Our bottom-up approach focuses primarily on already-profitable companies with experienced management teams, pricing power for their products and services, and the ability to drive their own destinies.

We believe our methodology, which has delivered excess returns despite periods of market stress, is bolstered by our patience and mindfulness of valuations. In other words, stock selection clearly matters and the Fund hasn’t just benefited from a rising tide of “beta” that lifts all boats. Across the Fund, we seek innovative growth companies tied to secular themes that are resilient to uncertain regulatory and macro developments.

Staying the Course—With Only Minor Adjustments

We didn’t make many changes to the Fund during the second quarter. But we did trim some of our long-term winners, and we redeployed that capital into the more-attractively valued companies in which we’re invested. So we’ve maintained good portfolio balance, and we’re comfortable that we have the right holdings at the appropriate weights in each sector.

Our long-term focus tends to minimize portfolio turnover. Our research process enables us to dive deep into analyzing the strength of a company’s management team, the size of its addressable market, the durability and extent of its growth potential, and how the company’s business model fits into our secular growth themes. We always ask, “Will this company be able to take market share and grow even in periods of economic weakness?”

With the bull market extending beyond 10 years, we remain vigilant regarding company valuations. So while our holdings in the Fund, on average, are somewhat more expensive—based on estimated forward price/earnings (P/E) multiples—than the names in the Russell 2000 Index, our companies are also outstanding both in terms of quality and growth rates. For example, as of June 30, 2019, the Fund’s average return on equity was 17.9% compared to the Russell 2000 Index at 3.0% and the Russell 2000 Growth Index at -0.3%.

We believe our emphasis on companies with solid earnings growth has helped drive the Fund’s outperformance of the Russell 2000 Index, which includes a relatively high proportion of businesses that are losing money. Additionally, stronger profitability usually means a company is more adaptable in times of market stress.

Everyone Has an App

We see the rapid digitalization of the economy and the innovative applications of technology as affecting companies in every sector and industry. One key development is the ability of even non-tech companies to establish more-personalized relationships with their customers through the use of mobile-phone apps. Several of the Fund’s holdings are technology companies that directly facilitate this secular trend or are companies that have embraced technology to gain a competitive advantage in the race to source, convert and retain customers.

Companies are increasingly utilizing mobile apps as critical sales tools. Today’s consumers are convenience-driven. Companies, large and small, have been finding that mobile apps help them to better engage with their customers, who are then likely to become more loyal and boost spending. In our view, most companies—whether business-to-business or business-to-consumer—will be left behind if they don’t integrate customer-facing technology into their operations.

We see Fund investment Q2 Holdings, Inc. (QTWO) as an enabler of the digitalization trend. Q2 focuses on delivering solutions, including mobile apps, to the customers of U.S. financial institutions like banks and credit unions. Customers increasingly want an app they can use on their phone to check balances, make deposits, transfer money and even get a loan. The financial institutions benefit because the convenience of using an app drives customer loyalty, improves efficiency and helps them stand out in a crowded field.

To stress the point that technology is ubiquitous and that mobile apps are helping companies in all sectors and industries gain a competitive advantage, we describe below two of our non-tech holdings that have embraced this trend.

Pool Corp. (POOL)—a leading distributor of chemicals, parts and supplies to pool-maintenance businesses—offers an app, POOL360, that allows maintenance businesses to search for and order materials and equipment for pool owners from the field. The app also enables maintenance businesses to provide instant customer quotes. A pool-maintenance competitor that doesn’t have such an app may need to research prices and check availability back at the office, activities that increase the workload and delay customer service.

Likewise, Valvoline, Inc. (VVV), a company that manufactures lubricants and car parts and operates oil-change service centers, has discovered the advantages of making a mobile app available. Valvoline customers can use the app to find the closest service center and view live estimated wait times.

Certainly, the adoption of technology to improve productivity and convenience isn’t a new theme. But we see mobile digitalization as a highly disruptive innovation that creates new direct relationships among companies, distributors and customers. As a result, mobile digitalization is a competitive consideration in more and more of the companies that we evaluate for investment.

Details of the Quarter

The Fund’s top contributor for the second quarter was RBC Bearings, Inc. (ROLL), which sells highly engineered precision bearings and components to the industrial, defense and aerospace industries. While the company’s industrial bearings business has posted satisfactory but not exceptional growth, the aerospace business has propelled the company and its valuation forward.

RBC’s stock declined in late 2018, perhaps on expectations that tariffs and higher interest rates would negatively affect industrial companies. We stayed the course—understanding that any near-term price decline was likely a long-term buying opportunity in what’s been a steady, double-digit earnings compounder. The stock’s resurgence in 2019 shows both how quickly market sentiment can change and how our patient, bottom-up perspective can benefit shareholders.

Another strong contributor to Fund performance was Copart, Inc. (CPRT), which processes and auctions salvaged vehicles primarily to licensed dismantlers, rebuilders and used-vehicle dealers. The company has been benefiting from high demand and a sufficient supply of wrecked vehicles. Sales and gross profits were both up about 15% in the most-recently reported quarter versus the same period a year ago.

Copart has been able to sustain operating margins even as capital expenditures have been on the rise for its expansion in the U.S., Germany, Brazil and Canada. The company has an unusually strong balance sheet, particularly for an operation growing on multiple continents. Copart has long been a prime example of how well-managed businesses can grow assertively while maintaining a healthy financial footing.

Hamilton Lane, Inc. (HLNE) also boosted Fund performance in the second quarter. The company is an asset-management middleman that provides high-net-worth individuals with institutional-type private-equity and other “alternative” investments. Hamilton Lane’s management and advisory fee revenue rose 12% for the fiscal year ended March 31st, while assets under management increased 14%. Fee-related earnings were up 11%.

Continuing its struggles from the first quarter, Metro Bank plc was one of the second quarter’s largest detractors from Fund performance. Troubles emerged in January when regulators discovered the bank had incorrectly applied low risk weightings to its mortgage book. In mid-May, the bank successfully raised £375 million ($467 million) in a highly dilutive sale of shares. Metro also disclosed measures to change its lending mix away from commercial real estate and loans to landlords.

Despite Metro’s missteps, we still hold the stock, in part because of the bank’s unique business model that drives customer loyalty, brand awareness and market share. Chief Executive Officer Craig Donaldson ranks among the United Kingdom’s most-favorably viewed CEOs in employee surveys, while Metro’s “Net Promoter Score”—an indicator of how likely a customer is to recommend a company—is well above industry peers.

Proofpoint, Inc. (PFPT) was another significant detractor during the quarter. Over a much-longer period, we had significant gains in the stock. We trimmed our position as part of our effort to take profits and reduce the Fund’s exposure to companies with higher valuations. Proofpoint offers a SaaS (Software-as-a-Service) cybersecurity and enterprise email solution that leverages the cloud-computing trend. (Current and future holdings are subject to risk.)

Outlook

While we’re very pleased with the short-, intermediate- and long-term performance of the Fund, we’re always mindful there could be some systematic factor that takes us by surprise. Based on our analysis, we don’t see such a factor and we believe the Fund is well-positioned for the remainder of 2019 and beyond.

As mentioned earlier, however, we did trim some of our more-richly valued holdings. In hindsight, we may have sold too early—but we have no regrets, as selling early is often part of a good risk-management process.

We continue to believe that a healthy skepticism of the consensus view, which can turn on a dime, is critical to the Fund’s long-term potential for outperformance. Just a few quarters ago, many investors were convinced that interest rates were on the rise—yet the 10-year U.S. Treasury yield is now down to about 2%. And despite declines in key manufacturing indexes such as the U.S. Purchasing Managers’ Index, the industrials sector was the strongest performer for the second quarter.

As we seek to balance risk with opportunity, we remain vigilant about stock valuations given the length of the current bull market. While we wouldn’t call the market—or our particular holdings—inexpensive, we believe the growth-oriented companies in which we’re invested are well-suited to an economy driven by digitalization and innovation.

Moreover, if interest rates stay low, we think high-quality growth-oriented companies have good prospects for P/E multiple expansion. In other words, with a low discount rate on cash flows, companies that can grow faster and for extended periods of time may be viewed as more valuable by the investment community.

Going forward, we’ll maintain a thoughtful approach regarding any potential changes to the Fund. At this point, we see no fundamental shifts in the investment landscape. We continue to like our companies and have confidence in their potential to produce significant sales and earnings growth over the long term.

Thank you for the opportunity to manage your assets.

Sincerely,

JB Taylor, Paul Lambert and Mike Valentine

 

 

**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.

The Russell 2000 Growth Index measures the performance of Russell 2000 Index companies with higher price-to-book ratios and higher forecasted growth values.

You cannot invest directly in these or any indexes.

The Wasatch Core Growth Fund has been developed solely by Wasatch Advisors, Inc. The Wasatch Core 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 and Russell 2000 Growth indexes vest in the relevant LSE Group company, which owns these indexes. Russell ® is a trademark of the relevant LSE Group company and is used by any other LSE Group company under license.

These indexes are 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 these indexes or (b) investment in or operation of the Wasatch Core Growth Fund or the suitability of these indexes for the purpose to which they are being put by Wasatch Advisors, Inc.

The Wasatch Core 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.

Beta is a quantitative measure of the volatility of a given stock relative to the overall market. A beta above one is more volatile than the overall market, while a beta below one is less volatile.

A bull market is defined as a prolonged period in which investment prices rise faster than their historical average. Bull markets can happen as the result of an economic recovery, an economic boom, or investor psychology.

The “cloud” is the internet. Cloud-computing is a model for delivering information-technology services in which resources are retrieved from the internet through web-based tools and applications, rather than from a direct connection to a server.

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

The price/earnings (P/E) ratio, also known as the P/E multiple, is the price of a stock divided by its earnings per share.

The U.S. Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI is based on five major indicators—new orders, inventory levels, production, supplier deliveries, and the employment environment.

Return on equity (ROE) measures a company’s efficiency at generating profits from shareholders’ equity.

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

The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.   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 Core 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.