Wasatch Micro Cap Fund® (WMICX)  Invest in this Fund 

  • print
1Q19
Financial Markets Began 2019 on a Strong Note
by Ken Korngiebel, CFA and Dan Chace, CFA

“For the most part, the prospect of lower interest rates and scarce growth in the economy made the innovative, growing companies we own more appealing to investors. We were pleased to see Fund performance also driven by earnings gains and strong company fundamentals.”

 Download a PDF (227 KB)
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, 2019, the average annual total returns of the Wasatch Micro Cap Fund for the one-, five- and ten-year periods were 15.71%, 12.05%, and 18.43%, the returns for the Russell Microcap Index were -2.36%, 5.03%, and 14.97%. Total Expense Ratio: 1.65%.

 

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

Micro-cap equities staged a strong rally during the first quarter of the year, recouping some of the ground lost during the final months of 2018. The benchmark Russell Microcap Index rose 13.10%. The Wasatch Micro Cap Fund surpassed the Index with a gain of 18.86%. We’re pleased we outperformed when markets were weak during the fourth quarter and as stocks rebounded to start the year. When markets are volatile, investors typically seek out higher-quality companies with strong growth prospects, which also happen to be the type of companies we strive to own.

U.S. stocks advanced as the Federal Reserve (Fed) adopted a more-accommodative stance toward monetary policy. A statement from Fed Chairman Jerome Powell in January signaling a “patient” approach to raising interest rates stoked investors’ appetite for risk assets. The Fed went a step further in March by slashing to zero its previous forecast for two rate hikes in 2019. Improved hopes for a speedy resolution to the U.S.-China trade dispute also underpinned support for equities.

Yields on U.S. Treasury bonds and notes fell sharply in March as the Fed downgraded its forecast for the U.S. economy and announced the end of its program to reduce the debt securities it holds on its balance sheet. With the weaker outlook threatening to crimp demand for loans and further depress lending rates, financial stocks were significant laggards. However, the Fund’s below-benchmark exposure to financials—about 9% compared to about 24% for the Index—significantly benefited relative performance.

Our underweight position in financials reflects a mismatch between our investment style—which seeks to invest in growth and innovation—and the typically static, low-growth profile of most small U.S. banks. While we do invest in banks that we believe have compelling product strategies and favorable geographic locations, we can typically find much better growth opportunities in other area of the market such as information technology (IT), health care and consumer discretionary.

For the most part, the prospect of lower interest rates and scarce growth in the economy made the innovative, growing companies we seek to own more appealing to investors. We were pleased to see the Fund’s first-quarter return also driven by earnings gains and strong company fundamentals. IT was by far the largest source of outperformance relative to the benchmark, followed by industrials and communication services.

Details of the Quarter

The strongest contributor to Fund performance for the quarter was Tandem Diabetes Care, Inc. (TNDM). 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.

With first-quarter outperformance in the Fund attributable primarily to IT, the software industry accounted for several of the top contributors. Notable among these were a pair of cybersecurity stocks, Rapid7, Inc. (RPD) and CyberArk Software Ltd. (CYBR). Rapid7 provides analytics solutions that include vulnerability management and incident detection. Helped by the company’s shift to a subscription-based business model and increased demand, revenues in Rapid7’s most-recent quarter surpassed Wall Street estimates. The company also reported a narrower-than-expected quarterly loss and forecast a surprise move to profitability in full-year 2019.

CyberArk specializes in products and services for organizations to safeguard and monitor their privileged accounts. Adjusted earnings per share jumped 117% in the company’s most-recent quarter on 36% revenue growth. Management said the trend toward cloud-based computing is boosting demand for CyberArk’s cybersecurity solutions and helping to make the company a “critical component” of its customers’ digital transformations.

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 management’s shifting account as to how the errors were discovered hasn’t soothed investors. Meanwhile, the bank’s ambitious growth plans have largely been shelved until the equity raise has been completed. We continue to hold the stock at a low weight but are watching it closely. The expected capital raise to address the regulatory requirements should occur later this year.

The second-largest detractor from Fund performance for the quarter was USANA Health Sciences, Inc. (USNA). The company develops and manufactures nutritional supplements and personal-care products sold directly to associates and customers in the U.S. and other countries. USANA’s stock price declined in February and March amid ongoing regulatory questions in China that were first disclosed about two years ago. With the company’s internal investigation into the matter now substantially complete, management reported that it doesn’t expect a material impact. In our own experience, it’s not unusual for firms employing USANA’s multi-level distribution model to attract the attention of regulators. We remain patient pending further developments.

Sangamo Therapeutics, Inc. (SGMO) was another significant detractor. A clinical-stage biopharmaceutical company, Sangamo specializes in the treatment and cure of gene disorders. Investors reacted negatively in February to interim results from an early-stage study using the company’s zinc-finger 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, which the company expects to enter into clinical trials 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%.

We sold TrueCar, Inc. (TRUE) due to deteriorating fundamentals. The company operates internet-based platforms that enable users to obtain market-based pricing on new and used cars, and to connect with its network of certified dealers. Shares of TrueCar declined sharply in February after revenues and earnings in the company’s most-recent quarter fell short of expectations. Citing operational issues related to TrueCar’s migration to a new technology platform, management issued cautious guidance for 2019. With the company still unprofitable and the timing of its return to double-digit revenue growth uncertain, we decided to move on. (Current and future holdings are subject to risk.)

Outlook

One of the questions we often face in the micro-cap universe is whether to invest in a company with strong revenue growth but negative earnings. The tolerance of U.S. investors for money-losing companies has improved in recent decades, driven in part by a secular decline in long-term interest rates. When interest rates are low, the cost for these companies to raise capital is also low. The positive effect of applying a lower discount rate to future cash flows is one of the reasons falling interest rates tend to benefit growth stocks in general and small-company growth stocks in particular.

While the majority of companies we own in the Fund make money, we recognize the potential that non-earners can offer. In the current quarter, for example, Tandem Diabetes’ recent shift to profitability was a key factor behind the stock’s outsized gains. We invested in Tandem when its prospects were bleak, but we saw the potential for it to become profitable. From its low of $2.14 on February 9, 2018 to the recent high of $74.81 on March 21, 2019, Tandem’s stock price increased nearly 35-fold in just over 13 months.

We’ve always been willing to invest in non-earners if our analysis indicates the risk is warranted. We believe we have the necessary experience with micro-cap companies to recognize those with the potential to turn a profit within a reasonable period of time. Of course, the future is always uncertain and our decisions don’t always pan out as we expect. But we consider the evaluation of money-losing companies an inherent part of investing in micro caps.

Although the Fed’s policy shift appeared to alter investor perceptions during the first quarter, our investment process doesn’t depend on a particular outlook or forecast. Regardless of which types of stocks happen to be in or out of vogue, we continue to do our job the same way. As bottom-up, fundamental investors focused on the long term, we seek companies that can grow regardless of the overall economic environment. We believe our disciplined, research-driven investment approach has the potential to generate attractive returns over time.

Thank you for the opportunity to manage your assets.

Sincerely,

Ken Korngiebel and Dan Chace

 

**The Russell Microcap Index is an unmanaged total return index of the smallest 1,000 securities in the small-cap Russell 2000 Index along with the next smallest 1,000 companies, based on a ranking of all U.S. equities by market capitalization. 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 Micro Cap Fund has been developed solely by Wasatch Advisors, Inc. The Wasatch Micro Cap 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 Microcap 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 Micro Cap 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 Micro Cap Fund’s investment objective is long-term growth of capital. Income is an objective only when consistent with long-term growth of capital.

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 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.

The Russell Microcap Index is an unmanaged total return index of the smallest 1,000 securities in the small cap Russell 2000 Index plus the next smallest 1,000 securities. The Index commenced operations after the fund commenced operations.   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 Micro Cap 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.