Learn About Retirement Planning and the 2018 Investing Landscape in These Webinars
   View Our Archived Education Events


Bookmark and Share


Printer Friendly Version

Fundamentals Apply at Wasatch Small-Cap Fund

Reopened Fund Looks for Long-Term Growth

 Amy E Buttell A few years ago, virtually every decent small-cap fund shut its doors to new investors, as floods of money threatened to turn most investing strategies for small-cap funds on their head. But today most of the funds that closed, including Wasatch Small-Cap Growth Fund (ticker: WAAEX), have reopened to new investors.

This might not be the case for long. So if you’re looking to fill a hole in your portfolio, the time to go shopping for a small-cap fund of any type is now. Since small- and micro-cap companies tend to be the fastest growers, growth funds focusing on these stocks can provide a lot of bang for the buck, as long as you’re prepared to ride the ups and downs that this category usually delivers.
The degrees of risk vary in small-cap growth investing. Some funds invest in any companies that are growing, regardless of the long-term fundamentals of those businesses. This is where Wasatch’s manager, Jeff Cardon, CFA, differs from his peers. Cardon relies on a rigorous bottom-up financial analysis to separate the companies that are built on a solid foundation from their fly-by-night peers.
As a result, the fund has delivered strong long-term results to investors, with 10-year average annual returns outpacing the Russell 2000 Growth index by 6.9 percent. Along with the long-term management, a lower-than-average expense ratio and unique investing style make Wasatch Small-Cap Growth a worthy choice for investors looking for a small-cap growth fund for the long haul.
Members of the BetterInvesting Fund Review Committee selected Wasatch Small-Cap Growth for these and other reasons. The fund is featured for educational purposes only; no investment recommendation is intended.

The ABCs of Small-Cap Growth

Small-cap growth funds are one of the most volatile mutual fund categories. Because managers are in the hunt for the best companies out of a group of fast-growing businesses, year-over-year results can yo-yo quite alarmingly. But it’s the nature of the beast: Although small-cap companies deliver some of the best growth rates, they’re also more likely than larger companies to blow up on you. This is especially the case in a recession, where they have less access to capital and less margin for error.
Many small-cap growth funds have high portfolio turnover rates and high expense ratios. The inflated turnover rates stem from the pursuit of the fastest-growing companies, as managers sell stocks out of their portfolios and buy companies with better prospects. High expense ratios are a function of the additional research that managers and their analysts must undertake for small- and micro-cap companies; less information and analysis is publicly available for these companies compared with larger ones.
Managers are more likely to close small- and mid-cap funds to new investors than they are large-cap funds. Small- and mid-cap companies are less liquid than large firms, making it more difficult for fund managers to find appropriate options when faced with a flood of new money. In addition, these managers don’t want to dilute their strategies by investing in companies that don’t meet their standards or are larger than the funds’ target size.

Investing Strategy Stresses Fundamentals
Cardon, who has been at the fund’s helm for 22 years, was recently appointed chief executive officer of Wasatch Advisors, the fund’s management company. He espouses a long-term, fundamentally oriented investment approach. According to the fund’s investment prospectus: “Within the fund’s portfolio, we seek to create a blend of ‘core’ companies that we believe have the potential to grow steadily over long periods of time at faster rates than average large companies, and ‘high growth’ companies that we believe have the potential to grow faster and more aggressively than core companies.
“We use a ‘bottom up’ process of fundamental analysis to look for individual companies that we believe have superior growth prospects. Our analysis may include studying a company’s financial statements, building proprietary financial models, visiting company facilities and meeting with executive management, suppliers and customers.” Specifically, Cardon and his analysts examine:

•  high return on capital
•  sound financial controls
•  reasonable use of debt
•  potential for increasing market share
•  sustainable competitive advantage
•  likelihood of sustainable, significant increases in sales and earnings growth
•  attractive valuation
The fund didn’t emerge unscathed from the downturn in the economy over the last few years — the fund was down 41.7 percent in 2008. But its emphasis on companies with low levels of debt and strong cash flow helped cushion it from a further decline, and this year it rebounded 38.8 percent through the end of September.
Cardon believes that the fund’s emphasis on investing in high-quality companies will pay off. In the fund’s most recent quarterly report, published on June 30, he wrote: “As previously noted, we do not think the economy is out of the woods and we expect growth to be muted for some time. The silver lining of a lower-growth environment is that we are unlikely to see any new asset bubbles emerge. Asset bubbles have historically been bad for Wasatch because we do not chase hot stocks; we pursue a consistent, long-term strategy. As investors look for companies with true economic growth rather than ‘fake’ growth, which is what bubble companies are, we expect to see quality stocks continue to do well.”

Diversified Portfolio

With holdings of 73 companies spread over an asset base of $819 million, as of Sept. 30, the portfolio is quite diversified. The top 10 holdings compose only 27 percent of the fund’s assets, so there isn’t a lot of issue-specific risk. If one holding blows up, it won’t hurt the fund too much.
The largest investments are in the services sector, which compose 58.3 percent of fund assets, according to Morningstar, with the information sector second at 27.6 percent and manufacturing last at 14.1 percent. The largest subsectors are in the service sector, with business services at 20.3 percent, consumer services at 16.6 percent and financial services at 10.9 percent.
Four of the top 11 holdings are also favorites of the BetterInvesting community. These include O’Reilly Automotive, the No. 11 holding, Cognizant Technologies, Copart and Knight Transportation.
The fund’s charter limits it to investing 20 percent of the fund’s assets at the time of purchase in foreign companies in both developed and developing markets. According to Lipper, as published at BetterInvesting’s Mutual Fund Resource Center, 79.3 percent of the fund’s assets are in U.S. companies, 5.0 percent in Canadian companies, 3.4 percent in Indian companies and less than 2 percent in firms based in Bermuda, Singapore, Germany, Hong Kong, Ireland and the United Kingdom.

Turnover and Expense Overview

The fund’s five-year average portfolio turnover rate is 41 percent, according to Lipper. Although that’s higher than BetterInvesting’s rule of thumb of 20 percent, it’s still reasonable for  small-cap growth funds, which tend to have very high turnover rates. Managers of these types of funds tend to trade frequently in an effort to add the companies with the highest growth rates to their portfolios.
The average portfolio turnover rate is a rough average of how often a manager buys and sells companies in and out of a fund’s portfolio. High turnover rates can translate into higher expenses for shareholders in the form of higher brokerage costs, which are wrapped into the fund’s expense ratio, and higher taxes owing to the realization of capital gains on sales of securities.
The fund’s expense ratio is 1.21 percent, significantly lower than the category average of 1.63 percent, according to Lipper. This translates into $121 of expenses per year for an investor with $10,000 invested in the fund. The fund also carries a redemption fee of 2 percent, which applies if you sell shares after owning them for 60 days or less. Redemption fees are generally designed to keep the disruptive effects of short-term shareholders at a minimum, as their activities can cause excess expenses to long-term shareholders.

Click image to enlarge

Final Word

Wasatch Small-Cap Growth is a solid option if you’re looking for a small-cap growth fund with a proven track record; consistent, long-term investing strategy; management with a long tenure; and reasonable expenses. Before investing, do your due diligence by checking out the fund’s website and reading the most recent manager commentary, annual or semiannual report and prospectus.
Make sure the fund also fits in with the rest of your portfolio and provides decent diversification before buying any shares.

— Reporting by contributor Amy E. Buttell

Freelance writer Amy E. Buttell of Erie, Pa., covers mutual funds for BetterInvesting. She’s also the author of the second edition of the association’s Mutual Fund Handbook.

Corporate Partners

Learn more about

companies supporting

BetterInvesting's mission