WASATCH FUNDS - Curian Clearing

WASATCH CORE GROWTH FUND (WGROX / WIGRX) — Management Discussion
MARCH 31, 2015 (UNAUDITED)
The Wasatch Core Growth Fund is managed by a team of
Wasatch portfolio managers led by JB Taylor and Paul Lambert.
JB Taylor
Lead Portfolio Manager
Paul Lambert
Portfolio Manager
OVERVIEW
Small-cap stocks
were strong in the
first quarter of
2015. After a year
of trailing the S&P
500 ® Index, small
caps outperformed
their larger-cap
counterparts for
the second quarter
in a row. It was
also another quarter in which the average small-cap manager
underperformed. In this context, we were pleased that the
Wasatch Core Growth Fund — Investor Class gained 7.30%
and outperformed its benchmarks. The Russell 2000 Index
advanced 4.32% and the Russell 2000 Growth Index
returned 6.63%. We attribute our performance to solid
stock-picking, which was strong across the Fund.
DETAILS OF THE QUARTER
It’s impossible to discuss the current market environment
without addressing the phenomenal performance of the
biotechnology industry. The average biotechnology stock in
the Russell 2000 Growth Index was up approximately 15%
in the quarter, more than double the overall Index return.
This has been an impressive run — in 13 of the last 16 quarters
biotechnology stocks have outperformed.
The Fund’s minimal exposure to biotech companies has
been a huge headwind. Most biotech companies go years
without generating profits, and a company with great science
may still fail to win Food and Drug Administration
approval for its products. More biotech companies will fail
than succeed, and the big winners heavily skew the
industry’s performance.
We want to own profitable companies like Icon plc,
which provides clinical-research services to the biotechnology
industry. We call this a “picks and shovels”
approach — selling goods and services to a well-capitalized
group of risk-takers. In the first quarter, Icon was among
our best contributors.
We will continue to execute our current strategy for the
biotech industry, running a large underweight versus the
benchmark, but occasionally rifle-shooting for a company
with great science, a proven management team and a market
valuation that is small relative to the company’s endmarket
potential.
The U.S. dollar continued to strengthen in the first quarter
and the price of oil is still nearly 50% below the price last
summer. Low-priced oil helps a company like our small-cap
airline Allegiant Travel Co., where fuel is the largest single
cost item in the income statement. Allegiant was the top
contributor to the Fund’s performance in the first quarter.
Although the overall backdrop for small-cap fundamentals
is the best we have seen in a long time, valuations
remain high for U.S. small caps. The number of companies
trading with market valuations greater than 10 times revenues,
a valuation metric we would consider “extreme,”
remains close to an all-time high. A historically low number
of companies today qualify as inexpensive (less than 1 times
revenues). We believe we must stay disciplined with our
valuations in such an elevated market. At quarter-end, the
Fund’s price-to-earnings (P/E) multiple was roughly in line
with both indices, but we have been capturing much betterthan-average
revenue and earnings growth rates.
It’s not customary for us to outperform in such a strong
small-cap market. Our focus on high-quality companies
typically has resulted in the Fund giving up some performance
relative to the indices in the strongest markets, but it
has often outperformed by a wide margin in choppier markets.
To illustrate, on the 100 worst market days between
December 31, 2012 and March 31, 2015, the Russell 2000
Growth Index was down, on average, -1.6%, and the
Wasatch Core Growth Fund outperformed on 92% of those
days. We attribute the Fund’s recent outperformance to the
underlying fundamentals of our portfolio companies. For
example, the Fund’s second-best contributor was Credit
Acceptance Corp., a non-prime auto-finance company that
we believe has an exceptional management team and a track
record for prudently allocating capital.
Life Time Fitness, Inc. and Polypore International, Inc.
announced that they were being acquired. Even though
these two companies were top contributors for the quarter,
we didn’t spend much time cheering. When they have been
acquired, we’ll need to find businesses of comparable
strength to replace them with.
From our first purchase in 2005 through the end of 2012,
MSC Industrial Direct Co., Inc. executed superbly and
continued to take profitable share in a large maintenance,
repair and operations market. Since then, the company has
had a difficult time turning investment spending on new
initiatives into profitable growth.
Cornerstone OnDemand, Inc. posted a solid fourth quarter,
but management gave disappointing guidance. With
30% of Cornerstone’s revenues generated outside the U.S.,
the strong dollar will make the company’s growth rate look
lower in the short term. We like Cornerstone and believe it
is one of the most attractively valued software-as-a-service
(SaaS) businesses in the market.
OUTLOOK
From where we sit, the operating environment for U.S.
small-cap companies continues to improve and the average
U.S. small-cap company’s fundamentals are accelerating.
This has provided a good environment for us to execute
our bottom-up selection process, as we focus on what we
consider to be the highest-quality and best-managed longduration
growth companies. Our companies have
consistently posted revenue and earnings growth rates that
are higher than the average company. The ability to
capture above-average earnings growth, compounded
patiently over time, is at the center of our time-tested
investment philosophy.
Thank you for the opportunity to manage your assets.
Current and future holdings are subject to risk.
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