Two Wasatch Funds Reopen
When a stellar fund that shunned new investors for years finally reopens, it's often because ... hmmm, because results of late haven't been up to the standard of years earlier, and many investors have fled to other funds.
This leaves you with a puzzle to solve. Is this your chance to hitch your wagon to a brilliant investment manager who had a few years of bad luck? Or were those golden years in the past just a run of good luck, and what you see now is what you'll get in the future?
We struggled with this when Oakmark Select reopened a few years ago (we eventually lost patience) and when Longleaf Partners reopened just recently (we still love the fund). Now, what are you to make of two once-magnificent funds from the highly regarded Wasatch family that have gone through a rough patch and are taking on new accounts?
Managers of both funds are shopping for new money because of beaten-down prices of small, fast-growing companies in sectors like consumer services, financials and healthcare. "Companies we like are extremely interesting now, continuing to grow faster than the overall economy," says Jeff Cardon, who has run Small Cap Growth since its inception in 1986. "But their stock prices are way down, so we want to build up positions at these prices." Mr. Cardon stresses his intention to build up existing positions, as opposed to increasing the breadth of the portfolio.
Small Cap Growth has struggled in the last twelve months. It's down 9% in the twelve months to March 12 and off 18% year to date. Its benchmark, the Russell 2000 Growth Index, dropped 7% since March 2007 and has plunged 15% this year.
We judge Small Cap Growth (as well as Core Growth) to be among the more conservative small-company growth funds. So when the Internet stock bubble burst in 2000-2002, it began a five-year hot streak in this category. That good run explains why its ten-year annualized return of 10% puts the fund in the top decile of its class.
Cardon applies Wasatch's hallmark strategy of mixing fast-growing companies with an assortment of slow but steady growers sitting atop lots of cash. He looks for companies with high-quality management (he always meets executives before investing) and trawls for little-known, entrepreneurial companies that could become household names within a decade. He cites Dell and Compaq as two companies he owned long before they hit the big time.
The profitable stocks that typify Cardon's approach include his largest holding, Missouri-based O'Reilly Automotive (ORLY), a retailer of auto parts and tools with 1,640-plus stores. "This is a stable company, resistant to economic fluctuations that is rolling out stores and experiencing high demand for its products over time," says Cardon.
He has altogether different reasons for investing in Techne (TECH), another top-five holding. This "backdoor biotech play" makes products used in biotechnology, including enzymes and antibodies. Cardon likes it for its high return on capital and stable revenue stream.
We ask Cardon why he hasn't loaded his fund with stocks from sectors that are hard chargers right now: commodities, energy and manufacturing. "The problem is," he replies, "if you look at those companies, commodity prices dominate their growth profiles, and if you look at long-term trends, this is a cyclical phenomenon."
Of course, many other investors are convinced that this is going to be a long, long cycle for such stocks. But he's sticking to his guns.
Across Wasatch's open-plan office, with views of the namesake Wasatch mountain range, sits J.B. Taylor, who has spent seven-plus years sculpting Core Growth into a sturdy tower of 76 reasonably priced, steady growers.
He targets companies with earnings-growth rates of 15% to 25% during a three to five-year time period. The fund is almost evenly split between small and mid-sized companies; the average market capitalization of its holdings is about $2 billion. The fund's volatility is slightly less than that of Small Cap Growth.
Core Growth, after five consecutive years of above-average returns among midsize-company growth funds, has had a rough time since 2005, when it finished in the bottom decile among its peers. It trailed the pack the next two years as well.
The fund has slumped 15% year to date compared with a 12% decline in the Russell 2000. For the 12 months to March 12, it is down 8% compared to the Russell's 12% decline. But like Wasatch Small Cap Growth, Core Growth's ten-year return of an annualized 11% places it in the top decile of its class.
Manager Taylor has held true to his strategy in recent years, even though returns have been much better in energy, materials and cyclical stocks. He says he needs to have confidence that a company's earnings growth is sustainable and says that he looks across all sectors for worthy candidates, including materials and energy-related plays.
"We are looking at businesses that will flourish regardless of the price of oil or any other commodity," he explains. "We would rather place our bets on business models with competitive advantages with great management teams that will guide their destiny." He says he has had a hard time finding such companies in the hot sectors of the current stock market, but continues to search for them.
In the meantime, he remains committed to companies such as online vehicle auctioneer Copart (CPRT), which makes up nearly 6% of the fund's assets. "This company takes no risks because it performs services for a fee. It has a 40% market share and makes extremely nice margins," says Taylor.
Both funds contain assets of less than $1 billion. Expense ratios of the duo are a bit less than 1.2% and somewhat less than average for their categories.
Both managers are optimistic that reopening the funds will draw investments from people with an investment time horizon of ten or more years. In-house research shows that most Wasatch shareholders are younger than 50 and enthused about investing in small, entrepreneurial companies.
Will these two funds get their mojo back? Small-company growth stocks had a great seven-year run through 2006. Now most funds in this category have trouble getting traction.
We'd give Wasatch Small Cap Growth and Wasatch Core Growth the benefit of a doubt. The same smart people as before are running them. When the investment spotlight again turns on small, well-run, growing businesses with good long-term outlooks, this pair of funds should be there to reap the rewards.