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Morningstar
A small-cap star tries its wings
Wasatch's first venture away from small-cap stocks will invest in companies that have grown too large to keep in its other portfolios. Can this well-regarded firm be successful in the midcap arena?
By Kunal Kapoor, Morningstar
If you look at fund-flow data, it's clear who the winners of the past few years have been. Bigwigs such as American, Vanguard and Fidelity have raked in assets, and even smaller firms such as Dodge & Cox, First Eagle and Oakmark have attracted quite of bit of money as well. One firm that isn't among the top asset gatherers is Salt Lake City-based Wasatch Investments. But it certainly has been noticed -- and deservedly so.
As investors in the firm's funds know, the main reason Wasatch hasn't been near the top of the asset-gathering charts is because the majority of its assets are in funds with hard closes (no new investments from current or new shareholders). That's because Wasatch has been one of the most compelling stories of the past decade, as the firm has executed its strategy of purchasing small-cap stocks to near perfection. Across the board, its managers have avoided the temptation to invest in speculative companies -- a tack that got many rivals into trouble -- and instead have focused on unearthing cash-generating businesses with staying power. The result has been great performance and strong flows that have led to the funds' closings.
All along, the firm has avoided the temptation to veer away from its small-cap roots. Even Wasatch International Growth (WAIGX), the firm's foreign offering, chose to mine international small caps.
But on June 18, the firm launches Wasatch Heritage Growth, its first product to move out of the small-cap arena. The firm is billing this offering as an owner of "Wasatch Graduates" -- companies that the small-cap funds can't invest in because they've grown too large. The fund plans to concentrate on owning companies in the $3 billion to $20 billion market-cap range. As a result, it's likely to land in midcap growth territory. Naturally, given the firm's hot hand, there's likely to be some interest in this offering at its launch. But is it worth investing in?
New fund rooted in tested strategies
In its favor is that Wasatch is keeping expenses below 1% at the launch by waiving some fees, at least until January 31, 2005. Additionally, we're encouraged that the firm isn't stretching too far beyond its core area of focus; it would be of greater concern if the fund had launched with a pure large-cap focus, for example. Instead, it makes sense to put together a portfolio of stocks largely consisting of firms that the small-cap funds may have owned. And managers Chris Bowen and Ryan Snow say that they'll concentrate their efforts on financials, health-care and technology companies -- areas in which other Wasatch funds have made a successful living.
Speaking of Bowen and Snow, this will be their first stints as managers of a fund. The latter joined Wasatch in 2001, while the former has an additional year at the firm under his belt. Most recently, Bowen has been a member of the team supporting Wasatch Core Growth (WGROX), while Snow has been part of the crew at Wasatch Small Cap Growth (WAAEX). The duo should expect to encounter more competition than Wasatch has typically faced. The small-cap categories are littered with undisciplined, faddish offerings that provide limited competition to more-disciplined funds. In contrast, the managers in the midcap and large-cap space comprises a deeper pool of talent, so it's tougher to stand out.
Still, there are good reasons why this fund should ultimately succeed. Most important, because the fund isn't stretching too far from the firm's roots, it shouldn't put a strain on resources. This also means that the fund will likely be disciplined in executing its strategy, which has been a key strength for its siblings. I'd venture to guess that this fund will be a lot less aggressive than momentum rivals such as Turner MidCap Growth (TMGFX) but with enough of a growth tilt to keep it out of the blend area. Finally, investors can draw confidence that other disciplined small-cap shops -- such as Baron and Ariel -- have successfully made the transition to running sound midcap offerings, a fact that bodes well for this fund.
Fund leverages opportunity but faces challenges
On an unrelated note, it's worth pointing out that with small-cap valuations looking stretched, we're increasingly hearing from managers that more-attractive possibilities lie outside this group. (In fact, one of the reasons why Wasatch's domestic funds all have hard closes right now is because it isn't easy to find opportunities among the market's smallest stocks.) So, at least the fund is picking an area of the market where there should be some interesting prospects.
Nevertheless, while the fund may indeed be a relative success, investors would do well to temper their expectations of its absolute returns. While all other Wasatch equity funds have extremely strong absolute and relative returns -- Core Growth, for instance, has returned approximately 19% for the trailing five-year period through June 8, 2004 -- this one is launching in an environment that promises lower absolute returns. Investors therefore shouldn't be counting on such strong absolute returns, even if the fund is a relative success.
As for Wasatch, it will be interesting to see where the firm goes from here. While it would be nice if a large number of investors could gain access to the firm's investing prowess, we don't want to see it grow too rapidly, either; the firm can only expand so far without meddling with its unique culture. By closing funds in a timely fashion and limiting new launches, though, Wasatch has shown it can look after the interests of its current fund shareholders and yet make itself available to others in a responsible manner as well.
Copyright 2004. Morningstar, Inc. All rights reserved.
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