Download - Wasatch Advisors

Wasatch-1st Source Income Fund
(FMEQX)
Quarterly Comments from Lead Portfolio Manager Paul Gifford, CFA and
Associate Portfolio Manager Erik Clapsaddle, CFA, CFP
Open to all investors
Average Annual Total Returns
For Periods Ended March 31, 2017
Quarter*
1 Year
3 Years
5 Years
10 Years
Income Fund
0.73%
0.52%
1.52%
1.29%
2.87%
Bloomberg Barclays US Intermediate
Government/Credit Bond Index**
0.78%
0.42%
2.01%
1.88%
3.76%
*Returns less than one year are not annualized.
Data show 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 visit www.WasatchFunds.com. Investment
returns and principal value will fluctuate and shares, when redeemed, may be worth
more or less than their original cost. Total Expense Ratio: 0.73%
Total Annual Fund Operating Expenses include direct expenses paid to the Advisor as
well as indirect expenses incurred by the Fund as a result of its investments in other
investment companies (each an “Acquired Fund”). See the prospectus for additional
information regarding Fund expenses.
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 or taxes, which if
reflected, would reduce the performance quoted. For more complete information
including charges, risks and expenses, read the prospectus carefully.
By investing in fixed-income securities, you are subject, but not limited to, the same
interest rate, inflation and credit risk associated with the underlying fixed-income
securities owned by the Fund. Return of principal is not guaranteed. Interest rate risk is
the risk that a debt security’s value will decline due to changes in market interest rates.
The interest rate is the amount charged, expressed as a percentage of principal, by a
lender to a borrower for the use of assets. Even though some interest-bearing securities
offer a stable stream of income, their prices will fluctuate with changes in interest rates.
Inflation risk is the possibility that inflation will reduce the purchasing power of a
currency, and subsequently reduce the value of a security or asset, and may result in
rising interest rates. Inflation is the overall upward price movement of goods and services
in an economy that causes the value of a dollar to decline. Credit risk is the risk that the
P.O. Box 2172 • Milwaukee, WI 53201-2172 • www.WasatchFunds.com
Phone: 800.551.1700
Wasatch Funds are distributed by ALPS Distributors, Inc.
issuer of a debt security will fail to repay principal and interest on the security when due.
Credit risk is affected by the issuer’s credit status, and is generally higher for noninvestment grade securities.
An investor should consider investment objectives, risks, charges and expenses carefully
before investing. To obtain a prospectus, containing this and other information, visit
www.WasatchFunds.com or call 800.551.1700. Please read the prospectus carefully
before investing.
OVERVIEW
The views expressed in this commentary are those of 1st Source Corporation, the subadvisor to the Fund, and may differ from the views of Wasatch Advisors.
The Wasatch-1st Source Income Fund gained 0.73% for the first quarter of 2017. The
Fund’s benchmark, the Bloomberg Barclays US Intermediate Government/Credit Bond
Index, gained 0.78%. The Federal Reserve (Fed) increased the federal-funds target rate
(target rate) by 0.25 of a percentage point on March 15, 2017 moving the target rate
range of 0.75% to 1.00%. Fed officials had maintained their hawkish tone for a higher
target rate throughout the quarter. As we previously stated, we expect some of the Fed’s
statements indicating tighter monetary policy will persist as inflation slowly rises and
wages continue to increase. In early April 2017, the Federal Open Market Committee
noted in its March meeting minutes that reducing the size of the Fed’s balance sheet
“would likely be appropriate later this year.”
ECONOMIC ACTIVITY
Labor markets continued to tighten in the first quarter as the unemployment rate
declined to 4.5% in March from 4.7% in February, and the underemployment rate,
which includes those who have given up looking for work and those who are employed
part time but would like full time work, dropped to 8.9%—its lowest level in
approximately nine years. The U.S. added 28,000 manufacturing jobs in February, the
largest increase since August 2013. This was driven by a surge in jobs for non-durable
manufactured goods. The Job Openings and Labor Turnover Survey, which measures the
number of job vacancies, showed there were 5.6 million job openings as of January 31,
2017. There have been more than five million job openings for 25 consecutive months.
P.O. Box 2172 • Milwaukee, WI 53201-2172 • www.WasatchFunds.com
Phone: 800.551.1700
Wasatch Funds are distributed by ALPS Distributors, Inc.
Prior to this streak, the last time job openings were above five million was in January
2001.
Wage growth continued to be tepid. We believe wages may increase faster given tight
domestic labor markets, a possible national infrastructure bill that would compete for
workers, and a crackdown on illegal immigration that is shrinking the labor markets.
From the same periods a year ago, average hourly earnings increased 2.9% in December
2016, the largest annual increase since early 2009, and 2.8% in February 2017.
Personal consumption continued to be the largest driver of domestic gross domestic
product (GDP) growth. Based on the third estimate from the Bureau of Economic
Analysis, GDP increased at an annual rate of 2.1% in the fourth quarter of 2016
compared to 3.5% growth in the third quarter. In four of the last five quarterly results,
GDP would have been negative without the contribution from personal consumption.
In March, the Conference Board’s Leading Economic Index, an index of 10 components
used to measure future economic growth, was at its highest level in over a decade and
had registered six consecutive monthly gains. Also in March, the National Federation of
Independent Business (NFIB) Small Business Optimism Index had one of its highest
readings in 43 years as small business owners awaited several policy initiatives from the
Trump administration that they hope will improve their business prospects.
INTEREST RATES
As mentioned above, the Fed increased its target rate by 0.25 of a percentage point to a
range of 0.75% to 1.00% on March 15, 2017 following a 0.25 percentage point
increase three months earlier on December 14, 2016. This was the first time the Fed
had increased the target rate in two out of three consecutive meetings since June 2006
when the target rate was raised by 0.25 of a percentage point for the 17th consecutive
time. Today, Fed officials must consider many variables before raising the target interest
rate, including much lower global interest rates (i.e., Germany, Japan and France), the
possibility of a stronger U.S. dollar amidst higher rates, an economy that is currently
considered to be at or near full employment, and asset prices that have been driven
higher by years of easy money. The Fed appears to be on course to raise interest rates
three times this year. With one rate increase already behind us, we would not be
P.O. Box 2172 • Milwaukee, WI 53201-2172 • www.WasatchFunds.com
Phone: 800.551.1700
Wasatch Funds are distributed by ALPS Distributors, Inc.
surprised if there were only two more increases, but that would largely depend on fiscal
policy and inflation data.
The first quarter of 2017 was a favorable period for returns on fixed-income investments,
as interest rates remained relatively flat from the beginning of the year. Although the
movement in bond yields was fairly tame from the beginning of the first quarter through
quarter-end, there was still much daily volatility coming on the heels of the significant
yield increase in late 2016. The 10-year U.S. Treasury note was as high as 2.63% and
as low as 2.30% during the first quarter. The market for U.S. Treasury securities appears
to have moved back to being economic data dependent as it focuses most importantly on
inflation and labor market data. High yield bonds continued their upward movement
despite being fairly priced as an asset class in our opinion and given recently increased
uncertainty in the energy sector.
STRATEGY
The Fund maintained an effective duration during the quarter that was much shorter
than that of its benchmark. The Fund’s effective duration was 2.73 years compared to
the benchmark’s duration of 4.06 years (an increase of 0.01 in the benchmark’s
duration relative to the fourth quarter of 2016). We reduced the Fund’s duration during
the first quarter from 3.24 on December 31, 2016 to 2.73 as of March 31, 2017, as we
believe bond yields should continue to move higher. We accomplished the reduction in
duration by investing in corporate floating-rate senior unsecured debt, securities with
approximate durations of 0.05 to 0.25, and fix-to-floating rate securities that are
currently floating or are within one-year of floating. These additions to the Fund
increased our allocation to credit. The floating-rate additions provide a strong spread to
the three-month LIBOR and a positive correlation to rising interest rates. Since the start
of 2016’s fourth quarter, the three-month LIBOR had increased 0.30 of a percentage
point to 1.15% as of March 31, 2017.
We mentioned in the previous two quarters that we would be cautious in adding to the
Fund’s exposure to residential mortgage-backed securities (MBS) due to extension risk.
During the first quarter, we reduced the Fund’s allocation to MBS by approximately 11%
through the sale of MBS and by not reinvesting prepayments back into MBS. At this
P.O. Box 2172 • Milwaukee, WI 53201-2172 • www.WasatchFunds.com
Phone: 800.551.1700
Wasatch Funds are distributed by ALPS Distributors, Inc.
point we are comfortable with the Fund’s current allocation to residential MBS. We also
added inflation-protected securities in late 2016.
The core of the Fund is currently focused on bonds with durations less than five years.
Ninety-nine percent of the Fund’s positions have effective durations of less than seven
years. To offset the interest rate risk of bonds with longer maturities, we have
overweighted the Fund in bonds with durations of less than three years. We believe the
Fund is well positioned whether or not the Fed increases the target rate one, two or three
more times in 2017.
Thank you for the opportunity to manage a portion of your assets.
Sincerely,
Paul Gifford and Erik Clapsaddle
**Bloomberg Barclays US Government/Credit Bond Index is a broad-based flagship benchmark that measures the nonsecuritized component of the US Aggregate Index. It includes investment grade, U.S. dollar-denominated, fixed-rate
Treasuries, government-related and corporate securities. You cannot invest directly in this or any index.
CFA® is a trademark owned by CFA Institute.
The investment objective of the Wasatch-1st Source Income Fund is to seek current income consistent with the
preservation of capital.
The Conference Board is a global, independent business-membership and research association working in the public
interest. It counts approximately 1,200 public and private corporations and other organizations as members,
encompassing 60 countries. The Conference Board convenes conferences and peer-learning groups, conducts
economic and business management research, and publishes several widely tracked economic indicators.
Correlation, in the financial world, is a statistical measure of how asset classes, securities, markets, or countries move
in relation to each other.
A credit spread is the difference in yield between two bonds of similar maturity but different credit quality. For
example, if the 10-year Treasury note is trading at a yield of 6% and a 10-year corporate bond is trading at a yield of
8%, the corporate bond is said to offer a spread over the Treasury of two percentage points.
A corporate bond is a debt security issued by a corporation for the purpose of raising money to expand its business.
Floating rate notes (FRNs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR
or federal funds rate, plus a quoted spread (also known as a quoted margin). The spread is a rate that remains
constant. A corporation can borrow money by issuing bonds or getting a bank loan. Both are different forms of debt.
“Senior” means that the debt has priority over other types of debt in bankruptcy. “Unsecured” means the debt is not
secured by any specific collateral.
Effective duration is a measure of the responsiveness of a bond’s price to market interest rate changes. For example, if
the interest rate increased 1%, a bond with an effective duration of five years would experience a decline in price of
5%.
P.O. Box 2172 • Milwaukee, WI 53201-2172 • www.WasatchFunds.com
Phone: 800.551.1700
Wasatch Funds are distributed by ALPS Distributors, Inc.
The federal-funds target rate (also known as the fed-funds target rate) is set by a committee within the Federal Reserve
System called The Federal Open Market Committee (FOMC). The FOMC usually meets every six weeks, and it is at
these meetings that the FOMC votes on whether to make changes to the federal funds target rate.
The Federal Open Market Committee (FOMC), a component of the Federal Reserve System, is charged under United
States law with overseeing the nation’s open market operations. Open market operations are the means of
implementing monetary policy by which a central bank controls the short term interest rate and the supply of base
money in an economy, and thus indirectly the total money supply.
Fixed-to-floating preferred shares and bonds offer a steady yield for several years, then switch to a floating rate that
keeps pace with market interest rates.
Gross domestic product (GDP) is a basic measure of a country’s economic performance and is the market value of all
final goods and services made within the borders of a country in a year.
High-yield bonds are those rated below investment grade by the primary rating agencies (e.g., below BB/Ba by
S&P/Moody’s). Such securities tend to have more volatile prices and increased price sensitivity to changing interest
rates and adverse economic and business developments than investment grade securities.
LIBOR or ICE LIBOR stands for IntercontinentalExchange London Interbank Offered Rate. It is a benchmark interest
rate that some of the world’s leading banks charge each other for short-term loans. LIBOR serves as the first step to
calculating interest rates on various loans throughout the world.
Mortgage-backed securities are debt issues backed by a pool of mortgages. Investors receive payments from the
interest and principal payments made on the underlying mortgages. Agency mortgage-backed securities are issued by
government-sponsored enterprises such as Ginnie Mae, Fannie Mae or Freddie Mac. Commercial mortgage-backed
securities are mortgages backed by commercial rather than residential real estate.
The National Federation of Independent Business (NFIB) research center has collected small business economic
trends data with quarterly surveys since the fourth quarter of 1973 and monthly surveys since 1986. Survey
respondents are drawn from NFIB’s membership. The Small Business Optimism Index report is released on the second
Tuesday of each month.
Income Fund Top 10 Holdings as of December 31, 2016
Security Name
Percent of
Net Assets
U.S. Treasury Note, 3.625%, 8/15/19
U.S. Treasury Note, 2.750%, 12/31/17
U.S. Treasury Note, 3.625%, 2/15/20
Citibank Credit Card Issuance Trust, Series 2007-A8, Class A8, 5.650%,
9/20/19
BB&T Corp., MTN, 2.150%, 3/22/17
World Financial Network Credit Card Master Trust, Series 2012-A, Class A,
3.140%, 1/17/23
General Electric Co., MTN, 5.400%, 2/15/17
Lubrizol Corp., 8.875%, 2/1/19
Wells Fargo & Co., 4.125%, 8/15/23
PNC Bank NA, 3.800%, 7/25/23
3.7%
2.6%
1.6%
1.6%
1.5%
1.5%
1.4%
1.3%
1.3%
1.3%
Total
17.7%
Portfolio holdings are subject to change at any time. References to specific securities should not be construed as
recommendations by the Fund, its Advisor or Sub-Advisor.
Wasatch Funds are distributed by ALPS Distributors, Inc.
WAS004403
7/30/2017
P.O. Box 2172 • Milwaukee, WI 53201-2172 • www.WasatchFunds.com
Phone: 800.551.1700
Wasatch Funds are distributed by ALPS Distributors, Inc.