By Debbie Carlson

Some asset-management companies have star portfolio managers. Wasatch Global Investors takes the opposite approach, says JB Taylor, CEO and a portfolio manager at the Salt Lake City--based firm.

Collaboration is at the core of how Wasatch, with $29.4 billion in assets, invests across its portfolio of 20 domestic and international actively managed small-cap growth strategies. Analysts and portfolio managers work together throughout the investment process and share ideas across strategies. This sort of teamwork creates a deep bench of long-tenured employees. Taylor, 52, has logged 28 years at the firm, and became CEO eight years ago.

Taylor has helmed the Wasatch Core Growth fund since 2000. It is a Morningstar five-star gold medalist, with no load and $4.2 billion in assets. The fund has returned an annualized 13.9% in the past 15 years, outperforming the Russell 2000 Growth index's return of 10.9% and peers' return of 11.5%. Wasatch Core Growth has an average fee level of 1.17%.

Barron's recently spoke with Taylor about the benefits of collaboration, the attraction of small-caps, and several holdings that exemplify the firm's favorite investment themes. An edited version of the conversation follows.

Barron's: How does collaboration work at Wasatch?

JB Taylor: The firm was set up with an idea that multiple people trying to ascertain the truth will come up with better answers than a single, very smart person. We always act with a long-term perspective that allows us to be collaborative. We build teams that really love to work together, and therefore want to work together for a long time. We try to figure out together what are the highest-hit opportunities in our universe, and how we should allocate our work to best vet those names. We travel as a pack of portfolio managers and analysts for every single company that we visit.

Small-cap investing has been out of favor for a while. What is the attraction for Wasatch?

We love the small-cap space because there are thousands of companies to choose from. We're trying to assemble a portfolio of 40 to 50 companies that we think are the highest-quality names in the small-cap universe and own those for the long term. We aren't chasing momentum, and we aren't chasing investment fads. If you can find companies with headroom for growth and get to them early, before they become larger companies, you can really benefit over the long term.

How does Wasatch approach small-cap investing?

For the past 30 years, we have used a DuPont Analysis screen, using data from FactSet and Bloomberg in a proprietary format. [A DuPont Analysis measures the impact of three factors -- net profit margin, asset turnover, and financial leverage -- on return on equity.]

We look for strong management teams, strong trends in top-line growth, profitability, return on capital, and use of capital over time. We look for sources of high-quality, sustainable growth. We like consistent margins. High margins are great, but stable and rising margins are even better than just high margins.

We look for companies that can double in size over the next five years, and then have the potential to double revenue and profit over the subsequent five years. A company that can quadruple over the next 10 years is our base case and target. We're looking for powerful growth, but sustainable growth. The [selection] process for U.S. companies works just as well internationally.

Strong corporate culture is important to Wasatch. Why?

We're huge believers in culture, and its ability to support and sustain growth and profitability over a long time. Every company has a culture. The keys are understanding if it is a strong culture or a weak culture. Does it help drive results? Is it aligned with the company's goals? Not every good culture is the same for every business, but it is something we spend a lot of time on trying to understand.

We also have a former investigative journalist who does nothing but background checks on management teams. He'll interview past employees, past managers, supply partners, anyone who gives us another interesting look into a company.

What are some hallmarks of good corporate culture, regardless of sector?

Good corporate culture stresses accountability and pushing accountability into decision-making, but also profit-and-loss responsibility. Good corporate culture also has an upside for employees down the chain of an organization. You want employees who are aligned to help the company succeed and don't come in simply feeling like they're punching the clock.

When a company is faced with challenges or new opportunities, you want to ensure that everyone in the company is aligned and pointing the same way when the unexpected happens. When you have great cultures, they tend to thrive through tough situations, and come out much stronger on the other side.

Core Growth is currently closed to new investors. Can you share a few names you expect to double in size over the next five years?

HealthEquity is the largest provider of health savings accounts in the U.S. It is a huge market. Employees put money into a health savings account, and if the money isn't used, it grows and compounds over time. If you have young, healthy employees who aren't huge utilizers of that money, they can really grow these accounts to be nice in size over long periods, and then use the money to pay for health expenditures late in life. It is an extremely profitable business. [The company generates revenue from fees paid by employers, employee-benefit partners, and merchants accepting payment cards, and from interest on custodial money deposited in employees' accounts.] It is generally an asset-light business. HealthEquity has a great management team and can grow earnings at a 15% rate annually.

What is an example of a company with good management in a difficult industry?

Ensign Group is in the skilled-nursing industry. It finds entrepreneurial, talented people who want to become CEOs of businesses, and teaches them how to run a high-service, high-care, highly efficient nursing facility. It has been able to acquire underperforming skilled-nursing homes across the U.S. using little debt, and turn them into profitable businesses while delivering great care and continuing to grow that model.

Ensign has maybe 300 facilities. There are 15,000 skilled-nursing homes in the U.S., and most of them are poorly run. We think Ensign can grow 15%-plus annually in a sustainable way, through a combination of organic growth and continued acquisitions of underperforming facilities that can be brought up to par.

You seek out companies with a high return on capital. What is an example of that?

BellRing Brands is one of the largest protein-shake manufacturers in the U.S. It distributes primarily through Costco. There is a nice trend of people being more health conscious and supplementing full meals with high-protein snacks. It is surprisingly hard to make a low-carbohydrate, high-protein drink taste very good. We think BellRing has done a great job of that, and continues to sell its products in huge numbers. It is a high-return-on-capital business, which can grow at 15% annually.

Small-caps continue to lag behind large-caps. Why should investors seek small-caps?

The Magnificent Seven [ Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla] have been driving that large-cap outperformance, and it's understandable because they are great companies with tremendous competitive advantages and good growth rates. While it is hard to bet against the Mag Seven in terms of their fundamentals, we know that even redwoods don't grow to the sky. Small-caps haven't been this cheap in 25 years.

What are some signs that market leadership may change?

There is almost never a recognizable bell-ringing event. The combination of size and valuation for the Mag Seven will result in a slowing down of returns and a bit of loss of momentum. When that happens, investors in the top seven companies might not have the same momentum-oriented returns they have had, and might start to look down cap. At some point, all the momentum that was carried into one space doesn't continue, and it starts to look for other places of return. When that happens, it could be pretty powerful.

What is the case to be bullish on international small-caps, which have lagged behind U.S. markets?

Leadership changes over time, and you never know when it will happen. When you look at the fundamentals on the ground level in a country like India, and you look out over the next 10, 15, 20 years, you should be as excited there as in any place in the world because of the innovation happening. India has the tailwind of a huge economy developing its middle class over a long time, and that is a very powerful driver of growth.

One of the great things about investing in a country like India is that we can adapt the playbooks we have used in the U.S. when investing in small companies that grew larger.

What is an example?

We have done extremely well investing in paint companies in India, such as Asian Paints. In the U.S., you wouldn't think of investing in Sherwin-Williams as a growth opportunity. But in a place like India, which has much more growth and development, a company that is well run and provides the best service and product can do well for a really long time.

What does the Federal Reserve's recent interest-rate cut mean for small-caps?

We are agnostic about what the Fed does. There are arguments to be made that once rates are cut, risk-taking resumes -- and it resumes in the lower-cap spaces. That is feasible, and possible. But rate cuts probably signal a softening in the economy, which will affect companies differently. We aren't focused on interest-rate directions or levels because our companies have great organic growth and don't use debt to finance their businesses.

Wasatch is known for closing funds quickly. Why?

(MORE TO FOLLOW) Dow Jones Newswires

October 17, 2024 04:00 ET (08:00 GMT)

Copyright (c) 2024 Dow Jones & Company, Inc.