Wasatch Ultra Growth: Navigating the Risks & Rewards of Small-Cap Investing

Investing in small, fast-growing firms isn't for the faint of heart. Over the past 10 years, the Russell 2000 Growth index, which tracks stocks in small, growing firms, has been 42% more volatile than the broad market benchmark, Standard & Poor's 500-stock index. Finding a winning firm still in its infancy can provide a huge payoff, but investors hoping to get in on the ground floor with the next Amazon.com (symbol AMZN) or Net­flix (NFLX) are in for bumpy ride.

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The fund dedicates about 20% of assets to what Ma­looly calls ballast stocks—growing firms, such as discount retailer Five Below (FIVE), that are unlikely to be roiled by competition—to add stability to the portfolio's returns.

But the bulk of the portfolio is dedicated to companies that have the potential to unseat the competition. These firms have business models that incumbent firms can't compete with, or they offer lower price points that competitors can't match. Ra Medical Systems (RMED), for instance, makes a sleep apnea treatment for patients who don't want to wear a mask; and Wayfair (W) sells furniture online at low costs. Malooly particularly favors firms with hefty recurring revenues, which he says makes growth in the business more predictable. Firms in Ultra Growth's portfolio boost revenues at a 21%-to-23% annualized clip, on average, says Malooly.

Since Malooly took the helm in early 2012, Ultra Growth has posted an annualized return of 14.8%, an average of 3.3 percentage points per year ahead of the Russell 2000 Growth index. The fund's 1.25% expense ratio isn't a bargain, but it's in line with the typical fund that invests in small, growing firms.