Small-Cap Growth Commentary – December 31, 2020
We hope this letter finds all of our investors and their families healthy and happy as we head into 2021. Most have been ready to turn the calendar to a new year for some time now — 2020 will undoubtedly leave a lasting impact on the nation and the world. On a bright note, despite the economic headwinds created by the pandemic, lockdowns and the political uncertainty that comes with a U.S. election, the equity markets performed quite well. Growth stocks helped lead the pace, with the Russell 2000® Growth Index ending the year near all-time highs. In fact, 2020 brought two of the best quarters the index has posted in the last twenty years: 2Q20’s +30.58% and 4Q20’s +29.60%. Further, despite the double-digit decline in 1Q20 (-25.76%), 2020 marked the Russell 2000® Growth Index’s 3rd best year in the past twenty, with the index rising +34.63%.
Overall, the volatility and uncertainty seen throughout the year created dislocations in equity prices as panic and fear drove a wedge between perception and reality. Hood River’s proactive, fundamental process allowed the team to identify and benefit from many of these pricing dislocations. On a net basis, our Small Cap Growth strategy generated the largest amount of excess returns since our inception, narrowly edging out our first full year’s 2,634 basis points (“bps”) back in 2003. For the full year of 2020, Hood River’s Small-Cap Growth strategy returned +61.17% net of fees, 2,654 bps ahead of the benchmark. For the fourth quarter of 2020, the Hood River Small-Cap Growth strategy returned +30.88% net of fees, coming in 128 bps ahead of the Russell 2000® Growth Index.
The best performing sectors in the Russell 2000® Growth Index during quarter were information technology (+35.98%), health care (+31.82%), and industrials (+31.14%). No sectors posted negative returns in the fourth quarter. Hood River’s outperformance for the quarter was once again driven by our bottom-up stock selection process. Our strongest sectors for stock selection in Q4 were industrials (+205 bps), consumer discretionary (+196 bps), and consumer staples (+108 bps). Sectors in which we posted negative stock selection in Q4 included health care (-276 bps), information technology (-102 bps), and communication services (-28 bps). Our negative selection effects in health care and technology were primarily driven by our underweight in biotech and software, respectively. We will touch on these underweights in greater detail a bit later in this commentary.
Throughout the fourth quarter, investors were keenly focused on two macro drivers: the U.S. election and the path of the pandemic. While we have clarity on who will sit in the oval office for the next term, control of the senate still hangs in the balance entering 2021. As the Hood River team has demonstrated throughout 2020, our investment philosophy, structure, and culture allow us to remain agile in light of quickly-changing markets. We will continue to remain so as we gain clarity on the senate run-offs in Georgia and the potential investment implications and opportunities over the next few years.
Regarding the pandemic and lockdowns, the market’s ‘reopening euphoria’ was on display in the fourth quarter as vaccines began to be rolled out. As we have previously stated, we don’t believe the path to a full economic recovery will be a straight line — there will likely be ebbs and flows, but the general trajectory of reopening is clear now. Our view that U.S. economic activity will remain choppy but show gradual improvement as the country and international markets reopen remains intact.
In light of this backdrop, our outlook for small-caps in general remains positive. This is based on our belief that small-cap companies tend to be more nimble than their larger-cap peers in a quickly-changing economic environment. History supports this view – although stocks across market caps generally rose in-line in the first year after the Great Financial Crisis and Dot-Com bubble, small-cap stock returns outpaced their larger-cap peers after the first year.
Given the strength of the Russell 2000® Growth Index, some have expressed their concern that the small-cap rally is over-extended. As we have expressed through many conversations and investor letters, while we employ a pure small-cap growth strategy, we are always cognizant of valuations. It goes without saying that some sectors — notably software and biotech — screen as expensive on an absolute and relative basis. Stocks within relatively expensive sectors typically underperform in broader market weakness and can quickly retrace gains should investors sense any slowdown in the growth trajectory or believe the valuation has reached its peak. Hood River’s discerning approach to expensive sectors has allowed us to achieve our historical performance numbers alongside generally lower risk in the form of a beta at-or-below the Russell 2000® Growth Index and a downside capture less than 100%. While we have found opportunities in both the software and biotech subsectors in the most recent quarter, we are underweight information technology and health care almost exclusively due to our underweights in these two industries.
Stepping back to the portfolio overall, we are entering 2021 with a relatively normal positioning. All of our sector weightings are within 500 bps of the benchmark except for health care, where we are underweight roughly 600 bps — again, largely due to biotech.
2020 brought many challenges to the nation and the world. Hood River’s investment team has demonstrated its ability to adapt to — and regarding the equity market, capitalize on — the changing environment. As we turn the calendar to a new year, 2021 will carry over many of the same challenges, uncertainties, and opportunities. We remain optimistic that our bottom-up stock selection process will continue to identify dislocations in this dynamic environment and create value for our investors. We hope everyone had a healthy holiday season, and we look forward to connecting with our investors as 2021 gets underway.
Brian Smoluch & David Swank
Investors in Hood River’s Small-Cap Growth strategy acknowledge and agree that (I) any information provided by the Firm is not a recommendation to invest in the strategy and that the Firm is not undertaking to provide any investment advice to the investor (impartial or otherwise), or to give advice to the investor in a fiduciary capacity in connection with an investment in the strategy and, accordingly, no part of any compensation received by the Firm is for the provision of investment advice to the investor and (II) Hood River has a financial interest in the investor’s investment in the strategy on account of the fees and other compensation the Firm expects to receive from the client.
Hood River Capital Management LLC, a Delaware limited liability company, offers investment advisory services to individuals, pension and profit-sharing plans, trusts, estates, corporations, as well as other institutional clients. Hood River has an arms-length service level agreement with mar Vista Investment Partners, a registered investment adviser, to provide back and middle office services. For purposes of compliance with GIPS®, Hood River has defined itself to not include bundled/WRAP fee accounts in the firm’s assets. Hood River maintains a complete list and description of firm composites, which is available upon request.
On 01/01/13, Brian Smoluch, Robert Marvin and David Swank formed Hood River to manage a small-cap growth strategy. Brian Smoluch, Robert Marvin and David Swank were dual employees until 05/31/13 when all of the assets under their management at Roxbury transitioned to Hood River through a sub-advisory arrangement. On 1/20/15, Hood River finalized an agreement that put 100% of its equity in the hands of Hood River’s three Principals, divided equally among them. All assets under management are managed by Hood River. Information provided for the period from June 2002 through December 2012 represents the performance of portfolios managed by Mr. Smoluch, Mr. Marvin and Mr. Swank while employed by Roxbury. Hood River claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS® standards. GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. Hood River has been independently verified for the periods 01/01/13 through 12/31/19. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS® standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS® standards. The Small-Cap Growth composite has been examined for the periods 6/30/02 through 12/31/19. The verification and performance examination reports are available upon request. Benchmark returns are not covered by the report of independent verifiers. For the entire period presented, Mr. Smoluch, Mr. Marvin and Mr. Swank have been substantially responsible for the all the investment decisions of the small-cap growth strategy. Performance prior to 01/01/13 meets GIPS® portability requirements. ACA served as the verifier, conducted a verification and examined the composite’s performance history that was ported over to Hood River prior to 1/1/13.
The Small-Cap Growth composite was created in 2002 with an inception date of 06/30/02. On 01/01/13 the name of the composite changed from Small-Cap Growth (Portland Team) to Small-Cap Growth. All returns are based in U.S. dollars and are computed using a time-weighted total rate of return. The composite is defined to include all fully discretionary, fee paying, taxable and tax-exempt portfolios with a minimum portfolio value of $500,000 managed in accordance with Hood River’s Small-Cap Growth strategy and that paid for execution on a transaction basis. Any account crossing over the composite’s minimum threshold due to contributions shall be included in the composite at the end of the month it increased in value. Any account which drops below 65% of the composite’s minimum threshold because of considerable cash withdrawals and not due to manager performance will be removed from the composite at the beginning of the month it declines in market value.
The benchmark is the Russell 2000® Growth Index, defined as an unmanaged, capitalization weighted index of those Russell 2,000 companies with higher price-to-book ratios and higher forecasted growth values. Index returns include dividends and/or interest income and do not reflect fees or expenses. In addition, unlike the composite, which periodically maintains a cash position, the Russell 2000® Growth Index is fully invested. Investors cannot directly invest in an index.
The dispersion in gross of fee composite returns shown herein was measured using an asset-weighted standard deviation formula. For returns presented gross of fees, results were calculated prior to a deduction for investment management fees. Client returns will be reduced by Hood River’s investment management fees. The fee schedule is disclosed in Part 2A of Form ADV filed with the Securities and Exchange Commission. Over a period of years, deductions for annual investment management fees will reduce the compounding effect on portfolio growth. For example, assuming 8% annual return for five years and application of the maximum annual fee of 1%, a total gross return of 46.9% and a total net return of 40.3% would be generated. Performance results presented reflect the reinvestment of dividends and other earnings. Gross performance is net of all transaction costs. Net performance is net of transaction costs, the maximum performance-based fees if applicable and actual management fees, but before any custodial fees. All returns are calculated net of withholding taxes on dividends and interest. Actual results may differ from composite results depending upon the size of the portfolio, investment objectives and restrictions, the amount of transaction and related costs, the inception date of the portfolio and other factors. Policies for valuing portfolios, calculating performance, and preparing GIPS® Composite Reports are available upon request.
Attribution information is as of 12/31/2020 in an account of a client that Hood River believes to be representative of the Small-Cap Growth accounts Hood River manages. Clients of Hood River managed with different investment objectives or restrictions may have different sector performance and daily beta than those listed. Information is provided for supplemental purposes only. Past performance is no guarantee of future results. Not FDIC insured, no bank guarantee, may lose value.
