Small-Cap Growth Commentary – June 30, 2020
The Hood River Small-Cap Growth strategy returned 39.06% net of fees in the second quarter, beating the Russell 2000® Growth Index by 848 basis points (“bps”). Year-to-date, Hood River’s Small-Cap Growth strategy returned 7.53% net of fees, 1,059 bps ahead of the benchmark’s return of -3.06%.
During the quarter, small-cap growth stocks surged to their biggest gain since 1999. Unprecedented stimulus from the Federal Reserve and Congress brightened investors’ outlooks even in the midst of the biggest economic shutdown in memory, and by quarter-end investors were seeing signs of resilience in the economy. Every major index was up dramatically, and the Russell 2000® Growth Index returned 30.58%. Stocks rallied steadily through early June, then went sideways as investors weighed the better-than-expected economic reopening of the economy against an earlier-than-hoped resurgence of Covid-19 cases, which ended June at a new daily record. While the final three weeks of June were the most stable in the markets since mid-February, much uncertainty persists regarding both the public health outlook and the economic future.
Over the course of nearly 20 years, we have added value through intensive focus on bottom-up stock selection while keeping the portfolio in-line on macro risk factors. Similar to last quarter, it is imperative to have a baseline outlook for how the health and economic situation will evolve while dynamically adjusting to real time information and reflecting it in the current portfolio on a bottom-up basis. Currently, we believe case counts will accelerate from here and then plateau as reopening happens but will be manageable by the US health system. A vaccine will likely be available in smaller quantities by Q4 of 2020 and larger quantities by early 2021. Economic activity will remain choppy, but will gradually improve as the country reopens.
Second quarter US small-cap company fundamental performance will likely prove to be a testament to unparalleled American capitalism. Great small companies quickly readjusted their businesses in uncertain times by streamlining costs, utilizing technology to effectively manage businesses from disparate locations, strengthening balance sheets, and conducting sales virtually. American companies figured out how to get business done and meet customers’ needs despite working from home. In lots of cases this means both demand and profitability will be much greater than sell side analysts were thinking in the beginning of April. Most analysts are still too conservative now and our process is designed precisely to capitalize on this inefficiency.
Within the Russell 2000® Growth Index, every sector was up for the quarter. The best performing sectors were consumer discretionary (+54%), energy (+49%), and healthcare (+32%). Hood River’s outperformance in the quarter was predominantly driven by stock selection. Our strongest sectors for stock selection were industrials (+411 bps), consumer discretionary (+294), and communication services (+151). Our weakest areas of stock selection were information technology (-122 bps), healthcare (-121), and real estate (-42). Our biggest winners in terms of stock selection included Plug Power, Macrogenics, DraftKings, Bandwidth and Eldorado Resorts. Plug Power, which makes hydrogen fuel cell systems for electric trucks and forklifts, did well as it communicated end market demand and profitability will accelerate this year. Macrogenics, a biotech company, rallied sharply in the wake of its first quarter earnings conference call in which it provided detail on its impressive emerging pipeline. DraftKings, a leading online sports betting and iGaming site, soared as investors grew enamored of its high growth potential; we exited our position in late June as the valuation mostly reflected a good case scenario. Stocks that detracted in terms of stock selection during the quarter were Tabula Rasa, Lumentum, Select Medical, Teladoc Health and Magnachip Semiconductor. Both Tabula Rasa and Lumentum were relatively quiet stocks in Q1, and while they were both up in 2Q, they experienced less of a snap back than the average stock. Select Medical’s stock, while up in 2Q, underperformed on fears of a lingering recession pressuring revenues, but we added to our position late in the quarter as we anticipate Select Medical will actually show strong long-term acute care hospital revenues in the near term, while remaining well-positioned to succeed when the covid19 threat recedes.
We entered July with a relatively normal portfolio positioning. All of our sector weightings are within 400 bps of the benchmark except for industrials, where we are 700 bps overweight. We remain underweight biotech. We estimate our current portfolio’s beta is similar to that of the Russell 2000® Growth Index.
As we announced in January, our partner Rob Marvin retired in April. We appreciate Rob’s contributions to the firm over the years, and we wish he and his family the best as they move on to new adventures. Our continuing six-person team is operating well and we are having more conversations than ever with small-cap companies.
This has been a turbulent year for all investors. Fortunately, turbulence can bring opportunities in the form of price dislocations that are not reflective of true values. Furthermore, at a time when many companies have withdrawn guidance, bottom-up research has an even greater opportunity to show its value in predicting earnings and other fundamentals. We are proud that our team has risen to this year’s challenges and are optimistic about the potential to build on what we have accomplished as we look to the second half of the year. Thank you for your continued support.
David Swank & Brian Smoluch
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. 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 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 compliant presentations are available upon request.
Attribution information is as of 6/30/2020 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. A complete list of portfolio holdings and specific securities transactions for the investment strategy during the preceding 12 months, the top contributors and underperformers calculation methodology, and a list of every holding’s contribution to the overall performance during the period is available upon request. The securities listed in this letter should not be considered a recommendation to purchase or sell any particular security. The reader should not assume that investments in the specific securities identified herein were or will be profitable. Past performance is no guarantee of future results. Not FDIC insured, no bank guarantee, may lose value.