Small-Cap Growth Commentary – June 30, 2021
The general tone of the market has changed somewhat since our Q1 2021 update. Following four years of growth style outperforming value, the first three months of 2021 began with a reversal of this trend and a debate over the potential for a longer-term rotation from growth into value. Indeed, the Russell 2000® Growth Index posted gains of 4.88% in Q1 while the Russell 2000® Value Index rose 21.17%. The moves in Q2 were much more muted and more in-line with one another: using these same indices as a proxy, growth rose 3.91% while value rose 4.56%. There certainly was some choppiness during the quarter, in part driven by macro data / commentary, but also a continuation of the growth vs. value tug-of-war.
As we discussed in our Q1 commentary, while we are committed and disciplined growth investors, our investment process also allows us to get ahead of fundamental market deviations, including value oriented environments. In general, a broader market shift away from growth into value tends to change the earnings momentum landscape, and thus the characteristics of our portfolio. Our U.S. Small-Cap Growth strategy characteristics tend to show us as having a slight value tilt relative to the Russell 2000® Growth Index when looking at factor exposures — this is often amplified when value outperforms growth, a characteristic that has generally aided our performance vs. our benchmark during these periods.
The second quarter was again a period in which value outperformed growth — albeit only slightly — and Hood River is pleased to report our Small-Cap Growth strategy continued to outperform the benchmark. Our Small-Cap Growth strategy gained +8.30% over the past three months (ending 6/30/21) on a net basis, 439 basis points (bps) ahead of the Russell 2000® Growth Index. The benchmark’s best performing sectors in the quarter were energy (+24.93%, although only 31 bps in the index), consumer staples (+7.44%), and financials (+6.90%). Industrials
(-1.06%) was the only sector posting negative returns in the period. Updating commentary from our Q1 letter, over the past decade the Russell 2000® Value Index has now outpaced the Russell 2000® Growth Index in 18 quarters. Our Small-Cap Growth strategy has now posted excess returns (gross of fees) in 11 of these 18 quarters. Regardless of your expectations for value vs. growth in the coming quarters and years, we believe our process, strategy, and batting average offer a compelling solution for investors seeking exposure to the U.S. small-cap space.
With the latest quarter behind us, the strategy’s year-to-date performance now stands at 20.57% (net), 1,159 bps ahead of the benchmark. Year-to-date, the benchmark’s best performing sectors were energy (+74.81%), consumer discretionary (+24.97%), and consumer staples (+20.18%). No sectors posted negative returns year-to-date through 6/30/21.
Excess returns during the quarter were primarily driven by stock selection, as is typically seen given our fundamental process. The sectors that contributed the most through stock selection in Q2 were industrials (+230 bps), consumer discretionary (+117 bps), and consumer staples (+84 bps). Sectors that lagged in stock selection during the quarter included utilities (-32 bps), information technology (-26 bps), and financials (-12 bps). We are entering the second half of 2021 with a relatively normal portfolio positioning relative to our benchmark. All of our sector weightings are within 600 bps of the benchmark except for health care and industrials. Regarding health care, despite having roughly 19% exposure in the portfolio, we are approximately 1,150 bps underweight. This underweighting is primarily driven by our relative underweighting to biotech. We are approximately 900 bps overweight industrials, which is largely a ‘catch all’ sector and includes companies that do not have traditional ‘industrial’ businesses.
Currently, demand is surging and oftentimes exceeds 2019 levels on a company specific level. Labor and component supply are struggling to keep up, which is driving inflation. Hood River is investing in companies where the business can either proactively take up prices more aggressively than its costs or efficiently manage its supply chain to make or exceed Wall Street estimates. We are proactively adding to stocks when 2022 estimates and expectations are too conservative and selling stocks in situations where expectations are too aggressive. In some cases, analysts are predicting 2022 levels below 2019 and in others, analysts have 2022 dramatically exceeding 2019 levels. We tend to like the set-up for the former and are staying away from the latter.
Last year was a year of dislocations, from which Hood River’s U.S. Small-Cap Growth strategy benefited. The market in the first half of 2021 has certainly been more ‘rational’ than what we saw just over a year ago, but the latest questions over inflation and growth are creating new dislocations — and Hood River continues to capitalize on the opportunities we uncover. We are always thankful for our investors’ confidence in the team and strategy. We have had a solid start to 2021 but remain diligent in our process and optimistic for the second half of the year. Lastly, while the majority of recent interactions have been over video calls, we would be happy to welcome investors for in-person meetings at our Palm Beach Gardens office or your location. We look forward to catching up with our investors over the coming months.
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 12/31/20. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Small-Cap Growth composite has had a performance examination for the periods 07/01/02 through 12/31/20. The verification and performance examination reports are available upon request. 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. 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, 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 6/30/2021 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.