The second quarter was slightly soft for US small cap growth stocks, as the Russell 2000® Growth Index (the benchmark) fell by -2.92% in the three months ending 6/30/2024, placing the index +4.44% year-to-date (“YTD”).  Small cap stocks lagged the S&P 500® Index’s +4.28% and Nasdaq’s +7.82% quarterly gains, which are now up +15.29% and +16.98% YTD, respectively.  Hood River’s investment team remained diligent in identifying stocks we viewed as mispriced, which lead to another quarter of outperformance.  Our US Small Cap Growth portfolio gained +2.75% for the quarter net of fees, outpacing the benchmark by +567 basis points (“bps”), and is now up +17.37% net of fees YTD, or 1,293 bps ahead of the benchmark. 

As is typical given our fundamental research process, the majority of the strategy’s alpha for the quarter was driven by stock selection (+652 bps).  Sectors that contributed the most to stock selection included industrials (+446 bps), information technology (+210 bps), and consumer discretionary (+63 bps).  Detracting sectors included financials (-75 bps), communication services (-14 bps), and health care (-9 bps).  

Year-to-date alpha is also driven by stock selection (+1,314 bps).  Leading sectors include industrials (+1,023), consumer discretionary (+254 bps), and materials (+127 bps).  This is slightly offset by information technology (-69 bps), health care (-43 bps), and communication services (-28 bps).

Although US small cap growth stocks were in the doldrums for Q2 2024, it was a straightforward — and welcomed — investment environment.  The past few months was not a period in which performance was driven by any large macro move.  Rather, it was a period rewarding stock pickers for bottom-up stock selection.  Granted, we strive to outperform in any investing environment — but fundamental research is usually better rewarded when correlations across stocks are relatively low.

Hood River’s investment team identified and invested in names that generally outperformed over the quarter — however, it is also imperative that we identify potential potholes and avoid losses.  We have always strived to add value on both buys and sells, and our sell discipline has created an asymmetric risk profile over time.  Our YTD and Q2 performance was a reflection of this, as the portfolio consisted of solid outperformers while we generally avoided large losses.

As most readers know, Hood River does not do ‘theme investing’ — rather, we seek to identify companies that we believe are mispriced by the market through our proprietary, fundamental research.  The result is a portfolio of names that is often illustrative of what themes may play out over the short and medium term.  Our bottom-up view is that AI and digital currency data centers continue to change the supply/demand balance in several industries: primarily in industrials, technology, materials, and utilities.  The buildout of capabilities is requiring more power, land, hardware, and chips. Some companies with ancillary exposure to these dynamics stand to benefit, yet we do not believe the market is fully pricing this in.  Of course, our investment team is focused on identifying the next beneficiaries instead of going to names where exposure is already baked in.

Our sector exposure remains fairly close to the benchmark outside of industrials, in which we are overweight by ~940 bps.  As we always point out, however, industrials is largely a catch-all for companies that don’t fit cleanly in another sector.  It is also an area where we are finding companies with the ancillary exposure to AI/data centers mentioned above.  All other sector exposures are within approximately 400 bps of the benchmark.

Turning briefly to the macro environment, interest rates have remained at the forefront of investors’ minds.  The assumption of rates remaining higher for longer has had some negative effects amongst banks and we could potentially see some credit problems in the back-half of the year.  We have seen some effect on the consumer as chunky purchases (e.g. boats, housing) slow down, commercial real estate remains a difficult area, and several metro regions are not showing signs of recovering.  Hood River has remained diligent in seeking to identify areas where demand remains good despite any macro headwinds.

Most management teams believe inflation is more manageable despite remaining elevated, and labor remains somewhat tight but the situation is no longer deteriorating.  Many companies are not concerned about margin expansion, it’s more of an issue of what to expect with demand.  As long as revenue hits expectations, many management teams believe they have enough toggles to achieve margin expansion — e.g. if labor is tight, they can make it up on the materials side.  While some are concerned about AI taking away jobs, we have found several instances of companies simply becoming more productive through the use of AI.  Management teams are finding ways to implement the technology and grow their top line with zero headcount growth or market expansion.

Lastly, we’d like to touch on valuations.  From our seats, US small cap growth stocks in general continue to look attractive on an absolute and relative basis.  The forward P/E for the Russell 2000® Growth Index is 19.5x, a slight discount to the ~20x average since 2000 (for profitable companies).  Further, the index typically trades at a 20% premium to the S&P 500® Index yet it is currently at a 7% discount.  Everyone has their own opinion on the timing and pace of rate cuts — yet given where valuations for small caps are, we believe the group could be poised to work well if and when we eventually see cuts.

The Hood River investment team has been generating materially more idea flow than we did just a few years ago — this is largely a reflection of the analysts’ tenures.  This has resulted in a position count of approximately 95-110 stocks in the portfolio, which is slightly higher than historical levels.  This also suggests we are not short of good ideas and continue to invest where we believe we have an advantage versus the market.  The team remains diligent in ensuring our portfolio is comprised of our best ideas and, as mentioned earlier, balanced against our sell discipline.  We greatly appreciate your confidence in, and partnership with, Hood River.  Please reach out to our marketing team if you would like additional information.

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, is a registered investment adviser under the Investment Advisers Act of 1940. The Firm 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 and a list of broadly distributed pooled funds, 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 Capital Management, LLC 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®). 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. 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.
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. 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.
Information has been gathered from sources that are considered reliable, however its accuracy cannot be guaranteed. The security mentioned in this letter was held in the account of a Small-Cap Growth client that Hood River believes to be representative of the accounts that Hood River manages for this investment strategy during the period from March 31, 2024-June 30, 2024. Other Hood River clients managed with different investment objectives may hold different securities than those listed. 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.  Sector attribution information is as of 12/31/23 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 as supplemental to the Small-Cap Growth GIPS® Composite Report. A Small-Cap Growth GIPS® Composite Report is available upon request by contacting Hood River directly at 561-484-5699 or via email at [email protected].. Past performance is no guarantee of future results. Not FDIC insured, no bank guarantee, may lose value.