Small-Cap Growth Commentary – March 31, 2021
It’s fair to say most everyone was ready to turn the page on the calendar and put 2020 in the rear view mirror. While the economy and various communities across the U.S. remain affected by Covid and the lock-downs to some extent, the gradual reopening is underway and we can see some sense of normalcy on the horizon. On that note, we hope this quarterly commentary finds everyone safe and healthy.
The Hood River team feels very fortunate to have made it through what appears to be the worst of the pandemic. Each team member remained resilient despite the challenges and demonstrated the ability to conduct business without missing a step. This is not by happenstance — our investment process, communications, and structure are designed for agility in a dynamic environment. Change is one constant in the markets, and Hood River capitalized on the many dislocations we found in 2020, resulting in 2,654 basis points (“bps”) of outperformance (net of fees) last year versus the Russell 2000® Growth Index.
The strategy continued to outperform in the first quarter of 2021: on a net basis, our Small-Cap Growth strategy posted gains of +11.33%, coming in 645 bps ahead of the Russell 2000® Growth Index. The best performing sectors in the Index during Q1 2021 were primarily cyclicals – notably, energy (+39.93%), consumer discretionary (+18.34%), and materials (+13.44%). Only two sectors posted negative returns for the quarter: health care
(-2.35%) and utilities (-0.61%).
Our independent, bottom-up research process drove the majority of excess returns during the quarter. Our strongest sectors for stock selection in Q1 were information technology (+271 bps), industrials (+76 bps), and consumer discretionary (+58 bps). Sectors in which we lagged during the quarter included health care (-46 bps), consumer staples (-25 bps), and utilities (-6 bps). Looking at the current portfolio, we are entering the second quarter of 2021 with a relatively normal positioning. All of our sector weightings are within approximately 600 bps of the benchmark, with health care being the only exception — despite having roughly 20% exposure in the portfolio, we are approximately 1,350 bps underweight. As we’ve previously discussed, this underweighting is primarily driven by our relative underweighting to biotech.
While the largest risk in 2020 was the immediate and longer-term effects of Covid and the shuttering of various parts of the economy, the focus has now pivoted to rising interest rates and the potential for inflation. That shift, in turn, has given pause to the rally in growth stocks relative to value stocks. While small-caps continue to fare well against their larger peers, some investors have questioned if the rally in growth is winding down. We are not market timers and don’t make macro calls — we will note, however, that historically a change in the earnings momentum landscape due to a significant shift towards value tends to impact the characteristics of our portfolio. We saw this in some fashion as 2020 progressed — despite finding opportunities in the technology and health care industries throughout the year, the investment team became increasingly concerned with valuations in the software and biotech sectors, respectively. This led to relative underweightings in technology and health care, but also gave our U.S. small-cap growth strategy a value tilt when looking at factor exposures. Our “value tilt” exists across market cycles and underscores one component of our investment process — while we are indeed growth investors, valuations are always a consideration and we will look for what we perceive to be disconnects in equity prices within our universe.
The resulting portfolio is also more defensive in periods where value outperforms growth. In the last decade ending 3/31/2021, the Russell 2000® Value Index has outpaced the Russell 2000® Growth Index in 17 quarters. Hood River’s U.S. small-cap growth strategy has posted excess returns (gross of fees) in 10 of these 17 quarters. It’s unclear how value versus growth will pan out, but we’d tout our strategy, process, and batting average for investors continuing to look for exposure to the U.S. small-cap space. The first quarter of 2021 was certainly one of these quarters when value outperformed growth, and Hood River’s results once again outpaced the benchmark.
Our view that the U.S. economy would begin to reopen in the first half of 2021 is panning out. While many of the challenges of the last year are waning, new uncertainties are taking their place. The market often manifests those uncertainties with overreactions and price dislocations, which create new opportunities for our portfolio. If the last 12 months showed us anything, it is that Hood River’s investment team can adapt to, and capitalize on, dynamic environments.
Touching once again on our team’s ability to execute in a changing environment, Hood River has officially moved our headquarters to Palm Beach Gardens on the intercostal waterway in Florida. Most of the investment team have already moved to the area and the entire team will be fully on the ground by the end of the year. Last year also demonstrated how well our team can operate in a hybrid model, or a mix between in-person and remote work. This hybrid model will likely continue in some fashion as we move forward in a more normal environment. We’re very excited to welcome visitors to our new office while also sharing some nice weather and views of palm trees.
We are off to a good start in 2021 but remain humble, vigilant in our process, and optimistic that our bottom-up stock selection process will continue to identify new opportunities. As always, we hope everyone is staying healthy and safe — we look forward to connecting with you in the months ahead.
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. 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 3/31/2021 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.
