Small-Cap Growth Commentary – September 30, 2020
The Hood River Small-Cap Growth strategy returned 14.52% net of fees in the third quarter of 2020, beating the Russell 2000® Growth Index by 736 basis points (“bps”). Year-to-date, Hood River’s Small-Cap Growth strategy returned 23.14% net of fees, 1,926 bps ahead of the benchmark’s return of 3.88%.
The third quarter of 2020 can be clearly divided into two periods: the first marked by a continuation of Q2’s strong equity returns and the second by concerns surrounding the near-term trajectory of the recovery. In July and August, equity investors remained bullish, pushing stocks higher as they priced in the reopening of economies around the world. The Russell 2000® Growth Index participated in this rally, rising 9.98% the first two months of 3Q. However, caution returned in September as investors fretted over the potential for tighter virus-related restrictions and a slowdown of another stimulus bill in Washington. Further, uncertainty surrounding the upcoming U.S. election has moved to the forefront as November draws nearer. The combination helped to reverse the positive trend equities had enjoyed since early Spring, and over the course of September the Russell 2000® Growth Index fell 2.14%.
The best performing sectors in the Russell 2000® Growth Index during quarter were Consumer Discretionary (+17.16%), Industrials (+15.30%), and Consumer Staples (+9.82%). Lagging sectors for the quarter included Energy (-6.05%), Utilities (-3.66%), and Communication Services (-1.32%). 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 Q3 were Industrials (+178 bps), Utilities (+104 bps), and Consumer Discretionary (+101 bps). The only sector in which we posted negative stock selection in Q3 was Energy (-3 bps).
As we have discussed in our prior quarterly commentary, we expect U.S. economic activity to remain choppy but show a gradual improvement as the U.S. reopens. Our outlook remains intact despite the turbulence seen in September. As always, in a presidential election year, we expect to see some volatility in the markets as November 3rd approaches. However, once the election results are behind us, investors will gain a better sense of the policy to expect from Washington. Further, a vaccine appears on track for initial availability in Q4 of 2020, which will likely be more widely distributed in the first half of 2021. Overall, we expect the U.S. to continue slowly moving towards full potential over the coming quarters. Within this backdrop, small cap companies have continued to exhibit their resilience and our outlook on small caps in general remains positive.
In the market recovery from the three recent bear markets (Covid-19, Great Financial Crisis (GFC) and Dot-Com bubble) we’ve seen similar absolute returns from large, mid and small-cap companies in the early stages of the rebound. By contrast, over the intermediate term of a year or two following the GFC and Dot-Com bubble, smaller-cap stock returns took a leadership role and delivered stronger outcomes. While we are only six months into the recovery at this point, we believe smaller companies will continue to benefit from their ability to adapt and grow revenue, expand margins, and thus increase earnings in a “new normal” environment.
Our bottom-up stock selection process continues to fare well in these volatile markets, in part due to our experience over market cycles and the independent nature of our research. The combination allows the investment team to remain nimble and act quickly in this dynamic environment. We have long believed sell-side coverage of small cap stocks is inefficient – and this “research gap” continues to grow.
We are entering Q4 with a relatively normal portfolio positioning. All of our sector weightings are within 500 bps of the benchmark except for Healthcare, where we are underweight roughly 600 bps, and Industrials, where we are overweight roughly 500 bps.
Despite relatively calm and sanguine equity markets this summer, September once again reminded investors there remain some near-term risks as the economy reopens. While several signs have pointed to a slowing of the recovery in the last few months, we expect the economy to gradually return to full potential. The recent pullback in equities has once again created opportunities in the form of prices dislocated from what we view as true values. Heading into year-end, we are optimistic that our bottom-up stock selection process will continue to identify these dislocations and create value for our investors. We look forward to visiting with many of you in the months ahead and 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 9/30/2020 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. Past performance is no guarantee of future results. Not FDIC insured, no bank guarantee, may lose value.