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 Fund Institutional Share Class (HRSMX) gained +2.70% for the quarter, outpacing the benchmark by +562 basis points (“bps”), and is now +17.11% YTD, or 1,267 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 (+641 bps).  Sectors that contributed the most to stock selection included industrials (+441 bps), information technology (+206 bps), and consumer discretionary (+63 bps).  Detracting sectors included financials (-74 bps), communication services (-14 bps), and health care (-10 bps).    

Year-to-date alpha is also driven by stock selection (+1,289 bps).  Leading sectors include industrials (+1,008), consumer discretionary (+252 bps), and materials (+125 bps).  This is slightly offset by information technology (-69 bps), health care (-49 bps), and communication services (-27 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 attempt to 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 ~795 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

		Annualized, as of 6/30/24
	YTD 6/30/24	1 Year	3 Year	5 Year	10 Year	Since Inception
HR Small Cap Growth – Institutional	17.11%	23.89%	1.75%	15.40%	13.22%	12.93%
Russell 2000® Growth Index	4.44%	9.14%	-4.86%	6.17%	7.39%	9.77%
HRSCG Net vs Benchmark	12.67%	14.75%	6.61%	9.23%	5.83%	3.16%

Inception date: 01/02/2003

Performance quoted represents past performance for the Fund’s institutional class shares and there is no guarantee of future results.  The investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than the original cost.  Current performance may be higher or lower than the performance data quoted above.  Please call 800-497-2960 to obtain current and the most recent month-end performance data.  The gross expense ratio:  1.07%; net expense ratio (contractual through 10/31/24): 1.07%.