Small Cap Growth Fund Commentary – Q3 2024

Comparing a snapshot of quarter-end performance from Q2 and Q3 would suggest it was a relatively quiet quarter for US small caps.  However, the third quarter began with quite a bit of volatility.  In July we witnessed what we would describe as the biggest rotation from growth to value we have seen in our 20+ year careers.  Illiquid, relatively weak stocks that were cheap on absolute valuation yet had negative earnings revisions rallied.  Given that Hood River focuses on companies we believe will outperform market expectations over the coming quarters and years, this rotation had a negative impact on our relative performance.  Further, we had an imbedded tilt towards AI in the portfolio — a group which also faced headwinds in July.  Thus, at one point our US Small Cap Growth fund was trailing the Russell 2000® Growth Index by approximately 400 points on a quarter to date basis.  Despite this, the investment team continued to execute on our 20+ year process to ensure we were invested in our best ideas heading into earnings season, and our process prevailed. 

We made a few adjustments to the sector exposure by adding more to consumer staples and taking a bit away from technology and industrials, but overall, we were focused on investing in companies with solid/improving fundamentals alongside attractive valuations.  For Q3, our US Small Cap Growth Fund Institutional Share Class (HRSMX) gained +12.14%, outpacing the Russell 2000® Growth Index by +373 basis points (“bps”).  Year to date, the fund is now up +31.33%, or +1,811 bps ahead of the benchmark.  A table of longer-term returns is provided below.

 

 

 

Annualized, as of 9/30/24

 

YTD 9/30/24

1 Year

3 Year

5 Year

10 Year

Since Inception

HR Small-Cap Growth (Institutional)

31.33%

51.80%

6.42%

20.20%

14.79%

13.37%

Russell 2000® Growth Index

13.22%

27.66%

-0.35%

8.82%

8.95%

10.06%

HRSMX vs Benchmark

18.11%

24.14%

6.77%

11.38%

5.84%

3.31%

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.  Fund inception: 01/02/2003

Our outperformance for the quarter was driven by stock selection, which is expected given our bottom-up, fundamental research process.  The largest contributing sectors for the quarter included industrials, health care, and consumer discretionary.  The two detracting sectors from overall stock selection were financials and consumer staples. 

Year-to-date alpha was also driven by stock selection.  Leading sectors included industrials, consumer discretionary, and materials.  Slightly offsetting this was information technology, financials, and communication services.

During the third quarter, we found several unique opportunities through our strong relationships with brokers and management teams to benefit our clients.  One of these was with Applied Digital Corporation (APLD).  The stock was already in our portfolio, but in September we added to the position by co-investing with NVIDIA at a discounted $3.20 per share; APLD closed out the quarter above $8.  Another example is QXO, which is run by business-guru Brad Jacobs.  QXO is a PIPE that we were able to add to the portfolio below $10 per share; QXO ended the quarter near $16.  In addition to our typical bottom-up research process, we will continue to be creative to find similar unique inefficiencies and seek to add value for our clients.

We have been asked by investors about our thoughts on the macro in 2025 — however, from our conversations with management teams, most are still focused on 2024.  There are a lot of moving pieces at the macro level, including the Federal Reserve lowering rates, the upcoming US election, the impacts from hurricanes, and ongoing wars in the Middle East.  Overall, from our hundreds of conversations during the quarter, the macro heading into Q4 is fairly similar to last quarter.  The consumer is clearly weaker, which is one of the reasons the Fed is easing.  However, our weighting of the consumer discretionary sector was relatively in-line with the benchmark for Q3 — we were able to outperform in the space by +90 bps by identifying interesting ideas that bucked the backdrop of a weakening consumer. 

Regarding the upcoming election, we are not implicitly tilting our portfolio towards one side or the other, as at this point it appears to be a toss-up.  That said, some of the recent commentary from the Republican side suggests a potential weakening of the Inflation Reduction Act.  This would have a negative impact on industrials, in our view.  During Q3, industrials were, in fact, a tough spot for small cap growth stocks.  Despite being overweight the sector, we were invested in companies that avoided negative earnings revisions and our industrial holdings outperformed the benchmark by nearly +200 bps. 

Heading into the fourth quarter, our sector weightings are fairly close to the benchmark.  No sector has more than a +/- 400 bps differential apart from industrials, in which we have a roughly 650 bps overweight.  Similar to the last few quarters, this is not a specific call on the group — rather, we continue to find opportunities in the sector that might have exposure to other sectors but are classified as ‘industrials’ given it is a catch-all sector. 

Looking at valuations, the forward P/E (earnings positive) for the Russell 2000® Growth Index is 22.0x, slightly above the average since 2000 for profitable companies.  As we have previously discussed, the benchmark typically trades at a 20% premium to the S&P 500® Index, yet it currently stands at a very slight discount.  Given the Fed has just begun its easing cycle — and small caps typically outperform during an easing cycle — we still believe small caps have the ability to outperform over the coming quarters. 

The team continues to expand the number of ideas and channel checks we perform each quarter.  We are confident of the ideas we are invested in heading into earnings season and Q4 in general.  We will note that the weighted average market cap is at a premium compared to where it has historically been — we view this as a high-class problem given our outperformance but expect this premium to decline over time.

We greatly appreciate everyone’s continued confidence in, and partnership with, Hood River.  We look forward to connecting with many of you in the coming months — please reach out to the marketing team if you have any questions or need anything.

Brian Smoluch & David Swank

 

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%.   As of 09/30/24, APLD was 2.12% of assets owned, QXO was 1.13% of assets owned.  Holdings are subject to change and are not a recommendation to buy or sell any security.

Basis Points (“bps”) is a unit of measure used to describe the percentage change in the value of an investment. Price/Earnings Ratio (“P/E”) is defined as the proportion of a company’s share price to its earnings per share.  Alpha is defined as the excess return versus the benchmark when adjusted for risk.

Investment Considerations:

All investing includes risk, including the loss of principal.  There can be no guarantee that any strategy (risk management or otherwise) will be successful.  The Fund invests in small-cap securities which present a greater risk of loss than large-cap securities, and in growth companies which can be more sensitive to the company’s earnings and more volatile than the stock market in general.  The Fund also invests in foreign securities which are subject to risks including currency fluctuations, economic and political change and differing accounting standards.  The Fund may invest in derivatives and IPOs, which are highly volatile.  Additional risk information may be found in the prospectus.

*All information in this report is as of September 30, 2024, unless otherwise indicated.  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.

Investors should carefully consider the Fund’s investment objective, risks, charges, and expenses before investing.  For a prospectus, which contains this and other important information about the Fund, please call 800-497-2960.  Please read the prospectus carefully before investing or sending money.

The Hood River Small Cap Growth Fund is distributed by Quasar Distributors, LLC.  Hood River Capital Management LLC serves as the advisor to the Hood River Small Cap Growth Fund.       

NOT FDIC INSURED-NO BANK GUARANTEE-MAY LOSE VALUE

 

Hood River Capital Management LLC serves as the advisor to the Fund.