Small-Cap Growth Commentary – March 31, 2020

In the first quarter of 2020 the Russell 2000® Growth Index returned -25.76%. The Hood River Small-Cap Growth strategy returned -22.68% net of fees, outperforming the benchmark by 308 basis points.

Covid-19’s emergence and the resultant national and global shutdown drove a bear market of historical speed in the first quarter of 2020. U.S. stocks peaked on February 19th as the nation was distracted by the democratic nomination race, and on Monday February 24th, stocks gapped down. The race to the bottom was on for the next several weeks, which was characterized by historically unprecedented volatility on both the up- and down-side as investors grappled with the rapidly evolving Covid situation. Over the course of a month, most investors’ worldviews changed dramatically from one involving solid domestic growth to one in which large swaths of the economy were shutdown, and a rampaging virus threatened a near-term surge and potential lingering effects. We are currently in a time of unprecedentedly low visibility into the near- and intermediate-term public health situation, and as a result, similarly low visibility into the economy and the lingering effects of the shutdown on household balance sheets, corporate balance sheets, and longer-term solvency of quite a few companies.

Over the course of nearly 20 years, we have added value through intensive focus on bottom-up stock selection while keeping the portfolio in-line on macro risk factors. Today, it is imperative to have a baseline outlook for how the health situation will evolve while dynamically adjusting to real time information and reflecting it in the current portfolio on a bottom-up basis. Currently, we believe the second derivative U.S. case count increase will decelerate in the middle of April leading to work start-up gradually in May or June and to more progressive economic activity in July and August. Meanwhile, we expect testing and ICU capacity to ramp into the fall to handle a resurgence of the disease in September and October, which could adversely effect economic activity in the winter. This will most likely hamper growth until a vaccine comes to market in perhaps eighteen to twenty-four months. Meanwhile, some treatments, such as antibodies and antivirals, hold some promise, could bridge the gap until we get a vaccine, and would dramatically improve economic activity if effective.

Given this uncertain backdrop, during the quarter we balanced the portfolio with innovative companies benefiting from this dislocation with companies that will see a surge in activity once the economy returns to normal. Some of the companies that we expect to see an acceleration in both short- and long-term business trends from the epidemic shock include companies involved in telemedicine (Teledoc Health), streaming (Limelight Networks), datacenters (Inphi), prescription optimization (Tabula Rasa Healthcare), online learning (Chegg) and online warehouse distribution (Plug Power). Companies we own with a near-term disruption to business trends but should recover quickly include Integra Lifescience, Charles River Labs, Kornit Digital, Integer Holdings, Nuvasive, and Dycom Industries.

Every sector within the benchmark was down substantially, with the worst carnage in energy (-66%), consumer discretionary (-41%), materials (-37%), and industrials (-31%). The relatively best-performing sectors within the benchmark were utilities (-8%), healthcare (-18%), financials (-22%) and consumer staples (-24%). Within the quarter, Hood River’s relative outperformance was driven by a mix of positive stock selection and positive sector allocation. Our best sectors for stock selection included healthcare (+178), communications services (+129), and technology (+79). Our worst stock selection sectors were industrials (-195), energy (-70), and consumer discretionary (-58). Sector allocation was helped by our underweight in consumer discretionary and our overweight in information technology, and hurt by a very slight overweight in energy.

We entered the quarter slightly underweight consumer discretionary, but overweight gaming-related companies based on our positive bottom-up outlook for those stocks. In late February and early March we significantly cut back on those gaming positions, as well as some other consumer discretionary companies, and avoided some of the carnage in that poor-performing sector even while some of the stocks we did own were hard hit. Combining sector allocation and stock selection, consumer discretionary contributed just over 100 basis points of positive attribution in the quarter. The opposite dynamic played out in healthcare, where our strong stock selection was slightly more than offset by a relatively small (268 basis point) underweight in the relatively well-performing sector. Our industrials stock selection was negatively impacted by a slight overweight in economically sensitive companies going into late February based on our previous bottom-up outlook. Energy, with very a small allocation within our portfolio, was still a painful sector in the quarter due to a combination of a slight (140 basis point) overweight, and some negative stock-selection in a quarter where almost every energy company’s plans were massively disrupted. Information technology and communication services were both strong in stock selection as well as total attribution.

As we enter the second quarter, we remain within 400 basis points of the benchmark’s sector weightings, except for consumer discretionary, where we are underweight by roughly 600 basis points, and information technology and communication services where we are overweight by roughly 700 basis points and 400 basis points, respectively. We remain underweight biotech. We estimate our current portfolio’s beta is similar to that of the Russell 2000® Growth Index.

This quarter has been the most volatile period in the markets and economy we have lived through, including the great recession. There is a low level of near- and intermediate-term visibility. In the long-run, our country and the world will get through this health problem and the resultant economic problems. In the meantime, we are hopeful that the volatility will create further opportunities for our research process to continue adding value to our clients’ portfolios. Small-cap stocks usually become more inefficient during market stress periods and our process tends to do well as the market resurges. Meanwhile, we have also structured the portfolio in an attempt to protect capital on a bottom-up basis during these uncertain times.

Please keep yourselves and your families safe, and thank you for your continuing support.

David Swank, Brian Smoluch & Rob Marvin

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 3/31/2020 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. A complete list of portfolio holdings and specific securities transactions for the investment strategy during the preceding 12 months, the top contributors and underperformers calculation methodology, and a list of every holding’s contribution to the overall performance during the period is available upon request. 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. Past performance is no guarantee of future results. Not FDIC insured, no bank guar
antee, may lose value.