Solid Fourth Quarter With Hood River Outperformance
The market posted a solid fourth quarter as the Russell 2000® Growth Index appreciated 4.3%. The Hood River Small-Cap Growth strategy outperformed the index by 60 bps, gaining 4.9% net of fees in the quarter. The market’s upward move came in the wake of a soft third quarter, during which investors priced into the market fears regarding Fed rate hikes and global growth. As a result, after years of investors wondering when the Fed would raise rates, on December 16, the Fed finally voted unanimously to lift rates by a well-telegraphed ¼ of a point, and the world did not end, with stocks down 1% from that point through year-end. The Fed further signaled that the pace of future rate hikes would be “gradual” and essentially in-line with its previous projections, which we are optimistic may lead to a healthy stock picking environment in the near-term. Within the index, the quarter’s strongest returns came in the healthcare sector, which returned 10.4%, followed by telecommunications up 6.5% and technology up 6.5%. Lagging sectors included energy down 13.8%, consumer discretionary down 4.2%, and industrials up 1.8%.
The Hood River portfolio performed well in the quarter, despite getting off to a slow relative start as the market jumped to a 9.5% gain in October and November, while our portfolio lagged slightly behind. As the market pulled back in December, we more than made up the lost ground. For the quarter, the bulk of our performance came from strong stock selection (+138 bps), with a slight negative impact from sector allocation primarily due to our below-index allocation to healthcare. Our strongest stock selection sectors in the quarter included industrials (+147 bps) and telecommunications (+38 bps), while our weaker sectors included healthcare (-48 bps), and consumer staples (-27 bps). Within industrials, our biggest winner was SolarCity (+100 bps stock selection), and within healthcare our biggest loser was Clovis Oncology (-39 bps stock selection).
Stockpicking Led to Outperformance for Full-Year 2015
While we were pleased to once again outperform our benchmark for the full year, 2015 was generally a mediocre year for most equity markets, and U.S. small cap growth was no exception as the Russell 2000® Growth Index lost 1.4% on the year. The Hood River Small-Cap Growth strategy gained 0.8% net of fees, for net outperformance of 2.1%. Essentially all of this outperformance for the year was due to bottom-up stock selection, with minimal net impact from sector weightings. The sectors that contributed the most to our stock selection were industrials (+221 bps), healthcare (+187 bps), and materials (+123 bps). Our worst stock selection sector for the year was consumer discretionary (-239 bps). All other sectors were essentially flat (+/- 40 bps).
Solar Continues to Offer Opportunities
We continue to be bullish on the solar industry. After taking significant profits in solar stocks in the middle of the year, we increased our weighting in solar during the quarter, including increasing or taking positions in SolarCity, JinkoSolar, Canadian Solar, and Terraform Power. These positions helped performance in the fourth quarter as the regulatory backdrop improved significantly and the industry’s fundamental outlook remained bright.
During December, Congress extended the renewable investment tax credit for five years through 2021, which caught most investors off guard. Before the bill was passed, solar energy investments were set to receive a 30% tax credit in 2016 but only a 10% credit in 2017. Now, solar equipment investments will receive a tax credit of 30% through 2019, falling to 26% in 2020, declining to 22% in 2021, and troughing at 10% thereafter. Until this bill was passed, solar investors were unwilling to ascribe much of a multiple to earnings in 2016 because 2017 visibility in the U.S. was low.
With more visibility now past 2016, the valuation of the industry should move higher as investors model a more sustainable long-term growth trajectory for solar demand. In 2016, demand worldwide should grow over 20% and 2017 could grow over 15%. Despite this growth, JinkoSolar is trading at less than 7x 2016 earnings, Canadian Solar is valued at 11x 2016 earnings, and Terraform is at less than run-off value for its stated projected cash flow values. Singularly, the tax credit increase impact to SolarCity could be equal to SolarCity’s market cap. Based on our research, we feel all of these companies’ earnings estimates are conservative as we enter 2016.
Portfolio Positioning and Investment Team Update
As we start 2016, our portfolio is positioned in a fairly typical stance for us. From a macro standpoint, we anticipate that our beta (essentially, our overall market exposure) is similar to that of the Russell 2000® Growth Index. Our sector exposures are reasonably close to the index, with technology our biggest overweight at 610 bps above the index and healthcare our biggest underweight at 770 bps below the index. The healthcare underweight is more than entirely due to biotech, similar to our positioning for most of 2015, as we remain unimpressed by valuations in the space. Our weighted average market cap at year-end was $2.1b, a 3% premium to the index. As we start the year, our liquidity remains generally very good, with our average position representing approximately one day’s trading volume in the stock.
In other news, we are pleased to report that Rohan Kumar joined Hood River as an analyst in November. Rohan was most recently an analyst at Hawkeye Capital, a hedge fund in New York. He is an electrical engineer and a California native, and has previously worked as an investment analyst at Reliance Capital and in product development at Intel Corp prior to earning Masters degrees at Wharton and Harvard.
While we are happy to have outperformed our benchmark for a fourth year in a row, 2015 was also an important year for Hood River Capital Management in terms of strengthening the organization and bolstering our investment team. As we enter 2016, we truly believe that we have the right team and the right strategy to succeed, and we are excited to continue finding exceptional investment ideas that can perform well for our clients. We love the work we are doing at Hood River, and we appreciate your ongoing support which makes our organization possible.
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 also serves as a sub-adviser to Roxbury Capital Management, LLC (“Roxbury”), a Delaware limited liability company. Hood River has a contractual agreement with Roxbury through which Roxbury provides various administrative, operational, and business services, including trading, marketing, client service, compliance, and accounting. 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. 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 12/31/15. 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 12/31/15. 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. One non-fee paying portfolio is included in the composite for the following period: 0.2% of the composite assets year end 12/31/03.
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. Gross performance is net of all transaction costs, and net performance is net of any applicable performance fees and net of transaction costs, performance-based fees 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 of12/31/15 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 guarantee, may lose value.