Small-cap growth stocks posted another quarter of good performance in the fourth quarter of 2017, with the Russell 2000® Growth Index returning 4.59%. With four positive quarters in 2017, the index had its best year since 2013, ending the year with a gain of 22.17%. The Hood River Small-Cap Growth product returned 2.18% net of fees for the quarter, underperforming the benchmark by 241 basis points (“bps”). For the year, the Small-Cap Growth strategy returned 21.07% net of fees, underperforming the benchmark by 110 bps.
Domestic stocks were helped in the fourth quarter by the passage of a Federal tax bill that, among other things, will sharply cut corporate tax rates. Small-cap stocks, in particular, should see lower tax rates due to their relatively greater exposure to domestic business. Beyond Washington, D.C. events, the broader economy appeared to hold up reasonably well in the quarter, with generally strong business conditions and employment markets. In fact, it seems that we are in the midst of the first broad synchronized global expansion in a while. The Fed continued to raise interest rates and indicated prospects for more increases, but stocks were able to shrug this off.
Within the Russell 2000® Growth Index, every sector except telecommunications was up in the quarter. The strongest major sectors included consumer discretionary (+8.37%), industrials (+7.55%), and financials (+5.94%). Consumer discretionary responded well to reasonably robust spending patterns in the quarter, while industrials continued to benefit from strong economies both at home and abroad. Among the major sectors, healthcare (+3.27%) and information technology (+1.33%) brought up the rear as less economically sensitive stocks in the healthcare services area lagged, and most areas of technology lagged as their greater exposure to foreign profits meant less benefit from U.S. corporate tax cuts.
Bottom-up stock selection (-176 bps) and sector allocation (-40 bps) detracted from the Small-Cap Growth strategy’s performance during the quarter. Our worst sectors for stock selection were information technology at -111 bps, followed by healthcare at -83 bps. The bulk of technology’s weakness was attributable to Impinj, Inc, which makes radio-frequency trackers used in numerous industries, and whose 3rd quarter earnings were weaker than expected as a result of customer order pushouts. Our healthcare underperformance in the quarter was largely due to underperformance by Tivity Health, Inc. Tivity provides disease management and wellness programs to managed care programs and hospitals. As one of our largest positions, the stock performed well through a strong 3rd quarter earnings report in late October. Unfortunately, in early November Tivity sold-off sharply on news that one of its largest customers, despite having just renewed its long-term contract in 2Q17, was developing an internal solution that could replace Tivity. While negative, we view this setback as a unique situation, and remain enthusiastic about Tivity’s prospects. Our best sector in the quarter was industrials, which contributed 37 bps of stock selection, helped by Energous Corp, which rose near year-end on news that its wireless charging solution for consumer electronics received FCC approval.
As we enter 2018, our portfolio remains positioned in a fairly narrow range relative to the benchmark sector weights. Most sectors are within 500 bps of the Russell 2000® Growth Index with the exception being industrials where we have an overweight exposure of approximately 730 bps. In addition, we remain underweight biotech stocks within our healthcare exposure. As in the past, the beta of our portfolio continues to be in-line to slightly less than the index.
Obviously, there will be years where our performance will lag the benchmark. However, over time, our bottom-up, research-intensive approach has led to strong returns, and we believe that tendency should hold true in the future as well. We continue to keep our noses to the grindstone and, more importantly, our ears to the telephones, as we continue to search for misunderstood opportunities that can turn into the next great stock.
Thank you for your ongoing 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 12/31/16. 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 12/31/16. The 2017 verification is in process.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. 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. Past performance is no guarantee of future results.
Attribution information is as of 12/31/17 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.