For the second quarter of 2014, the Russell 2000® Growth Index posted a modest gain of 1.7%. While this is the eighth consecutive quarter the index has delivered a positive return, it does not begin to tell the story that unfolded throughout the quarter. The correction that began in mid-March continued through mid-May pushing the index down more than 10% and delivering negative monthly returns in both April and May. Companies that demonstrated higher ROE, lower beta, higher market capitalization and lower valuations navigated the pull-back more effectively. An extremely strong rebound in June, dominated by higher PE, higher beta and lower quality companies, helped the Russell 2000® Growth Index climb back into positive territory for the quarter.
Investor concerns in the quarter were driven by the announcement of negative GDP in the first quarter, increased volatility in the small-cap market, historically high valuations, equity outflows in small-cap ETF’s and persistently low interest rates. All of these factors impacted sector returns within the Russell 2000® Growth Index and saw many non-traditional areas of growth outperform. The strongest performing sectors included energy (+19%), utilities (+5%) and materials (+4%).
The Hood River Small-Cap Growth strategy gained 1.9% net of fees while the average small-cap growth manager returned 0.2% in the second quarter. It was a difficult quarter for active managers as only 28% of small-cap growth funds were able to outperform the 1.7% performance of the Russell 2000® Growth index.
On average and over time, our excess return has been attributable to superior stock selection. The second quarter was no exception. The positive impact from our stock selection in information technology and consumer discretionary was more than enough to offset the portfolio’s underweight exposure to the energy sector. The strong results in the information technology sector were led by Synaptics, which had its recently acquired swipe sensor technology broadly utilized by Samsung in its next generation phones leading to upward revisions in revenue and earnings guidance. In consumer discretionary, Hanesbrands was the top performer as the company continued to take share and improve margins in their new, higher end activewear and innerwear products. Understanding the factors that influence the market or being aware of the modest macroeconomic headwinds may be interesting, but we believe that our ability to analyze companies and our experience in gathering unique insight through speaking with multiple sources will continue to provide our investors with long-term outperformance.
We continue to be extremely optimistic about the prospects for our portfolio. While the media and its pundits continue to talk about high valuations in small-cap, what they fail to mention is that the extreme valuation exists mainly within small-cap value. In fact, our “bottom-up” fundamental research continues to identify high quality small-cap growth companies at reasonable valuations. By continuing to implement our investment philosophy and process, we are confident that we will be able to reward our clients with strong returns over the long-term.
This commentary is intended for one-on-one purposes only.
Hood River Capital Management LLC (“Hood River”) is an investment adviser registered with the SEC. Performance presentations compliant with the requirements of GIPS standards can be obtained by calling 877-725-4432. 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 the 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 12/31/13. The Small-Cap Growth composite has been examined for the periods 6/30/02 through 12/31/13. The verification and performance examination reports are available upon request. . 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 014/01/13 meets GIPS® portability requirements.
The Small-Cap Growth composite was created in 2002 with an inception date of 06/30/02. 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 end 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.
Net 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 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.
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.