Small-cap growth stocks posted strong gains in the second quarter of 2017, with the Russell 2000® Growth Index returning 4.39%. The Hood River Small-Cap Growth strategy outperformed the benchmark, returning 7.49% in the quarter, beating the benchmark by 310 basis points net of fees. Year-to-date, Hood River’s Small-Cap Growth strategy is up 14.31%, ahead of the benchmark by 434 basis points net of fees.
The index’s second quarter returns came amidst an environment of continued economic growth, and an improving employment market combined with low wage growth. At the same time, many “Trump trades” took a back seat as investors witnessed the GOP Congress make no progress on its pro-growth agenda and instead get bogged down in healthcare re-reform. At this point, if plans to cut corporate tax rates regain momentum, not much is built into the market, and it could reignite domestically-oriented stocks. Finally, the Fed appears poised to continue to slowly raise rates and even to begin shrinking its balance sheet. While Fed tightening may make a tougher backdrop, continued economic strength and earnings growth at least in the near-term should help offset negatives.
Within the index, the strongest major sectors in the quarter were healthcare, +9.83%, and technology, +5.50%, with lagging sectors including industrials +0.76% and financials -1.08%. Healthcare benefited from a continued lack of progress on the repeal/replace of The Affordable Care Act as well as less jawboning regarding drug prices from Washington. Energy, while only a small part of the index at a roughly 1% weight, was down 20.61% as oil prices remained weak.
Hood River’s 310 basis points (bps) of net outperformance in the quarter was essentially entirely (327 bps) driven by our bottom-up stock selection. Our stock selection was positive in most major sectors, with our best stock selection in healthcare (+125 bps), industrials (+91 bps) and consumer discretionary (+70 bps). Only three sectors (consumer staples, real estate and telecommunications) had negative stock selection, with none worse than -14 bps. In general, our strong stock selection was driven by good fundamental news on our companies, in particular during earnings reporting season in April and early May, combined with relatively few companies with significantly bad news. Performance in healthcare was driven by Tivity Health’s good first quarter results and extending a relationship with its largest customer, by a good first quarter at Integra Life Sciences and optimism around its recent acquisitions, and by a strong first quarter result at Teladoc. While our healthcare performance was hurt by its biotech underweight, the strong fundamentals, leading to strong stock performance, of our non-biotech healthcare holdings was enough to more than offset the biotech underweight. Within industrials and consumer discretionary our winners included Chegg, Mastec and Swift Transportation.
As we enter the third quarter, our portfolio positioning remains fairly normal, with our expected beta approximately in-line with that of our benchmark, and our sector weights remain relatively tight to the benchmark with no sector more than 500 basis points from the benchmark weighting. We remain underweight in biotech.
While we are pleased with the returns we have generated in the first half of the year, we remain optimistic with the ideas we currently have in our portfolio and are excited about the second half of the year. We continue to spend the bulk of our time talking to management teams, their competitors, customers and suppliers, and if anything, we have ramped up our research throughput. As always, we are committed to serve as strong stewards of capital for our investors by continuing to consistently implement our time-tested philosophy and process.
Thank you for your continued 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 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 6/30/17 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.