The Russell 2000® Growth Index was essentially flat for the first quarter, but within the quarter there was considerable volatility driven by sector and factor rotation. The first two months saw dramatic returns in speculative areas like biotech and within aggressive factors like momentum, low quality and high beta stocks. These areas gave back most of their year-to-date gains by the end of March and into early April, driven by tougher talk from the Fed as well as the run-up in valuations of these speculative areas over the prior two months that had more broadly laid the groundwork for a pullback.
When the dust had settled at the end of the quarter, energy and healthcare were the best performing sectors in the index. Factors that performed well for the full quarter included small size, low ROE and non-earnings stories. In other words, “low-quality” was still a bit ahead at quarter-end despite the March pullback.
For the first quarter of 2014, the Hood River Small-Cap Growth strategy returned +0.46% net of fees, in-line with the Russell 2000® Growth Index, which returned +0.48%. Reflecting our bias toward high quality companies with earnings trading at reasonable valuations, Hood River lagged the market through the end of February. However, when the market shifted back toward quality and away from speculation in March, our relative performance improved.
While macro discussions are interesting, in practice the bulk of our performance relative to the index is attributable to stock picking, and the first quarter was no exception. In the period, the consumer discretionary sector cost us 173 basis points of stock selection, which was offset by a gain of 178 basis points of stock selection in technology. The strong results in the technology sector were led by SunEdison, which executed well on its strategy to carve out its solar project assets and spin-off its semiconductor business unit. The weak performance in consumer discretionary was driven by CONN’S Inc., a specialty retailer that provides financing to its blue-collar client base, which gave up much of the gains it saw in 2013 as it suffered a slight 30 basis point increase in delinquencies for its January quarter, which resulted in a heavy sell-off in the stock.
As we alluded to in our last quarterly letter, we will not chase the latest speculative stock market fad. Instead, we abide by our sensible philosophy that the small cap market is inefficient, providing us with the opportunity to buy quality small cap growth companies at reasonable valuations when our research suggests fundamentals are better than believed by other investors.
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 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.
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.