Volatility returned to the markets in the first quarter, and the Russell 2000® Growth Index cycled through a few ups and downs before ending the quarter with a 2.30% gain. The Hood River Small-Cap Growth product returned 1.64% net of fees for the quarter, trailing the benchmark by 66 basis points (“bps”). Correlations rose to the highest level since June of 2016, which represented a slight headwind to our stocks positively differentiating themselves on a bottom-up basis.
For the benchmark, January was mostly up, as stocks continued to lift on the economic and earnings optimism inspired by year-end tax reform. The ten-year government bond yield rose from roughly 2.43% to 2.74% during January, which investors largely shrugged off until the final days of the month at which point a correction began. The Russell 2000® Growth Index fell more than 10% peak-to-trough, bottoming in mid-February as rates approached 3%. After a rebound in stocks as those fears subsided, March brought another sell-off as investors grew concerned with hotter trade rhetoric between the U.S. and China. By the end of the quarter, stocks were up slightly, and valuations had fallen to more attractive levels as earnings estimates continued to rise.
The benchmark’s positive return was driven by three sectors: technology (+9.90%), healthcare (+6.42%) and financials (+2.34%). Within technology, software was particularly strong and was almost all of the absolute return in the sector. Healthcare saw broad strength, and benefited from relatively little exposure to the trade dispute with China. Of the other major sectors, consumer discretionary was down 3.19% and industrials was down 2.98%.
The vast majority of our 66 bps of underperformance was from stock selection. The information technology sector (-257 stock selection) accounted for more than all of the weakness, but strength in industrials (+138), consumer discretionary (+59), financials (+28), and telecommunications (+24) almost made up for it. Information technology was best characterized as widespread low-grade underperformance as the most speculative areas of the benchmark, such as software-as-a-service (SAAS), saw their already stretched valuations stretch still further, and set a bogey that was hard to keep up with. Semiconductors, which we were slightly overweight, underperformed broader technology as trade tensions rose. In addition to the tough benchmark, we saw stock-specific weakness in a couple names. Coherent (-96), which makes OLED display equipment, came under pressure as concerns around the OLED cycle and sell-through of the Apple iPhone X caused stock deprecation despite solid earnings. ViaSat (-45) fell as its comparable company group declined and its proposed joint venture with Eutelsat never materialized. Industrials had widespread strength in names including On Assignment (+44), CoStar Group (+34), Old Dominion (+34), and DXP Enterprises (+30) as a result of strong earnings performance. Consumer discretionary’s strength came from names such as Chegg and Grand Canyon Education, which also had strong earnings and guidance for 2018.
Entering the second quarter our portfolio remains positioned within normal ranges. All sector weights are within 500 bps of the benchmark, except for industrials, where we entered the quarter overweight by approximately 900 bps. The industrials overweight spans a variety of sub-industries and is based on the bottom-up opportunities we have found. We continue to remain underweight biopharma stocks.
We are pleased to announce that during the first quarter we made two additions to our investment team, as Lance Cannon and Brad Carpenter joined us as analysts. Lance, who has a BS from BYU and an MBA from UCLA, has 10 years of financial markets experience that spans equities, credit and FX. Lance joined us from USDR Investment Management. Brad brings nine years of experience at firms including Citigroup and Wells Fargo, where he participated in both investment banking and equity research. He has an MBA from Carnegie Mellon and a BA from Bucknell University. We look forward to introducing Brad and Lance to all of you as we speak over the coming quarters.
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 12/31/17. 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 12/31/17. 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 3/31/18 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.