Small-cap growth stocks rallied nicely in the third quarter, with the Russell 2000® Growth Index up 6.22%. A firm July was followed by a tough first few weeks of August in which the index fell roughly 5%, before recovering in late August and September and going on to close at new highs as investors rekindled their hopes of progress on a growth agenda in Washington. During the quarter, investors largely shrugged off a variety of concerns including increased tensions with a nuclear North Korea, multiple hurricanes impacting Texas, Florida, and beyond, and uncertainty around future changes in the top position at the Fed.
The third quarter was a poor one in relative terms for the Hood River Small-Cap Growth strategy as it returned +3.65% net of fees, underperforming its benchmark by 257 basis points (“bps”). Essentially all of the underperformance was due to stock selection of -249 bps, and while we anticipate getting this lost performance back in some cases, on other stocks we have taken our losses and moved on. Our worst sector was information technology, with stock selection down 90 bps, followed by healthcare -61 bps, industrials -38 bps, and consumer discretionary -30 bps. Our net year-to-date performance as of September 30, 2017 was +18.48%, 167 basis points ahead of the Russell 2000® Growth Index’s return of 16.81%.
Within information technology, our lowest contributing stock was Impinj (-68 bps stock selection), which makes RFID tags. We think there is a large opportunity with Amazon, which is underestimated by the Street. Amazon’s Whole Foods acquisition pushed out the timeline, however, and the quarter was further hurt by a delay in an order from McDonalds. The combined effect pushed the stock lower, but we continue to like the name as we head into 2018. Infinera (-37 bps), a manufacturer of telecom equipment, began to launch its new product line in June, and while we believe that several large customers are evaluating the product, purchases have not met our expectations. Finisar (-30 bps) was primarily hit by a slowdown in purchasing of optical equipment in China. We believe there are solid indications that the Chinese market has begun to come back in the fourth calendar quarter. Axcelis (+26 bps) continued to gain share in the market for ion implantation, which is used in fabricating semiconductors.
Within healthcare, we were hurt by a slowdown in hospital volumes, which impacted our medtech stocks like Integra Lifesciences (-26 bps) and Nuvasive (-22 bps). We were also hurt by our underweight in biotech, as that industry outperformed in the quarter. While we trimmed both Integra and Nuvasive significantly ahead of the earnings reports, we did not exit either position completely. Nuvasive was further impacted by the surprise departure of a well-respected CFO and a government investigation. We have sold our Nuvasive position and further trimmed our Integra position. A strong healthcare position in the quarter was Tabula Rasa (+59 bps), which has an innovative drug regimen algorithm that it monetizes via various healthcare services and software. A combination of strong organic growth, an accretive acquisition, and an attractive valuation led to strong relative outperformance in the quarter.
Within industrials, losses in Energous (-44 bps) accounted for the entire underperformance. Energous was weak after its wireless charging solution, Watt Up, was not included in the iPhone. While we had not assumed it would be introduced in Apple’s September ’17 iPhone rollout, we remain very enthusiastic about Energous’ ability to revolutionize the personal electronics charging paradigm, and in the reasonable case that it is adopted by a significant player, the upside in Energous stock should be large. On the positive side, new position Harsco (+29 bps) helped our industrials performance as it benefited from broad-based improvements in its end markets, including the steel mills it services, to beat 2Q estimates and raise guidance for the year.
Boingo Wireless (+36 bps) was also strong within telecom as customer demand for its military base, distributed antenna systems, and WiFi offload networks continued to exceed expectations.
At the end of September, our portfolios continued to have a fairly typical risk profile. Our expected beta is roughly in-line with that of the index, and we remain happy with our liquidity. All sector weights are within normal limits, and we are overweight information technology and healthcare services. We are underweight consumer discretionary and biotech. We have had no changes to the Hood River team in the quarter.
While we are not happy with our third quarter performance, we remain meaningfully ahead of our benchmark year-to-date. We are keeping our noses to the grindstone and focusing on our original research and conversations with management teams and other industry sources. Our research effort is stronger than ever, and over the intermediate- to long-term our research should result in strong returns consistent with our history.
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 9/30/17 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.