Third Quarter Update - Fundamental Growth

Dear Investor,

During the third quarter, investment returns for the Shaker Fundamental Growth Strategy performed broadly in line with U.S. Equity Markets, which were modestly higher. We achieved these results due to alpha generated from stock selection despite market headwinds impacting our preferred segments of the markets.

Recall that the strategy is weighted more heavily in small capitalization and growth stocks relative to the overall market, as we believe such companies will deliver outperformance over the long-term. But long-term outperformance will still be susceptible to shorter-term, quarterly underperformance at times. The small-cap growth portion of the market was down 4.1% this quarter based on the US Small Cap Growth Index. More broadly, all small-cap stocks were down 2.4% (US Small Cap Index) while large-cap growth stocks were flat, gaining 0.2% (Nasdaq Composite). Given these market headwinds toward our preferred styles, we were pleased that our approach to individual company stock selection enabled us to deliver performance closer to the more widely followed large-cap indexes.

While small-cap growth stocks were down in the third quarter, the S&P 500 gained 1.7%. Investors rotated into large-cap names, and, particularly in September, there was a bias toward more international-exposed and value names, offset by a rotation out of more expensive growth names. This was driven by hopes of improving global growth following an economic slowdown year-to-date, along with related hopes of easing of trade tensions between the United States and China. As discussed in the investment outlook section, we remain cautious on this “hope” trade, although are closely following economic data and company reports for signs of follow through and are prepared to adjust the Strategy accordingly.

As always, your actual investment returns, including your statement of realized gains, are enclosed. The following is a summary of returns for the selected major indexes for the third quarter, year-to-date, and average annual returns since January 1, 2007:

	3 Months Ending 9/30/19	Year-To-Date Ending 9/30/19	Annualized Returns since 01/01/2007
Shaker Fundamental Growth*	0.97%	24.31%	8.32%
S&P 500 Index	1.70%	20.55%	8.25%
US Small Cap Equity Index	-2.40%	14.18%	6.77%
US Large Cap Equity Index	1.16%	20.09%	8.20%

*returns are preliminary and net of expenses and 1% management fee.

Individual position returns were mixed with a similar number of contributors and detractors. The top contributors in the third quarter were Insulet, the homebuilders, Fidelity National Information Services (which acquired WorldPay), Alphabet, and Synnex. The top detractors in the third quarter were Trade Desk, Ulta Beauty, Paypal, Paycom, and Globant. The top detractors were concentrated in year-to-date winners that were hit by the rotation out of high growth stocks in September. In aggregate, all other positions were relatively flat in the quarter.

During the most recent quarter we sold our remaining investments in Abiomed Inc., Jazz Pharmaceuticals, Supernus Pharmaceuticals, and Continental Building Products.

We added several new long ideas due to a combination of attractive long-term growth potential and valuation relative to peers. New positions include Edwards Lifesciences (EW) and Tandem Diabetes (TNDM) in healthcare, as well as Encore Capital (ECPG) and Synovus (SNV) in financials. As always, we are continuing to look for new ideas that can create value for the fund.

Investment Outlook

The market has been trying to decide which direction to take. Growth has outperformed value for almost three years. Large-cap stocks have outperformed small-cap stocks for thirteen months. These trends will not continue indefinitely, but there is no set timeline for how long they can persist before changing.

Likewise, will the economy reaccelerate to extend the decade-long expansion, or will it continue to slow and increase the risk of recession?

Some indicators signal that near-term recession risk in the United States is elevated. The most commonly discussed of these signals in financial media has been the multi-month inversion of the yield curve (when short-term Treasury bill rates fall below long-term Treasury bond rates), which has preceded every recession since World War II by an average of eighteen months. Changes in short term interest rates (which are controlled by the Federal Reserve) impact economic growth with an average lag of eighteen months. Thus, the recent slowing of economic indicators is a result of the Fed’s rate hike cycle that began in December 2015 and ended in December 2018. The ISM Manufacturing Report recently fell below 50, signaling contraction, and the sub-index on New Business Orders has been in a declining trend for twenty-one months and is similarly in contraction territory. We are also dealing with the negative effects of trade disputes, political uncertainty, and a labor strike at GM.

Other signs point to a more positive outlook. The U.S. labor market remains healthy and consumer spending continues to steadily grow at a rate near recovery averages driven by a strong services sector that has thus far been relatively unscathed by the global manufacturing slowdown. After slowing in 2018, the housing sector is reaccelerating in 2019 stimulated by lower long-term interest rates. The Federal Reserve is now cutting short-term interest rates, as are Central Banks across the world. Credit markets for private companies and consumers remain robust, and declining global interest rates are an incentive for continued spending and expansion. Tax cuts and increased defense spending have increased the U.S. Government budget deficit, which is stimulative in the short run. We expect the companies in the Fundamental Growth Strategy to continue to show strong results in their upcoming third quarter earnings reports.

In summary, the markets are being impacted by a significant amount of uncertainty, and uncertainty increases risk. The S&P 500 is within a few percentage points of all-time highs, but is effectively unchanged for the last twenty months since January 2018. At this time, we are closely monitoring economic and market risks given the conflicting signals for the outlook. Economists opinions on growth in the next twelve or twenty-four months are very mixed. Thus, we have an open mind as to the direction and magnitude of future economic growth in the United States and will adjust accordingly as we get more information from shorter-term leading indicators like initial jobless claims.

In the meantime, we remain focused on individual stock selection. We continue to own stocks that we believe offer attractive combinations of predictable growth and value. Relative to investment alternatives, equity investing continues to look attractive as a means to generate positive, long-term risk-adjusted returns. The current yield on a ten-year Treasury bond is just 1.7%. Stated more starkly, an investor receives $17,000 per year for every $1 million invested in ten-year treasury securities. This is less than the dividend yield on the S&P 500 Index, and significantly lower than the earnings yield on the S&P 500.

We are always happy to discuss in detail any of our investments with you.

We look forward to updating you in January.

Sincerely,

The Shaker Investments Team

General Disclosures: The information contained in these materials is as of 09/30/2019. This document is confidential and for the sole use of the intended original recipient. It is not intended as investment advice or recommendation, nor is it an offer to sell or a solicitation of an offer to buy any interest in any fund or product.
Risk: An investment in any of our strategies is speculative and involves a high degree of risk, including potential loss of principal. There is no guarantee that the investment objective will be achieved, or that the investment strategies will be profitable. Investments in smaller companies may be riskier, less liquid, more volatile and more vulnerable to economic, market and industry changes than investments in larger, more established companies.
Performance: Past performance is not indicative of future results. Returns in the current year are preliminary. The strategy’s overall return is a composite of clients’ separately managed account returns. Some clients’ investment returns were more or less than the overall strategy return. Not all our client’s returns surpassed the benchmark. The index return information herein has been obtained from public sources and we do not guarantee its accuracy. The following disclosures applies to information mentioned in this document: 1. Gross returns are net of expenses. 2. Net returns are net of expenses and a 0.25% quarterly (1% annual) management fee for the corresponding period. 3. Inception date for the Fundamental Growth Strategy is 10/01/1991. 4. The benchmark for the Fundamental Growth Strategy is the Dow Jones US Total Market Index, a broad All Cap index. However, the strategy is more concentrated and contains a higher percentage of growth stocks than the benchmark. 5. Risk metrics are estimated using monthly returns net of fees for the last 3 years, unless otherwise noted. 6. Sector allocations may not add up to 100% because of rounding.
Recommendations: The specific securities identified and described in this report do not represent all of the securities purchased, sold or recommended for clients. It should not be assumed that investments in the securities identified and discussed will be profitable in the future. Holdings and sector weightings in any strategy are subject to change and should not be considered investment advice or a recommendation to buy or sell a particular security. Actual holdings may vary by client. A list of the stocks selected for any of our strategies during the trailing twelve months is available upon request.