Third Quarter Update - Small Cap Growth

Dear Investor: 

Quarterly Market Commentary:

US Equities were volatile in the 3rd quarter as uncertainty about the economy, headwinds from trade wars and recession concerns created some angst among investors.  The Federal Reserve Bank lowered the Federal Funds Rate 0.25% in July, the first rate cut in a decade, and another 0.25% in September.  The US Equity market moved up in anticipation of the first rate cut but has been choppy since.  Overall, the S&P 500 returned 1.7% for the quarter, while the US Small Cap Growth Index was down 4.17% for the same period.  For the year, the S&P 500 is up 20.6% while the US Small Cap Growth Index is up 15.3% 

The most unanticipated occurrence in Q3 was the rotation of market leadership from growth to value.  Companies most impacted were those that had high levels of sales and earnings growth, and multiple expansion over the last year.  Since 2016, and for much of the last decade, growth stocks have been outperforming value stocks quite significantly as evident in the chart below.  This goes against much of the prevailing market research stating value stocks will outperform (Fama-French).  We believe this new trend of growth leading the market higher will continue as the U.S. economy enters a long period of low GDP growth and low interest rates as a result of global demographics.

10 year chart of Russell 2000 Growth/Russell 2000 Value, 200WMA

Source: Bloomberg

Portfolio Update:

The Shaker Small Cap Growth Strategy (SCG) was down slightly for the quarter, -0.45%, but outperformed its benchmark, the US Small Cap Growth Index, which was down 4.17%.  The SCG has outperformed its benchmark nine of the last twelve quarters.  Year-to-date through September, the US Small Cap Growth Index is up 15.3% and the SCG Strategy is up 21.03% on a gross basis. Continued diligent efforts by our analysts to find growing companies that meet our rigorous stock selection criteria, and improved discipline in our portfolio management continue to drive performance.

In the quarter, stock selection in Healthcare and Technology contributed the most to performance. Insulet and Medpace were the top contributors in Healthcare.  Synnex Corp., Monolithic Power Systems and LivePerson Inc. were the top contributors in Technology.  Some of the portfolios detractors in the third quarter were companies that experienced multiple expansions in the first two quarters of the year including Globant SA, Paycom Software, and The Trade Desk.

The following is a summary of returns for the Shaker Small Cap Growth strategy and selected indexes for the third quarter, trailing twelve months, and last three years: 

	3 Months Ending 9/30/19	12 Months Ending 9/30/19	3 Year Annualized Returns
Shaker Small Cap Growth	-0.45%	-4.05%	14.86%
Shaker Small Cap Growth (net)*	-0.70%	-5.01%	13.73%
US Small Cap Equity Growth Index	-4.17%	-9.63%	9.79%
US Small Cap Equity Index	-2.40%	-8.89%	8.23%

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

The Top Q3 Contributors:  

1)      A reoccurring top performer from Q2 this year, Insulet (PODD) manufactures a wearable insulin delivery system for diabetics that reduces the burden of daily injections and complications related to noncompliance. The market for devices that can improve outcomes and quality of life for diabetics continues to grow and PODD remains a market leader in that space. With the stock up 38% for the quarter and 108% for the year, we rebalanced the portfolio and took some profits.

2)      LivePerson Inc (LPSN) is the leader in text based business-to-consumer (B2C) interaction. Initially with web chat and today via mobile messaging as well, LPSN solves major business and consumer pain points (e.g. waiting on hold) at a much lower cost and is investing to drive rapid growth in a $60B market opportunity. LPSN is a good example of a company using currently available artificial intelligence to provide great service for their clients.  The stock was up 28.46% during the 3Q (click here for more information on LPSN).

3)      Medpace Holdings Inc. (MEDP) is a clinical contact research organization (CRO). Medpace provides clinical research based drug and medical device development services.  Biotech stock performance is generally based on the outcome of clinical trials, not fundamentals.  MEDP provides the portfolio exposure to the biotech industry without the risks of a bad clinical trial. The stock was up 29.57% during the 3Q.

The Top Q3 Detractors:

1)      Trade Desk (TTD) is a technology company providing a self-service platform that enables clients to purchase and manage digital advertising campaigns across various advertising formats.   After being up over 95% during the first two quarters of 2019, the company was down 19.77% during Q3.  This price movement is consistent with a broader market reversal of the performance of growth stocks and value stocks, and not indicative of a fundamental change to TTD’s business or industry.  Despite reducing our weighting in TTD earlier in the year, it remains one of the largest holdings in the SCG strategy. 

2)      Abiomed Inc. (ABMD) is a medical device company that operates in the segment of research, development to assist or replace the pumping function of the failing heart. It had been a long-term holding in the SCG strategy.  Despite the positive outcomes of their devices, ABMD has suffered from slowing revenue growth over the last year and traded at a premium to peers for much of the year.  We still like the company, but the slowing revenue growth, lofty valuation and sector sentiment is a near term concern for us.  We had reduced our position in ABMD earlier in the year, and decided to liquidate the remainder of the position in Q3.  ABMD is on our watch list.

3)      Malibu Boats (MBUU) is a designer, manufacturer, and marketer of performance sports boats. The stock declined 21.77% in the quarter, and is down nearly 12% for the year.  Although MBUU handily exceeded earnings expectations for the quarter on both the top and bottom lines, guidance was soft, calling for just mid-to-high single digit sales growth and virtually no profit growth.  We believe this guidance to be overly conservative and expect multiples to expand near term as retail demand has improved following extremely poor weather in June. 

Q3 Key Portfolio Notes:

Shaker’s Small Cap Growth strategy ended the quarter with 50 holdings. We took advantage of the volatile markets by adding to some portfolio holdings that we believe exhibit good fundamentals and opportunity for future growth. We added five new names to the strategy during the quarter, including Tandem Diabetes Care, Inc. (TNDM) and Omnicell Inc (OMCL).  In addition to ABMD, Shaker liquidated five other positions including Cabot Corp. (CBT) and Supernus Pharmaceuticals (SUPN). The SCG strategy also took some gains in some stocks that have appreciated greatly during the year, such as CoStar Group Inc. (CSGP) and Globant SA (GLOB).

Tandem is a diabetes pump manufacturer.  TNDM pumps work with constant glucose monitoring (CGM) systems to administer the needed dosage of insulin to type I diabetics.  TNDM received FDA approval for their Basal IQ technology, an automated insulin delivery algorithm that is software updatable and controls for hypoglycemia, in Q4 of 2018.  They expect to receive approval for Control IQ, which will control for hypo and hyperglycemia in Q4 of 2019.  Shaker Investments believes the diabetes care industry is at an inflection point due to technology innovations that will dramatically improve the lives of the users.  We currently hold positions in companies that we believe are the most innovative in the space. 

Omnicell Inc. is a healthcare company that manufactures automated medication dispensing cabinets, modular systems and software for hospitals and pharmacies. OMCL products offer hospitals and pharmacies a more controlled medicine and supply dispensing system to ensure patients receive the proper medicine and doses. Shaker portfolio manager Chris Hemmelgarn’s visit with OMCL management in Pittsburg left us confident in the company’s growth prospects.

We are pleased with the portfolio’s recent performance and will continue to work diligently at identifying the best small cap growth stocks to drive future performance. We look forward to providing an update next quarter.

 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 Small Cap Growth Strategy is 07/01/2004. 4. The benchmark for the Small Cap Growth Strategy is a US Small Cap Growth index. At times, the iShares Russell 2000 Growth ETF is used as a proxy. The strategy is more concentrated than the benchmark. 5. Risk metrics are estimated using monthly returns net of fees for the last 3 years, unless otherwise noted.
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.