Small Cap Growth Q2 Update : Cautiously Optimistic
It was a challenging quarter but the Shaker Small Cap Growth strategy rebounded well from its Covid-19 lows. In absolute terms the SCG was up 39.5% for the quarter and is up 11.47% for the year. While pleased with this short-term performance, we continue to focus on building a strong portfolio of stocks that can weather a full market cycle. Our long-term goal has not changed, deliver long-term performance for our investors.
The following is a summary of returns for the Shaker Small Cap Growth strategy (SCG) and selected indexes for the second quarter, trailing twelve months, and last three years:
| 3 Months Ending 06/30/20 | 12 Months Ending 06/30/2020 | 3 Year Annualized Returns | |
|---|---|---|---|
| Shaker Small Cap Growth | 39.74% | 15.74% | 16.55% |
| Shaker Small Cap Growth (net)* | 39.49% | 14.60% | 15.40% |
| US Small Cap Growth Index | 30.58% | 3.48% | 7.86% |
| US Small Cap Index | 25.42% | -6.63% | 2.01% |
| *Returns are preliminary and net of 1% management fee and expenses | |||
Quarterly Market Commentary:
The S&P 500 was down 19.60% in the first quarter of 2020 and up 20.54% in the second quarter of 2020. This is not normal. As active managers, we believe market volatility provides opportunity to deferentiate our returns. However, the speed at which the market collapsed and then recovered took us by surprise. Timing the market is very difficult in normal times, and it has not gotten any easier amidst all the uncertainty in this environment. We try to avoid timing issue by prudently building positions in primarily secular growth companies and letting our winners run. We believe that a process driven investment approach with a long-term outlook will be succesful now and into the future.
As mentioned earlier, the 1st half of 2020 has been an extremely difficult period of time to manage investments. The S&P 500 was down 33.8% from February 19th through March 23rd and up 45.09% from March 23rd until June 8th. What caused the turnaround in the market from the lows of March 23rd?
Early in the 2nd quarter, it became clear that the Federal Reserve was going to be aggressive in limiting the economic damage caused by the pandemic. Aggressive monetary policy was put in place to support businesses and individuals. Interest rates were cut to help borrowers on mortgages, auto loans and home equity loans. Banks were encouraged to lend and Government backed SBA programs were put in place to help small business.
In tandem with monetary policy, there has been unprecedented fiscal stimulus to support the economy. In late March, the CARES Act was passed into law and by nominal dollar amount, the $2.3 trillion appropriated is the largest single relief package in US history. To put that number into perspective, $2.3 trillion is approximately 11% of last year’s GDP.
While many factors impact the market, much of the price expansion experienced in the second quarter could be attributed to the swift and sizable actions of the Fed and Congress.
Q2 Portfolio Update: Cautiously Optimistic
In the past, the Shaker SCG strategy had underperformed its benchmark during market corrections. Changes made to our risk management process were implemented a little over four years ago to reduce risk and volatility. The effective changes were 1) be more cognizant of portfolio sector weightings relative to the benchmark and 2) better manage individual position sizing. We are encouraged that the changes we implemented are working.
During the second quarter we continued to stress-test the portfolio to determine which businesses were likely impacted by the pandemic. There are some fairly obvious negative effects to industries like travel, restaurants and hotels, and positive effects to industries like grocery, e-commerce and video communication. Beyond the obvious, the main impact of COVID-19 has been an acceleration of pre-existing trends. This has been mostly positive for the Shaker SCG portfolio because we focus on investing in high quality secular growth companies, and avoid companies facing structural headwinds. We only made minor changes to the portfolio in the quarter.
We looked to add new positions or add to holding that would maintain or increase in value coming out of this recessionary environment. We again focused on our core characteristics to drive this decision. New positions were initiated in Immunomedics Inc. (IMMU), M/I Homes, Inc. (MHO), WESCO International (WCC), Ingles Markets (IMKTA), and SolarEdge Technologies (SEDG). We added to positions in Sprouts Farmers Markets (SFM), LGI Homes (LGIH), and Tandem Diabetes (TNDM).
Trusting our process, we sold positions in stocks likely to face growth challenges near term and in those stocks that saw a fundamental change in growth characteristics important to Shaker Investments. We sold positions in Meta Financial Group (CASH), Criteo SA (CRTO), and Preformed Line Products (PLPC). These stocks are exposed to industries we believe are most severely impacted by coronavirus policy responses and the slowing economy.
We remain close to a market weight (+/- 2%) for most sectors, with the exception of Producer Durables where we are overweight 5% and Health Care where we are underweight 7%. The strategy does not actively use sector weightings to differentiate returns, but sector weights can deviate from the benchmark weight and did account for some of the return variance during the quarter.
| Holding | Return Contribution | Sector | Original Purchase Date (Firm) |
|---|---|---|---|
| Livongo Health (LVGO) | 4.64% | Health Care | October 2019 |
| The Trade Desk (TTD) | 3.48% | Consumer Discretionary | May 2017 |
| Dexcom (DXCM) | 2.8% | Health Care | June 2014 |
| Paylocity Holdings (PCTY) | 2.16% | Producer Durables | November 2017 |
| Globant SA (GLOB) | 2.03% | Technology | February 2018 |
The Shaker SCG strategy saw positive performance from all sectors during 2Q. The top five portfolio positions that contributed to returns are listed above. Our thorough work in the diabetes stocks continues to help the portfolio. As we have explained in previous letters, we feel the diabetes care industry is at an inflection point. Our health care team at Shaker Investments is very experienced and we believe gives us an edge in this space. We have owned Dexcom (DXCM) for several years and added to our position in Livango (LVGO) earlier this year. In addition, we also own Insulet Corp (PODD) and Tandem Diabetes Care (TNDM) in the space.
The Q2 Detractors:
The U.S. Small Cap Growth Index was up 30.58% with all sectors having positive performance. Given the strong performance of small cap growth stocks it may come as no surprise that only four positions in the Shaker SCG portfolio had negative returns for the quarter, one of which we liquidated (META) and none held a significant weighting in the portfolio. Other than META, the only detractors from performance for the second quarter were Ingles Markets, Inc. (IMKTA), NiSource Inc. (NI) and WESCO International (WCC) which was purchased late in the quarter.
Small Cap Growth Outlook:
We believe in active equity management. Our investment philosophy – that superior returns can be achieved by identifying companies with strong fundamentals, catalysts for future growth and that are currently mispriced by the market – is the cornerstone of that belief.
We believe COVID-19 has fundamentally impacted consumer behavior and accelerated adoption trends of certain technologies. Good active managers will be able to realize these changes and (if needed) adjust portfolios to take advantage. Passive strategies will not.
We are pleased with our investment efforts and will continue to focus on buying great companies at attractive valuations.
Wear a mask and stay healthy.
Sincerely,
The Shaker Investment Team
General Disclosures:
The information contained in these materials is as of 06/30/2020. 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.