Small Cap Growth - Third Quarter 2022 Update

The investment environment remained very complex and volatile in the 3rd quarter.  The S&P 500 Index was down 4.88% for 3rd quarter but was up over 17% from mid-June to mid-August, only to decline sharply in the 2nd half of the quarter.  The US Small Cap Growth Index was no exception, rising nearly 28% early in the quarter only to fall back near where the index bottomed late in June. 

High volatility in a declining market does not make for a fun ride, but as long-term investors we remain encouraged that the outlook for returns over the next ten years has improved significantly.  While cautious, we have not changed our mantra.  We continue to build the portfolio from the bottom-up and search for companies that will deliver fundamental outperformance, even against an environment with a more challenging economic backdrop.

The Shaker Small Cap Growth Strategy (SCG) on absolute terms increased 0.96% in the third quarter, slightly outperforming the US Small Cap Growth Index (USSGI) which increased 0.24%.  Over the last 12 months, the SCG strategy was down 20.71% on absolute terms compared to a loss of 29.27% for the USSGI.  We continue to remain focused on outperforming the index over the long-term.

The following is a summary of returns for the Shaker Small Cap Growth Strategy and selected indexes:

3Q Portfolio Update

The first half of the year was dominated by broad selling, particularly of expensive, high growth names.  During the 3rd quarter, we began to see more differentiation, driven by fundamental performance.  Many growth stocks with negative earnings continued to deteriorate amid the riskier economic backdrop.  Some of the more profitable growth stocks with higher margins and stronger balance sheets began to show improved stock price. 

A name we had been monitoring for a while, i3 Verticals (IIIV), was added to the portfolio during the quarter.  IIIV provides integrated software solutions (payment and billing solutions) to small and medium size business.  The business model is diversified working with healthcare, education, non-profit, and merchant industries.  IIIV continues to grow earnings and we believe there is a real opportunity for them to increase their market share.  This undercovered stock fits the characteristics of a Shaker stock. 

Returns: Contributors and Detractors

For the third quarter, the top and bottom five contributors to the portfolio’s return are below, along with their year-to-date return contribution:

Within the Portfolio, Paylocity (PCTY), The Trade Desk (TTD), and Paycom (PAYC) benefited during the quarter from this shift toward more fundamental based stock performance.  We have owned each own of these names for over 5 years.  PCTY and PAYC are software companies that operate as online human resource and payroll providers.  Both benefit from a rising interest rate environment and strong employment.  TTD operates as a digital marketer and continues to grow revenue faster than peers (30% 3Q).   All three remain core holdings. 

The largest detractors from performance included Encore Capital Group (ECPG), Concentrix (CNCX), and ICON PLC (ICLR).  ICLR is a healthcare company that provides comprehensive clinical research used by the pharmaceutical, biotech and medical device industries.  We continue to like this company and maintained our position size. CNCX is a technology company that provides enterprise platforms to small businesses.    ECPG is a specialty finance company that purchases defaulted debt from banks, credit unions and other credit providers.  We did reduce our position size in both ECPG and CNCX. ECPG remains a top ten holding in the strategy.

The portfolio remains concentrated, but in these challenging conditions, we are closely monitoring position sizing to protect against over-exposure to any individual position.  At quarter end, the top ten positions comprised 32.7% of the portfolio with no individual position size, other than cash, greater than 5%.  Typically, the portfolio is more concentrated.  We feel it is prudent to be more conservative in this environment. 

Small Cap Growth Outlook

Volatility likely continues to be a theme in small cap stocks as investors remain cautious in this rising rate environment.  But, as mentioned earlier, stocks have been on sale.  The SCG strategy continues to be built from the bottom up.  Our research team is focused on finding companies that will deliver fundamental outperformance, even in a more challenging economy, that have been harshly oversold.  As long-term investors, we will be patient in adding new quality names to the portfolio.

We are excited to announce our research team continues to grow.  Andrew Frye has joined Shaker Investments as a research analyst working with the Senior Portfolio Managers.  Andrew interned at Shaker and recently graduated from Case Western Reserve University majoring in Economics and is working towards a Masters in Business Analytics.

We appreciate your investment alongside ours and look forward to updating you on our views and performance in the future.

Sincerely,

The Shaker Investment Team

Disclosure: Past performance is not indicative of future performance. It should not be assumed that any investment or strategy discussed in this publication will be equally profitable in the future. Investment in this strategy carries risks, including loss of principal. There is no guarantee that any specific investment strategy will be suitable or 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. 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 and the strategy is more concentrated than the benchmark. The index performance information in the table is based on public information which we believe to be accurate but have not been verified.

The specific securities identified in this report does not represent all of the securities purchased or sold or recommended to clients. Holdings / 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 all the stocks selected for any of our strategies during the trailing twelve months is available upon request. 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.