Shaker's Small Cap Growth - 2021 Fourth Quarter Update

In the fourth quarter and full year 2021, the Small Cap Growth Strategy had very strong returns as compared to the performance of U.S. small cap growth stocks as measured by the largest US small cap growth index.  In general, small cap stocks underperformed large cap stocks, with small cap growth stocks lagging even more. We did a very good job of investing in stocks with both revenue and earnings growth in 2021, while avoiding stocks with strong revenue growth but limited earnings. We correctly anticipated that strong economic growth and the significant IPO Market in 2021 would hurt the performance of unprofitable stocks.

Over the last five years the Shaker Investments Small Cap Growth fund has produced a cumulative total return of almost 200%. This strong return was fueled by stock selection, low interest rates and substantial increases in the money supply in the U.S., Europe, and Japan. We expect that these conditions will be less favorable in 2022 and thus do not expect that market returns in 2022, or the next five years, will match the return of the last five years. However, as always, we expect that there will be opportunities to make money, especially over the longer five-year time period.

The following is a summary of estimated returns for our composite small cap growth accounts and selected major indexes for the fourth quarter, last one, five, ten and fifteen year time periods. Multi-year returns are average annual returns. 

	3 Months Ending 12/31/21	Year to Date Ending 12/31/21	5 Years Ending 12/31/21	10 Years Ending 12/31/21	15 Years Ending 12/31/21
Shaker Small Cap Growth (gross)	6.53%	29.84%	25.71%	17.13%	12.87%
Shaker Small Cap Growth (net)	6.28%	28.63%	24.48%	15.98%	11.76%
US Small Cap Growth Equity Index	0.01%	2.83%	14.53%	14.14%	9.97%
US Small Cap Equity Index	2.14%	14.82%	12.02%	13.23%	8.69%

Discussion of Fourth Quarter Performance and Positions

The most significant individual contributors to and detractors from the the Shaker Small Cap Growth fund in the fourth quarter and the full year of 2021 are as follows:

Company	Fourth Quarter 2021	Full Year 2021
WESCO International (WCC)	0.81%	2.82%
Axos Financial (AX)	0.43%	2.21%
Concentrix (CNXC)	0.03%	1.79%
Medpace (MEDP)	0.53%	1.76%
Charles River Laboratories (CRL)	-0.30%	1.42%
Encore Capital Group (ECPG)	0.71%	1.37%
PRA Health Sciences (PRAH)	N/A	1.32%
Boot Barn Holdings (BOOT)	0.49%	1.23%
Installed Building Products (IBP)	0.64%	1.03%
Zebra Technologies (ZBRA)	0.36%	1.03%
EPAM Systems (EPAM)	0.28%	1.01%
IPG Photonics (IPGP)	0.00%	-0.32%
Paycom Software (PAYC)	-0.62%	-0.32%
SPDR S&P Biotech ETF (XBI)	-0.16%	-0.45%
CoStar Group (CSGP)	-0.25%	-0.57%
LivePerson (LPSN)	-0.50%	-0.62%
All other positions in total	4.05%	12.12%

Note: Individual position return contributions are preliminary and based on gross returns prior to fees, interest, and other expenses.

Despite the underperformance of small cap growth stocks in the U.S. market, we were pleased to generate strong returns, which we attribute to our ability to identify growing businesses with competitive advantages at attractive valuations, even among small cap growth stocks.

Investment Outlook for 2022

The U.S. investment outlook has changed significantly in the last year. One year ago, the Federal Reserve was committed to maintaining the easy money policies in place since the onset of the pandemic in March of 2020. The outlook was robust as the economy snapped back from the pandemic – job growth continued at record rates, business confidence was high, vaccines were on the way so our lives could “return to normal,” and fiscal stimulus would support consumers and businesses through the lingering effects of the pandemic. The financial markets were fueled by a speculative frenzy as “meme” stocks like Gamestop (GME) headed “to the moon” and a record number of companies (mostly unprofitable) entered the public markets via IPO or SPAC at extreme valuations.

Oh what a difference a year makes! The Fed’s perspective for most of 2021 was that, although inflation had increased, it was only transitory as the economy and supply chains returned to normal and was likely to decline by the fourth quarter of 2021. Today, inflation is higher than at any time in the last 35 years. The Federal Reserve is in the process of tapering its economic accommodations and has indicated that it will soon be removing some of the past liquidity assistance through higher interest rates and a reduced balance sheet.

Many of the stocks that achieved abnormally elevated valuations have started to plunge in price and a broad small capitalization growth stock index is now down 30% from highs reached in the first quarter of 2021.

This change in the posture of the Federal Reserve impacts markets in a number of ways:

1.     There is increased uncertainty of the ultimate effect of this change in policy. Will the Federal Reserve be too slow in tightening? Will it do too little (excess inflation persists far too long and the Fed ultimately has to raise rates much more than would otherwise be required), or will it do too much too fast and trigger a recession? At present, the range of potential outcomes is quite wide and that is likely weighing on the willingness of investors to put more money to work in the market. 

2.     The expected increase in interest rates is causing investors to increase the discount rate used in valuing investments, which typically impacts high growth investments as more of their value is derived from projected cash flows further in the future. 

3.     The expected shrinkage in the Fed balance sheet will reduce the significant increase in the money supply, which made more capital available to invest in increasingly speculative assets.  This especially impacts companies that are unprofitable in addition to highly speculative assets e.g. crypto currencies, NFTs and collectables. These assets already are being hit by the expected change in monetary policy.

Specifically for 2022, we expect the Fed will be able to make progress on reducing inflation without triggering a recession in the US. Although this environment is different (high inflation, lingering effects from Covid-19 and the fact that the Fed is shifting to a tighter money policy from a very easy money policy) we believe that there is a good chance that US equity markets could end the year higher. On average, markets have historically continued to move higher after the Fed begins an interim rate hike cycle. We also expect that the more speculative assets will underperform high quality companies that are not dependent on raising additional capital. That said, our forecast could change, especially if inflation does not moderate and the Fed elects to take more drastic actions.

The ten largest positions account for 38.1% of the portfolio, which is in the normal range for the top-ten holdings. In general, the average cash position in accounts that we manage is also higher than normal as we are actively looking to take advantage of more attractive valuations in individual stocks and have begun to do so with the recent market pullback.

We look forward to updating you further as the year progresses and are always available to assist in any way we can.

General Disclosures: The information contained in these materials is as of 12/31/2021. 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. The period commencing 1/1/2007 is significant because it covers full market cycles that include the recession and bear market of 2008/2009 and the sharp recession, bear market and subsequent sharp recovery of 2020-2021. Growth of $100,000 invested as of 1/1/2007. 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. 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.