September 2018 Portfolio Manager Review
The small cap universe, represented by the Russell 2000 Index, was down 2.4% in September, the first down month in the last seven. Telecommunication Services (+6.2%), Utilities (+0.6%), and Energy (+0.2%) were the top performing sectors. Weaker sectors included the Consumer Staples (-4.1%), Information Technology (-3.9%) and Financials (-3.5%) sectors.
With the pullback in the small cap market, there was little divergence between growth and value styles, with the Russell 2000 Growth outperforming the Russell 2000 Value by 15 basis points during the month. However, Growth has remained a driver of the market, now up almost 12ppts versus Value over the last year. The weakness in small caps was emblematic of a broader shift in the market away from riskier assets, as large caps outperformed by over 275 basis points, and significantly reducing small cap year-to-date outperformance. With the weakness, the valuation of the Index decreased to 13.3x from 13.5x EV/LTM EBITDA, and remains both down year-to-date and over a turn below the recent peak of 14.4x. The small cap value premium versus large caps declined this month back to 1%, which is well below historical levels of 14%.
There have been some concerns about the market, with investors increasing short interest levels to around 7.4 days, which may suggest concerns around current price levels. The divergence during the month and quarter between large and small stocks is also an indication that investors may be concerned about the current embedded risk in market valuations as interest rates increase, as well as potential negative impacts from tariffs and inflation.
However, fundamental results remain quite strong and supportive of continued growth. Earnings growth for small caps remained high at 11% during the month on improving margins. On a capital allocation basis, capital spending and leverage remain at high levels. Lastly, fund flows to small cap equities remained strong, up $3.5bn, driven primarily by Core and Growth portfolios.
We think SCAP’s approach, which places a premium on discipline, remains well-positioned. Companies that demonstrate fundamental performance improvement supported by quality balance sheets should continue to provide attractive opportunities for the portfolio. We look forward to the opportunity to discuss SCAP and our firm with any interested investors. Please reach out to our team or AdvisorShares if you have any questions.
In September, the portfolio underlying the AdvisorShares Cornerstone Small Cap ETF outperformed the Russell 2000 Index, with stock selection the driver of outperformance during the month. The AdvisorShares Cornerstone Small Cap ETF declined 2.1% during the month, while the Russell 2000 declined 2.4%, an outperformance of approximately 30 basis points.
Monthly Performance By Sector
Contributors and Detractors
Financials, Energy, and Health Care were the largest outperformers versus the benchmark during the month. Specifically, our stock selection and underweight allocation to Financials, our stock selection and overweight allocation to Energy, and our stock selection in Information Technology, were the primary positive contributors to our performance. Denbury Resources (DNR), Bandwidth (BAND), and Ocean Rig UDW (ORIG) were three of the largest individual contributors.
- Denbury Resources (Energy) is an oil and gas E&P company focused on tertiary oil production. The stock was strong as investor sentiment improved on the company during the month as oil prices remained high and the company’s free cash flow yield is attractive.
- Bandwidth (Information Technology) is a CPaaS software company focused on developing voice-based APIs. The company was the subject of a positive research report that detailed potential significant growth in its TAM and the centrality of its APIs to an increasing number of voice-driven user interfaces.
- Ocean Rig UDW (Energy) is an owner and operator of offshore oil and gas drilling rigs. The company announced it would be acquired by larger peer Transocean (RIG) in a cash and stock deal worth a 20% premium to the company’s 10-day average price. The stock continued to move upward during the month as the broader offshore market improved and drove RIG’s price up.
Performance in the portfolio was partly offset by the Industrials, Utilities, and Consumer Staples sectors. Our stock selection in Industrials, overweight allocation to Information Technology, and underweight allocation to Utilities, hurt overall performance. American Software (AMSWA), KEMET (KEM), and Acorda Therapeutics (ACOR) were three of the largest individual detractors.
- American Software (Information Technology) is a developer of software solutions for supply chain management. The company reported weaker than expected profitability during its 1st fiscal quarter. Like many software firms, the company is undergoing a transition from a traditional perpetual license model to a subscription approach, which can create significant volatility in results.
- KEMET (Industrials) is a producer of capacitors. KEMET was weak on the quarter, as was other similar manufacturers like Vishay Intertechnology and AVX, as capacity in the industry remains extremely tight and companies chosen not to match demand in case the market turns. In response, customers have been placing larger-than-normal orders to ensure supply, which could hurt the producers if those orders are eventually cancelled.
- Acorda Therapeutics (Healthcare) is a biotech focused on neurological disorders. During the month, the company lost an appeals case which invalidated patents on its only significant marketed drug (MS therapy AMPYRA) and opened the door to generic competition. Additionally, the FDA delayed approval of its primary pipeline drug, Parkinson’s therapy INBRIJA.
We did not initiate or exit any name in the strategy underlying the AdvisorShares Cornerstone Small Cap ETF during the month.
Top 10 Holdings by Weight
Each of the top 10 holdings as of the end of August remained in the top 10 at the end of September.
|2||DNR||Denbury Resources Inc.||Energy||1.15%|
|4||MMSI||Merit Medical Systems, Inc.||Health Care||0.94%|
|5||TCMD||Tactile Systems Technology, Inc.||Health Care||0.85%|
|6||GDOT||Green Dot Corp cl A||Financials||0.79%|
|7||FOXF||Fox Factory Holding Corp.||Consumer Discretionary||0.78%|
|8||JBT||John Bean Technologies||Industrials||0.76%|
|9||AMED||Amedisys Inc.||Health Care||0.73%|
|10||CARB||Carbonite, Inc.||Information Technology||0.69%|
Note: Cash (including accrued dividends) represents a 0.6% weight in the portfolio.
Portfolio Weight by Sector
Source: Factset. Weights as of 9/28/2018. Excludes cash and unassigned.
Very Truly Yours,
Cornerstone Investment Partners
Portfolio Manager of SCAP