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SCAP: May 2019 Portfolio Manager Review

Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. Returns less than one year are not annualized. For the fund’s most recent standardized and month-end performance, please click

Performance Review

Well that’s it—that’s the last time I get to make references to Game of Thrones, since the HBO show is over and we’ll likely wait longer for George R.R. Martin to write the next book than the Hound did for fratricidal vengeance or Samwell Tarly will for Westerosi democracy. Unfortunately for the market, trade war concerns re-emerged to the forefront early in the month, as a deal with China that was “imminent” was followed up by cancelled meetings, increasingly bellicose rhetoric on both sides, and corporate attacks. At the same time, new fronts opened or re-opened, including Mexico (where a deal had been signed for months), Europe, Japan, and even India.

While small cap stocks are more domestically exposed than large caps on the whole, they have greater revenue and profit exposure to China (both on the import and export side) according to research by Barclays, and their size makes it more difficult to respond to supply chain challenges than multinational firms. Small caps also have historically responded negatively to risk-off market movements.

Not surprisingly then, the excitement the market felt last month has been replaced by fear, and concerns related to decelerating economic growth (particularly as seen in the bond market) in response even led Federal Reserve Chairman Powell to suggest rate cuts are not off the table a few days ago.

The Russell 2000 Index declined 7.8% in May, making the post-December “V”-shaped recovery to start looking more like a “W”. On a total return basis, small caps are still up 9.3% year-to-date, but are now down 9.0% for the last twelve months.

Large caps have continued to be stronger than small caps. For the month, the Russell 2000 missed the Russell 1000 index by 140 basis points, and is now behind large caps by over 1,250 basis points over the last year. On a style basis, growth returned to the fore, with the Russell 2000 Growth outperforming the Russell 2000 Value by approximately 75 basis points in May, and 510 basis points YTD. Additionally, the negative small cap bias was consistent at the style level, with small cap value and growth each underperforming their large cap counterpart. At the sector level, all sectors were down for the month, although a return to the bond proxy trade would have served investors well, with Utilities (-0.1%), clearly “a bargain” at the moment as they trade at an LTM P/E of 25x, and Real Estate (-2.5%) both significant outperformers. Health Care (-5.6%) also outperformed the market, as drug price discussions got overwhelmed by trade talk. On the other side, cyclically exposed sectors like Energy (-16.5%), Materials (-15.3%) were down on economic concerns and commodity weakness, and Communication Services (-9.4%) was also relatively weak.

Lower valuations drove most of the price action this month, with the Russell 2000 falling back to 12.0x LTM EV/EBITDA. While down from 12.7x last month, valuations are up from 11.0x at the end of the year, but remain below their five year median of 12.6x, and well below highs we saw last year before small caps fell. Relatively stronger earnings results and weakness out of mega cap technology drove large cap valuations down more than small caps, so while the rarely-seen small cap discount from last month has gone away, they remain significantly cheaper vs. large caps than they have historically. For example, December’s discount was the first time since the tech bubble, and the long-term median premium is over 14%. While small cap companies slowed buybacks, they remain up over 16% compared to last year and leverage spiked again (almost 3.3x Net Debt/EBITDA) to hit new post-recession highs.

As expected, earnings growth continues to decelerate as companies finish reporting 1st quarter numbers, with the year-over-year EBITDA growth of Russell 2000 constituents moving to 4% from 6% in April and 9% in March on both top-line and margins. While a material deceleration from recent peaks (12.1% in January) may seem ugly, it remains significantly above levels from a few years ago, and margins are at longer-term averages. For 2019, estimated earnings still suggest that profits continue to decelerate from last year’s tax-reform-affected levels, but while we’ve seen rates fall and occasionally hit inversion, outside of exogenous factors (i.e., extended trade war), the economy appears to remains stable.

The one thing we know is that we don’t know what’s going to happen next, but we think SCAP’s approach, which places a premium on discipline, remains well-positioned. While results have been weaker than we would like YTD, we have a long-term view on both small caps in general, and our approach to the market more specifically. As such, we remain confident in the long-term sustainability of our strategy and philosophy. Particularly in a more volatile environment, companies that demonstrate fundamental performance improvement supported by quality balance sheets and cash flows 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.

Portfolio Attribution

In May, the NAV and market price of the AdvisorShares Cornerstone Small Cap ETF was down 9.05% and 8.58%,respectively, the Russell 2000 Index, which was down 7.78%. Over the last twelve months, the AdvisorShares Cornerstone Small Cap ETF had declined 9.09%, while the Russell 2000 Index declined 9.04%.

Monthly Performance By Sector

Past performance is not indicative of future results. Source: Factset; as of 05.31.2019.

Contributors and Detractors

Health Care, Materials, and Energy were the best-performing sectors versus the benchmark during the month. At a component level, the largest positive contributors to performance included our stock selection in Energy, Health Care, and Materials. Endava (DAVA), Arena Pharmaceuticals (ARNA), and iStar (STAR) were three of the largest individual contributors.

  • Endava (Information Technology) provides digital services (cloud, automation, UX) to enterprise companies. The company announced another strong quarter, beating Wall Street consensus estimates and increasing guidance. It continues to deliver strong growth as it is exposed to key IT service verticals and pricing has driven higher margins.
  • Arena Pharmaceuticals (Health Care) is a biopharma company with a pipeline of drugs for a range of therapeutic areas. During its latest quarterly results, the company reported that pipeline drugs etrasimod (IBD and atopic dermatitis) and olorinab, IBS) are advancing well in Phase II/III trials, and the recent sale of rights to ralinepag (PAH) increased confidence in their R&D capabilities.
  • iStar (Real Estate) is a diversified REIT focused on both financing and direct asset ownership. It announced a sale/leaseback transaction with key customer Bowlero (world’s largest bowling operator) whereby iStar would acquire some bowling alleys from Bowlero, and also increased its lease (~150 centers) term by 15 years, and now through 2047.

Performance in the portfolio was more than offset by the Consumer Discretionary, Communication Services, and Information Technology sectors. At a component level, the largest negative contributors to performance included our stock selection in Consumer Discretionary and Communication Services, as well as our overweight position to Energy and underweight position to Utilities. Glu Mobile (GLUU), YETI Holdings (YETI), and Abercrombie & Fitch (ANF) were three of the largest individual detractors. 

  • Glu Mobile (Communication Services) is a developer of mobile video games. The company released quarterly earnings that indicated continued growth, but reduced guidance related to higher user acquisition cost and lower ad revenue from changes to Apple’s app store rules. This guidance reduction hurt investor confidence, and given that the stock was up 40% YTD, it reacted negatively to the news.
  • YETI Holdings (Consumer Discretionary) is a maker of coolers and other branded outdoor equipment. After outperforming the Russell 2000 significantly since our initiation this year, the stock fell this month. While earnings were strong behind both double-digit revenue growth and 5ppts of margin expansion in a seasonally small quarter, and sell-side perspectives remain positive, the stock’s huge run YTD led many investors to use the quarter to take profit.
  • Abercrombie & Fitch (Consumer Discretionary) is a mall-driven apparel retailer. Abercrombie and peers were all weak during the month on economic and tariff concerns given increased trade war uncertainty. Abercrombie had held up better than peers and was trading at a materially higher multiple. With the market priced to perfection, the results (which were otherwise generally in-line) were not good enough, and the stock fell significantly in response.

Portfolio Changes

We completed the quarterly reconstitution of the portfolio underlying the AdvisorShares Cornerstone Small Cap ETF during the month. As a reminder, we have developed a strategy for small cap equities focused on identifying stocks exhibiting four key characteristics:

  • Upside opportunity through identifying companies that are (1) demonstrating improving fundamentals and (2) have a history of achieving market expectations; and
  • Downside protection through ensuring those companies have (1) robust cash flows and (2) real assets.

Our portfolio holds approximately 240 stocks, which provides diversification and limits the idiosyncratic risk of individual small cap securities. Each calendar quarter, based on that screening process, we replace the weakest 25% of the portfolio with the most attractive available securities in our small cap investable universe. As such, 60 new securities that rank well in our valuation analysis were initiated in the portfolio, and we exited 60 names currently owned in the portfolio.

Security Selection Update

One of the key elements of our process is that it is rules-based, which helps minimize the behavioral biases common to investment managers. Particularly in the small cap space, it is easy to fall prey to individual stories about unique disruptors or potential customer wins, even when it may be time to sell a security. We also exit positions when they no longer would be included in our small cap investible universe, such as by getting too large or small. The 3 largest positions we sold were the following. All were strong performers during our ownership period.

  • Supply chain consulting company Manhattan Associates (MANH). Initially purchased in March 2018, at the time of its sale it was the 14th largest position in the portfolio. We exited the position because it became too large to be included in our investible universe.
  • Semiconductor and life science equipment manufacturer Brooks Automation (BRKS). Initially purchased in March 2017, at the time of its sale it was the 16th largest position in the portfolio. We exited the position because estimates fell on lowered profitability guidance.
  • Security software company Forescout Technologies (FSCT). Initially purchased in November 2018, at the time of its sale it was the 25th largest position in the portfolio. We exited the position because guidance fell on questions around an upcoming deal.

We also exit stocks currently being acquired, and during this quarter, we sold two companies for that reason:

  • Real estate services company HFF (HF) is being acquired by larger competitor JLL (JLL)

In their place, we purchased 60 new names for the portfolio. Among the top-ranked securities we purchased were the following:

  • Diversified West Coast REIT American Asset Trust (AAT, Real Estate), which has been leasing up newer properties and raising capital for further investments in core markets.
  • Infrastructure equipment manufacturer DMC Global (BOOM, Energy) has been gaining share in a growing well perforating system market.
  • College and graduate program online curriculum platform 2U (TWOU, Information Technology) has seen expectations recover somewhat after weakness at the end of last year on concerns that partners were reducing admissions into online graduate programs

 A full list of the names we traded is below:

Through these trades, we materially (>1%) increased our exposure to the Energy sector, and materially reduced our exposure to the Information Technology, Real Estate, and Industrials sector.

Top Holdings

One name changed within the top 10. Holdings (ALRM) underperformed the broader market as core revenue growth decelerated, and in its place medical device company Tactile Systems Technology (TCMD) moved back up. The top 10 holdings continue to represent 8.5% of the portfolio.

Ticker Security Description Sector Portfolio Weight %
SKYW SKYWEST INC Industrials 1.32%
FOXF FOX FACTORY HOLDING CORP Consumer Discretionary 0.89%
GLUU GLU MOBILE INC Communication Services 0.81%
LHCG LHC GROUP INC Health Care 0.79%
FIVN FIVE9 INC Information Technology 0.72%

Note: Cash (including accrued dividends) represents a 0.71% weight in the portfolio. As of 05.31.2019.

Portfolio Weights by Sector

The process underlying SCAP is bottom-up, and driven by the attractiveness of individual companies with the goal of providing actual stock diversification, rather than by just a few top-down sector or industry bets. As such, our sector exposures can vary significantly versus the benchmark as a whole. As of the end of May, our largest exposures compared to the benchmark are now the Information Technology and Energy sectors, and the Financials and Real Estate sectors the largest underweights.

Source: Factset. Weights as of 5/31/2019. Excludes cash and unassigned.

Very Truly Yours,

Cornerstone Investment Partners
AdvisorShares Cornerstone Small Cap ETF (SCAP) Portfolio Manager

Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by visiting Please read the prospectus carefully before you invest. Foreside Fund Services, LLC, distributor.

There is no guarantee that the Fund will achieve its investment objective. An investment in the Fund is subject to risk, including the possible loss of principal amount invested. Emerging Markets, which consist of countries or markets with low to middle income economics can be subject to greater social, economic, regulatory and political uncertainties and can be extremely volatile. Other Fund risks include concentration risk, foreign securities and currency risk, ADRs which may be less liquid, large-cap risk, early closing risk, counterparty risk and trading risk, which can increase Fund expenses and may decrease Fund performance. The Fund is, also, subject to the same risks associated with the underlying ETFs, which can result in higher volatility. This Fund may not be suitable for all investors. See prospectus for detail regarding risk.

Shares are bought and sold at market price (closing price) not NAV and are not individually redeemed from the Fund. Market price returns are based on the midpoint of the bid/ask spread at 4:00 pm Eastern Time (when NAV is normally determined), and do not represent the return you would receive if you traded at other times.

Holdings and allocations are subject to risks and to change.

The views in this commentary are those of the portfolio manager and may not reflect his views on the date this material is distributed or anytime thereafter. These views are intended to assist shareholders in understanding their investments and do not constitute investment advice.