SCAP: September 2019 Portfolio Manager Review

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Performance Review

It was a good month to be a contrarian. The Wall Street Journal just published an article titled, “Mixed Market Signals Pose a Conundrum for Investors.” On the same day, CNBC published an article titled, “The Hard Data Says the US Economy is Just Fine.” The results of the market appear contradictory as well, as it feels like stocks have been moving up and down like a see-saw every day for the last few months. After a weak performance in August, improving perspectives on the macroeconomic environment and trade discussions, small caps did well this month, returning 2.1%. Small caps slightly outperformed large caps (35 basis points) this month, but have lost by 1,275 basis points over the last year.

Taking a broader view of the market, the valuation spread between value-oriented stocks and the rest of the large cap space hit 30-year records early last quarter, even wider than during the technology bubble. However, the hard data, such as a 50-year low unemployment level, retail spending, and 2% GDP growth, is still supportive of economic stability, and this factor effect has started to reverse. While the timing of these reversals is unknowable, they can be sudden and fierce. For example, in mid-September, there was a rotation into value-oriented stocks and away from momentum stocks as investors began to react to supportive macroeconomic sentiment and considered the read-throughs from former IPO darlings. On a style basis, this led the Russell 2000 Growth to underperform the Russell 2000 Value by approximately 600 basis points in September, the largest monthly difference in over a decade. The recent IPO space is a great example of this driver, as a market usually driven by stories instead of fundamentals (remember, equity raises in the public markets can be a more expensive form of financing than many other options). The last few years have seen very high prices for companies that are unprofitable or highly risky, but the narrative may be shifting against these new offerings, as investors have become more selective. We(Work), whose filings led to serious questions about governance and financial strength, had to pull its listing, and unprofitable Uber and Lyft are each down over 30% this quarter.

At the sector level, value-oriented industries were not surprisingly the drivers of performance, with Materials (+7.0%), Real Estate (+4.6%), and Industrials (+4.5%) strongest. In addition to Healthcare (-4.1%), which was impacted by perceived political pressure, growthier sectors were weaker, with Communication Services (-0.9%) and Information Technology (+0.4%) among the biggest underperformers. Some of the value/growth trade has been given back, so it’s unclear where it will shake out over the rest of the year.

Multiples were stable, with the LTM EV/EBITDA multiple of the Russell 2000 rising to 12.0x from 11.9x. While valuations are up somewhat from 11.0x at the end of the year, they remain well below the five year median, and the 4.4% discount to large caps (any discount is quite rare) near the largest level since the dot-com boom. In the near-term, it’s unclear whether small cap valuations will rise to historical premia or large caps need to fall, but given the historical growth performance of small cap stocks, it seems this is unlikely to persist forever, given the long-term median premium is over 14%. Leverage (3.4x Net Debt/EBITDA) continues to remain at post-recession highs, but given low rates, interest coverage is also strong. We will start to see the impact of 3Q earnings during late October and early November.

Earnings growth rates remained generally stable last month, with the year-over-year EBITDA growth of Russell 2000 constituents moving to 1.2% from 1.3% last month, and still well below where we started the year (+12%). Revenue growth actually improved, but margins have continued to fall and the large to small margin spread remains quite wide (currently, large cap EBITDA margins average ~19% versus ~10% for small caps), as small cap margins have remained effectively flat for the last decade while large cap margins have increased ~300bp over the last fifteen years. A key driver of outperformance for individual small cap stocks is likely to be the ability to separate themselves, fundamentally, from these two broader trends.

Until last month, bonds have been on a heck of a run this year, and one line we’ve heard often is that these days, stocks are used for income and bonds are used for appreciation. The math suggests it’s partly true. The dividend yield of the Russell 2000 is 1.85%, which is slightly above around the 10-year average for the Index, but 10-year U.S. Treasury bond yields are only 1.68%, and as low as those are, they are the highest among major economies in the world. Over 60% of the Russell 2000 index has a dividend higher than the 10-year Treasury yield. However, stocks have a much longer history of appreciation and can also increase their dividend levels. Since 2007, there have been five other times when Russell 2000 dividend yields were higher than the 10-year Treasury (Nov. ’08, Aug. ‘11, May ’12, April ’13, Jan. ‘16). Over the next three years, the Russell 2000 returned 22%, 21%, 18%, 8% and 14%, respectively, on a total return basis. The Vanguard Total Bond Fund returned 8%, 2%, 2%, 2% and 2%. Additionally, 65% of the (dividend-paying) companies in the Russell 2000 have increased dividend payouts over the past year. We would expect greater payouts for those companies with better cash flows and improving earnings profiles.

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. 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 September, the NAV of the AdvisorShares Cornerstone Small Cap ETF was up 1.2%, underperforming the Russell 2000 Index, which was up 2.1%. We would note that the ETF did outperform the Russell 2000 Growth Index, down 0.8%, by almost 200 basis points. Individual stock selection was the primary detractor to relative performance versus the Russell 2000 benchmark during the month.

Monthly Performance By Sector

Past performance is not indicative of future results. Source: Factset; as of 09.30.2019.

Contributors and Detractors

Consumer Staples, Consumer Discretionary, and Materials 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 Consumer Staples and Materials, as well as our overweight allocation to Consumer Discretionary and underweight allocation to Health Care. Lands End (LE), Casa Systems (CASA), and Hibbett Sports (HIBB) were three of the largest individual contributors.

  • Lands End (Consumer Discretionary) is an apparel retailer. The stock had very strong performance during the month as it released better-than-expected quarterly earnings. Additionally, it reported US same-store-sales of +7.5%, which was better than peers. The strong comps helped drive a significant short squeeze amid increased investor confidence. Lands End was a stock added in August as part of the most recent quarterly reconstitution.
  • Casa Systems (Information Technology) is a provider of software solutions to support video and wireline service providers. There was no particular news that drove the stock during the month, but investors likely became more comfortable with the longer-term spending path of service providers, who have recently cut capex spend on Casa’s type of services. Casa was a stock added in August as part of the most recent quarterly reconstitution.
  • Hibbett Sports (Consumer Discretionary) is a retailer of sneakers and athletic clothing under the Hibbett and City Gear banners. The stock benefited from strength out of peers and the investor rotation to more value-oriented stocks.

Performance in the portfolio was more than offset by the Financials, Communication Services, and Information Technology sectors. At a component level, the largest negative contributors to performance included our stock selection in Communication Services, Industrials, and Energy, as well as our underweight allocation to Financials. NAPCO Security Technologies (NSSC), TeleNav (TNAV), and NeoGenomics (NEO) were three of the largest individual detractors.

  • NAPCO Security Technologies (Information Technology) is a provider of physical security hardware and software solutions. While the company announced generally in line earnings for the quarter, margins were down somewhat on hardware discounts and investors appeared to be expecting stronger results given recently positive stock appreciation (while down this month, the stock is up 62% YTD). The company still grew revenue by 9% and EPS by 29% for the quarter.
  • TeleNav (Information Technology) TeleNav is a provider of auto infotainment and mapping solutions. General Motors, the company’s 2nd largest customer at 1/5 of 2018 revenues, announced it would be integrating Google’s infotainment solutions into its cars starting in 2021.
  • NeoGenomics (Health Care) is a provider of oncology testing for clinical use and pharmaceutical development. The stock was weak. While there was no particular news related to the company itself and estimates remained consistent, investor sentiment was weak across the genetic testing space, likely due to high valuations and potential political pressure.

Portfolio Changes

We did not purchase or exit any securities during the month.

Top Holdings

Two names changed within the top 10. IT services consultant Perficient (PRFT) and health care insurance validation provider HMS Holdings (HMSY) joined the top 10, while software company NAPCO Security (NSSC) and medical device producer Tactile Systems Technology (TCMD) underperformed. The top 10 holdings continue to represent approximately 8% of the portfolio.

Ticker Security Description Sector Portfolio Weight %
SKYW SKYWEST INC Industrials 1.27%
EXPO EXPONENT INC Industrials 0.83%
LHCG LHC GROUP INC Health Care 0.78%
ZYME ZYMEWORKS INC Health Care 0.76%
FIVN FIVE9 INC Info Technology 0.74%
PRFT PERFICIENT INC Info Technology 0.70%

Note: Cash (including accrued dividends) represents a 1.1% weight in the portfolio. As of 09.30.2019.

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 August, our largest exposures compared to the Russell 2000 benchmark are the Information Technology and Consumer Discretionary sectors, and the Financials and Utilities sectors the largest underweights.

Source: Factset. Weights as of 09.30.2019. Excludes cash and unassigned.

Very Truly Yours,

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


Past Manager Commentary


EBITDA stands for earnings before interest, taxes, depreciation, and amortization.

EV is the “enterprise value” of a company which measures a company’s total value, taking market capitalization, short- and long-term debt and cash into consideration. It is a popular metric used to value a company for a potential takeover.

The LTM EV/EBIDTA is the “enterprise multiple” for the last 12 months (LTM) used to determine the value of a company. It looks at a firm in the way that a potential acquirer would by considering the company’s debt. Unlike other common measures, the enterprise multiple takes into account a company’s debt and cash levels in addition to its stock price and relates that value to the firm’s cash profitability (e.g. the price-to-earnings ratio).

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.