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SCAP: November 2018 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 www.advisorshares.com/fund/scap.

Performance Review

The small cap universe, represented by the Russell 2000 Index, was up 1.6% in November on a total return basis, taking a breather after the worst month since 2011. However, the month was much more volatile than the final number implied. Within a week, the Russell 2000 was up nearly 5%, fell 8% over the next two weeks, and climbed back by the end of the month. With such swings, there did not seem to be key themes to point to during the month, as Utilities were up 6.7%, but Consumer Staples, another safety trade, was only up 0.2%. Other strong sectors included Financials (+3.4%) and Real Estate (+3.0%). Energy was the big loser, falling 11.0% after a 16% drop last month, as WTI (W&T Offshore, Inc.) declined over 20% during the month. Since peaking in early October, oil prices are now down 33% since peaking in early October. Other weaker sectors included Communication Services (-0.3%), Consumer Staples, and Materials (+0.2%).

Small Cap has continued its relative decline compared to Large Cap, as the Russell 1000 returned over 2% during the month. There was no style shift, as the Russell 2000 Growth and Russell 2000 Value were generally in line. Small caps and large caps now trade at the same EV/EBITDA multiple, which is well below small cap’s historical valuation premium of 14%. We stated this last month, but this is the first time small caps have traded at parity since the tech bubble. Other valuation metrics have also fallen as fundamentals remain strong in the face of price weakness, including Price to Book, Sales and Earnings multiples. However, fundamental results remain quite strong and supportive of continued growth. Earnings growth for small caps accelerated during the month to 11.8%, and looking back YTD, has been driven by both revenue (75%) and margins (25%).

We’re writing this during December, and weakness in the small cap asset class has returned. To repeat something we wrote last month, corrections, which represent 10+% declines in an asset class, are normal (this is the fourth since the financial crisis), and provide an opportunity for active managers in the market to take advantage of situations when stock prices move in a more volatile manner than fundamentals – it’s a reminder that what you own matters. While there are some fundamental reasons why small cap may underperform in the near-term, including slowing margin opportunities, a few markets facing slow-down concerns, and higher debt leverage, most of the movement in the market can be attributed to a sentiment shift towards risk-off securities. The opportunity for multiple expansion may be more limited going forward, but a diversified collection of companies demonstrating fundamental improvement and growth can drive relative outperformance versus the asset class.

We think SCAP’s approach, which places a premium on discipline, remains well-positioned. Particularly in a more volatile environment, 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 November, the portfolio underlying the AdvisorShares Cornerstone Small Cap ETF underperformed the Russell 2000 Index. The AdvisorShares Cornerstone Small Cap ETF declined 0.3% during the month, while the Russell 2000 increased 1.6%, an underperformance of approximately 190 basis points.

Sector

Monthly Performance By Sector

Past performance is not indicative of future results. Source: Factset; as of 11.30.2018.

Contributors and Detractors

Communication Services and Real Estate were outperformers versus the benchmark during the month. Specifically, our stock selection in Communication Services, primarily from performance out of Shenandoah Telecommunications and US Cellular, our overweight allocation to Information Technology, and our stock selection in Utilities, were the primary positive contributors to our performance. Apptio (APTI), Amedisys (AMED), and Shenandoah Telecommunications (SHEN) were three of the largest individual contributors.

  • Apptio (Information Technology) is a provider of SaaS-based business intelligence software. The company announced early in the month it would be acquired by technology-oriented PE firm Vista Equity for a 53% premium.
  • Amedisys (Health Care) is a provider of at-home care services. After reporting strong performance at the end of October, investor sentiment broadly improved for the company during the month.
  • Shenandoah Telecommunications (Communication Services) is a provider of wireless, cable, and wireline communications in rural areas of the US Mid-Atlantic. The company reported strong results for its third quarter, with profits well above Wall Street estimates.

Performance in the portfolio was more than offset by the Industrials, Consumer Staples, and Information Technology sectors. Our stock selection in Information Technology, Industrials, and Consumer Staples, as well as our underweight allocation to Utilities, hurt overall performance. Denbury Resources (DNR), Insperity (NSP), and Health Insurance Innovations (HIIQ) were three of the largest individual detractors.

  • Denbury Resources (Energy), the weakest performer for the second month in a row, is an oil and gas exploration and production company, with a focus on tertiary oil recovery. With its position in the oil and gas value chain, changes in expected oil prices and US production levels can have a meaningful impact on the company. Given the weakness in oil prices during the month, Denbury traded down materially, but remains above the initial purchase price.
  • Insperity (Industrials) is a professional employer organization. The company announced strong results for the quarter, but the broader PEO industry ended the month relatively weak as concerns around the economy began to impact perceptions of the employee growth opportunity. We sold Insperity during the month, as it is now too large to be in our small cap investible universe.
  • Health Insurance Innovations (Health Care) manages a health insurance platform. The company terminated its relationship with Simple Health, a company under investigation by the FTC, which sold policies on HIIQ’s platform. Additionally, a short seller has begun a campaign against the company.

Portfolio Weight 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. During the most recent reconstitution, we materially increased our exposure to the Health Care sector. On the other side, we materially reduced our exposure to the Real Estate and Industrials sectors. In response to volatile interest rates and debate about the robustness of the US economy, there are concerns about real estate asset valuations. Expectations for industrial companies have been hurt by the continuing trade war with China, which can impact both margins and demand for products made by small cap companies.

Currently, our largest overweight exposures are to the Information Technology and Consumer Discretionary sectors. Our largest underweight exposures are to the Financials and Utilities sectors.

Excludes cash and unassigned. Source: Factset; as of 11.30.2018.

Portfolio Changes

We completed the 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:

  • Professional Employer Organization Insperity (NSP), which was up significantly during our ownership period and is now too large for our investible universe. At the time of its sale, it was the largest position in the portfolio.
  • Payments platform Green Dot (GDOT), which was also up significantly during our ownership period and is now too large for our investible universe. At the time of its sale, it was the sixth-largest position in the portfolio.
  • Residential solar energy company Sunrun (RUN) has continued to deliver top-line growth, but expectations for increased SG&A costs led estimates to fall significantly.

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

  • Online wedding services platform XO Holdings (XOXO)  is being acquired by PE-owned WeddingWire
  • Offshore oil driller Ocean Rig UDW (ORIG) is being acquired by Transocean (RIG)
  • US oil and gas E&P Penn Virginia (PVAC) is being acquired by Denbury Resources (DNR)
  • MA-based Community bank Blue Hulls Bancorp (BHBK) is being acquired by Independent Bank (INDB)
  • Business intelligence SaaS provider Apptio (APTI) is being acquired by PE firm Vista Equity
  • CRM Communication platform SendGrid (SEND) is being acquired by Twilio (TWLO)
  • Electric transmission asset owner InfraREIT (HIFR) is being acquired by Sempra Energy (SRE)

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

  • Office and Industrial REIT PS Business Parks (PSB), which is steadily increasing FFO behind improvement in new assets and accelerating SSNOI.
  • Self-service data analytics company Alteryx (AYX), which continues to deliver strong and accelerating growth in its key business lines, including significant growth in both its customer base and up-sell/cross-sell execution.
  • “Unique” shoe designer Crocs (CROX), which is expected to see positive sales growth for the first time since 2014 driven by newer brand ambassadors and its fast-growing internet and wholesale channel. Additionally, the company could see EPS accretion from a potential equity conversion of expensive outstanding debt.

Top 10 Holdings

As part of the quarterly reconstitution, there was a shake-up in the top-10 holdings during the month. As discussed, we exited Insperity (NSP), Green Dot (GDOT), and Sunrun (RUN). Fox Factory (FOXF), Glu Mobile (GLUU), eHealth (EHTH), LHC Group (LHCG), and Enanta Pharmaceuticals (ENTA) entered the top-10 due to strong relative performance, while Carbonite (CARB) and John Bean Technologies (JBT) exited.

Stock Ticker

Security Description

Portfolio Weight %

SKYW

SKYWEST INC

1.24%

MMSI

MERIT MEDICAL SYSTEMS INC

1.09%

AMED

AMEDISYS INC

0.91%

FOXF

FOX FACTORY HOLDING CORP

0.80%

TCMD

TACTILE SYSTEMS TECHNOLOGY I

0.76%

HSC

HARSCO CORP

0.72%

GLUU

GLU MOBILE INC

0.71%

EHTH

EHEALTH INC

0.69%

LHCG

LHC GROUP INC

0.69%

ENTA

ENANTA PHARMACEUTICALS INC

0.68%

Note: Cash (including accrued dividends) represents a 0.9% weight in the portfolio.

 

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 www.advisorshares.com. 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.