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Special Report

Small-cap strategies still king of the quarter as 2017 shifts to growth

Brooke de Boutray
Zevenbergen Capital Investments’ Brooke de Boutray

Small-cap equity strategies once again made up the bulk of Morningstar Inc.'s domestic equity separate account/collective investment trust database, claiming seven of the top 10 spots for the year ended June 30.

Of the seven, four were growth strategies. Also, of the seven, one was a financial strategy and one was a health strategy.

Last quarter, small-cap equity managers occupied six of the top 10 spots for the 12 months ended March 31, also with four growth managers.

The remaining strategies in the top 10 this time around were a midcap growth strategy, a midcap growth technology strategy and a large-cap growth financial strategy.

While 2016 was the year of value, the second quarter of 2017 was "the continued reversal of that," said Andrew Daniels, analyst for equity strategies at Morningstar in Chicago. "The late part of 2016 was very strong for value, and the first part of 2017 was very strong for growth, so you see both (value and growth) managers ending up in the trailing one year," Mr. Daniels said.

For the year ended June 30, the Russell 2000 Growth index returned 24.4%, edging out the Russell 2000 Value index, which returned 22.42%. The median Morningstar domestic growth and value equity strategies, meanwhile, returned 20.39% and 18.63%, respectively.

During the same period, the median return for the overall Morningstar domestic equity universe was 19.22%, while the Russell 3000 returned 18.51%, the Russell 2000, 24.6%; Russell 1000, 18.03%, and the Russell Midcap index, 16.48%.

Top-performing managers: overall U.S. equity
One-year returnCategoryGross
Schneider Capital Mgmt. Small-Cap ValueU.S. SA small value56.65%54.92%
ZPR Volume ValueU.S. SA financial55.79%53.26%
Zevenbergen Z/TechU.S. SA technology53.28%51.96%
Bares Capital Mgmt. Small-CapU.S. SA small growth50.99%48.95%
Pacific Ridge Capital Partners Micro Cap ValueU.S. SA small value47.10%45.00%
Naylor & Co. Core CompositeU.S. SA midcap growth46.27%43.58%
RS Technology CompositeU.S. SA technology45.54%44.09%
Baron Discovery StrategyU.S. SA small growth45.44%44.38%
Kopp AccruHealthU.S. SA health45.36%43.57%
Weatherbie Capital – Spec. Growth EquityU.S. SA small growth44.37%43.26%
Five-year returnCategoryGross
Zevenbergen Z/TechU.S. SA technology26.27%25.12%
Naylor & Co. Core CompositeU.S. SA midcap growth25.31%22.71%
ZPR Volume ValueU.S. SA financial25.09%23.00%
Pacific Ridge Capital Partners Micro Cap ValueU.S. SA small value21.90%20.10%
Wellington Global Technology OpportunitiesU.S. SA technology21.62%20.72%
BMO Microcap Equity – Institutional - SAU.S. SA small growth21.56%20.34%
LEIA CBIU.S. SA large growth21.23%21.23%
Financial Trust Health ValueU.S. SA health20.73%19.23%
Towle & Co. Deep ValueU.S. SA small value20.71%19.86%
O'Shaughnessy Micro CapU.S. SA small value20.55%19.26%

​Like Mr. Daniels, Mark Zavanelli, president and head portfolio manager at Orange City, Fla.-based ZPR Investment Management Inc., described the 12 months ended June 30 as a "tale of two periods."

"What was doing well in the second half of 2016 (microcap stocks, value stocks, and small financials), was not doing as well in the first half of 2017," Mr. Zavanelli said.

"In late 2016, expectations for U.S. growth and what the (Trump) administration was going to do really boosted interest rates strongly," Mr. Zavanelli said. In the first half of 2017, however, interest rates have fallen as growth expectations for the U.S. have trailed off, and the Trump administration's tax reform and infrastructure plans have not really materialized, he said.

ZPR's volume value strategy ranked second in the year ended June 30 with a gross return of 55.79%, down one spot from last quarter. For the five years ended June 30, the strategy ranked third with an annualized gross return of 25.09%, down two spots from the previous quarter. All five-year returns are annualized.

Mr. Zavanelli said the portfolio team looks for microcap stocks with attractive valuations and low trading volume relative to their total shares outstanding.

The combination of those factors — microcap, value and low trading volume — worked well for the strategy over the last year, Mr. Zavanelli said.

The portfolio also continues to have a more than 60% weighting to small financials. Those stocks had a "terrific fourth quarter of 2016," Mr. Zavanelli said.

Occupying the No. 1 spot for the 12 months ended June 30 was Schneider Capital Management Corp.'s small-cap value strategy with a gross return of 56.65%.

Arnold C. Schneider III, president and chief investment officer, said the Wayne, Pa.-based firm is a deep value manager that invests in cheap stocks where the firm sees a chance for improved fundamentals.

According to Mr. Schneider, four sectors — banks, materials, producers and cyclical technology — contributed to the strategy's success over the year ended June 30.

Banks rebounded after Donald Trump's election and KeyCorp. and Regions Financial Corp. stood out as winners, Mr. Schneider said. In materials, Chemours Co., a leading producer of titanium dioxide, was a top contributor, and in producers, so was industrial distributor DXP Enterprises Inc.

Occupying third place on the one-year list was Zevenbergen Capital Investments LLC's Z/Tech strategy with a gross return of 53.28%. The strategy also ranked first on the five-year list with a gross return of 26.27%.

Z/Tech is a concentrated growth portfolio of about 25 companies, said Brooke de Boutray, portfolio manager and managing director at the Seattle-based firm. It is considered a large-cap strategy by Morningstar.

The portfolio team looks for companies with founder-led, visionary management that are often disrupting industries, Ms. de Boutray said.

There's been "so much change and disruption" in the way people shop, consume entertainment, prepare meals or buy a home, Ms. de Boutray said.

Winners over the past year included Tesla Inc., Netflix Inc., Nvidia Corp., MercadoLibre Inc., and Wayfair Inc.

Behind Zevenbergen on the one-year list was Bares Capital Management Inc.'s small-cap strategy with a gross return of 50.99%, up one spot from last quarter.

Brian T. Bares, founder and research analyst at the Austin-based firm, said the portfolio team takes a qualitative approach to build a concentrated portfolio of eight to 12 stocks. Eleven research analysts meet with companies' management teams, attend trade shows and walk factory floors, he said.

Standouts over the year included Interactive Intelligence Group Inc., which was acquired in 2016; Colefax Group PLC and Platform Specialty Products Corp., which benefited from a post-election rebound in industrials; and technology names Alarm.com and Box Inc.

Rounding out the top five on the one-year list was Pacific Ridge Capital Partners LLC's microcap value strategy with a gross return of 47.1%. The strategy also ranked fourth on the five-year list with a gross return of 21.9%.

Mark Cooper, president and co-senior portfolio manager, said that the Portland, Ore.-based firm is a fundamental, bottom-up stock picker that invests in out-of-favor companies.

Standouts over the last year included shipping container leasing company CAI International Inc., which benefited from rising steel prices and dissipating bankruptcy concerns for some shipping companies, Mr. Cooper said. Ultra Clean Technologies Corp., a semiconductor capital equipment company, was another standout over the one-year period.

The remaining strategies of the top five on the five-year list was Naylor & Co.'s core composite midcap growth strategy, in second place with a gross return of 25.31%, and Wellington Management Co. LLP's Global Technology Opportunities with a gross return of 21.62%, ranking fifth. Both strategies were on last quarter's five-year list.

The median return for the overall domestic equity universe for the five years ended June 30 was 14.32%.

Among domestic collective investment trusts, The Boston Co. Asset Management LLC's small-cap opportunistic value equity strategy ranked first on the one-year list with a net return of 31.48%, followed by J.P. Morgan Asset Management (JPM)'s U.S. active value fund, 29.84%; State Street Global Advisors' Nasdaq-100 index strategy, 29.35%; American Century Investments' U.S. small-cap value equity trust, 28.85%; and Harris Associates LP's Oakmark collective fund, 28.54%. The median return for domestic collective investment trusts for the year ended June 30 was 18.66%.

For the five years ended June 30, the highest-returning CIT was State Street Global Advisors' Nasdaq-100 index strategy, with a net return of 18.15%, followed by J.P. Morgan's growth advantage strategy, 18.01%; BNY Mellon Investment Management's EB DV dynamic U.S. equity strategy, 17.93%; J.P. Morgan's U.S. active value fund, 17.62%; and Amalgamated Bank's Longview quantitative midcap fund, 17.23%.

The median return for domestic collective investment trusts over the five-year period was 14.57%.

All data for Pensions & Investments' top-performing managers report are provided from Morningstar's global separate account/collective investment trust database. The data for the rankings on which this story is based were pulled Aug. 3.