Small-cap growth strategies continue to expand reach in top 10

Small-cap stocks, particularly growth strategies, dominated the best-performing domestic equity strategies for the year ended Dec. 31, according to Morningstar Inc.'s separate account/collective investment trust database.

Nine of the top 10 strategies for the year were small-cap equity, including seven growth strategies. There were seven small-cap strategies in the top 10 for the year ended Sept. 30, but only three of them remained on the list at the end of the fourth quarter. (The three were growth strategies managed by Lord, Abbett & Co. LLC and Granahan Investment Management, and a value strategy managed by O'Shaughnessy Asset Management.

The median return for all equity strategies for the 12 months ended Dec. 31 was 35.33%, topping the Russell 3000 index return of 33.55% for the period. Growth strategies marginally had the lowest median return for the fourth quarter, but were tops for the year ended Dec. 31 with a median 36.65%. Value and blend strategies had median returns of 35.07% and 34.7%, respectively, for the year.

“It's pretty obvious small-cap growth managers and small-cap growth strategies are taking over the scene,” said Andy Kwon, Chicago-based data analyst at Morningstar. “Small cap has dominated the lists for most” of 2013, he said.

Still, Mr. Kwon expects to see more large-cap strategies rising to the top in the coming quarters. Large-cap portfolios of all types had a median 10.15% return in the fourth quarter, topping small caps, 9.35%; and midcaps, 9.04%.

“It might be very possible they are in the top-10 lists next quarter,” Mr. Kwon said.

Another emerging trend is small-cap strategies in the top 10 for the five years as of Dec. 31. Seven of the top 10 are small-cap strategies, up from four the previous quarter. All four from the five years ended Sept. 30 remained in the top 10. The rise of the small-cap managers came at the expense of energy strategies, which had dominated the rankings.

Even with small-cap portfolios littering the top 10, a technology strategy managed by Seattle-based Zevenbergen Capital Investments LLC topped the one-year returns for the second consecutive quarter. The Z/Tech portfolio had a whopping 101.17% gross return, nearly 20 percentage points above the next strategy.

“We look for strong revenue and earnings growth and solid management,” said Brooke de Boutray, managing director and portfolio manager of the strategy. “We are focused on all things Internet and the Internet of things.”

Z/Tech was also one of only two strategies to appear on the top 10 for both the one- and five-year periods, with an annualized five-year return of 36.12%, ranking fourth. The portfolio typically has about 25 holdings across all market capitalization sizes with a relatively low turnover, Ms. de Boutray said.

Some of the holdings that contributed to the portfolio's outperformance were Netflix Inc., Tesla Motors Inc., Google Inc. and Priceline.com.

“We have really been beneficiaries of the growth of the Internet and all that goes with that — mobile, social media and Internet advertising,” Ms. de Boutray said.

Ms. de Boutray said the portfolio is still positioned well for growth, with Internet advertising, the monetization of mobile applications and growing e-commerce all strong areas.

Right behind the Z/Tech strategy for the second consecutive quarter was Jersey City, N.J-based Lord, Abbett's microcap growth strategy with an 81.28% gross return.

The microcap strategy has about 80 to 100 diversified holdings and is focused on growth companies. It looks at several qualitative attributes such as a sound business model, capable management, healthy industry conditions and that the company holds a competitive advantage in its market, said F. Thomas O'Halloran, partner, director and lead portfolio manager.

“The best is a company that creates an industry and then dominates it,” Mr. O'Halloran said.

He said the portfolio saw most of its growth last year from areas such as digitization, U.S. mass consumerism, the U.S. manufacturing renaissance, North American energy revival and modern medicine.

“The mapping of the human gen-ome is a game changer,” Mr. O'Halloran said. He said biotechnology stocks had “huge gains” and were some of the largest contributors to last year's performance. Portfolio holdings Celldex Therapeutics Inc., Aegerion Pharmaceuticals Inc., and ACADIA Pharmaceuticals Inc. were all up more than 200% for the year.

“The biotechs are benefiting from the genomic revolution,” Mr. O'Halloran said. “I think they are going through what Internet companies were in the '90s. I think it will be an explosion.”

Following Lord Abbett's strategy was Essex Investment Management Co. LLC's microcap growth portfolio with a 78.29% gross return. Essex's small/microcap growth strategy also finished in the top 10 for the year, ranking eighth with 66.51%.

Both strategies are bottom-up approaches that overlap on the microcap investments, said Nancy Prial, Evanston, Ill.-based managing principal and portfolio manager. Each has about 90 to 95 holdings with a turnover rate between 60% and 80%. Ms. Prial said the strategies had success last year in health care, technology and alternative energy. She added she continues to be bullish on those areas in addition to cloud-based computing, the manufacturing resurgence in the U.S. and businesses that can make money through the Internet.

“One thing that has worked very well across both portfolios is the market has turned back to a good stock-picking environment ... and we have been able to get rewarded,” Ms. Prial said.

Rounding out the top five in the one-year rankings were Falcon Point Capital LLC's microcap growth strategy with a 73.78% gross return; and O'Shaughnessy Asset Management LLC's microcap portfolio, 70.03%.

Small-cap strategies made up the majority of the top 10 for five-year returns with seven portfolios on the list, but it was energy strategies that took the top two spots. Cushing MLP Asset Management's MLP institutional alpha strategy finished first with an annualized gross return of 38.28%, followed by Harvest Fund Advisors LLC's MLP alpha strategy at 37.27%. (All returns for periods of more than one year are compound annualized figures.)

The Russell 3000 annualized five-year return was 18.5%; the median return for Morningstar's separate account database was 19.96%.

The Cushing portfolio is a total-return focused strategy that has 28 holdings that seek the best growth prospects, are highly liquid and not highly concentrated.

“I give up yield all day for growth,” said Libby Toudouze, Dallas-based president of Cushing. “One thing that helps set us apart is our robust portfolio construction. We look at more than just the fundamentals.”

Ms. Toudouze said over the past few years, companies with growth and businesses with a “thematic position with energy infrastructure” have been rewarded. She added the portfolio had a lot of success by identifying a wave to crude oil “very early.”

Following the energy strategies in the five-year rankings were Allianz Global Investors' ultra microcap strategy, at 36.42%; Zevenbergen's Z/Tech, 36.12%; and Granahan Investment Management Inc.'s small-cap focused growth strategy, 36.04%.

Among collective investment trusts, five of the top 10 performers for the year ended Dec. 31 were small-cap managers as well.

The top CIT for the year ended Dec. 31 was Morgan Stanley Investment Management's small-cap growth strategy, returning a net 61.69%.

Second was Zevenbergen's U.S. Growth Opportunities large-cap growth fund with 60.09%, followed by Wellington Management Co. LLP's small-cap blend fund with 55.23%. The median return for collective investment trusts for the year was 33.55%.

For the five-year period in the collective investment trust universe, Wilmington Trust Fiduciary Services Co.'s small-cap growth fund was first with an annualized 29.32% gross return. Following were The Boston Co. Asset Management LLC's small-cap opportunity value equity strategy, with 28.68%; and Columbus Circle Investors' smidcap growth fund, with 28.47%. The median return for collective investment trusts for the five years ended Dec. 31 was 18.92%.

All of the data for Pensions & Investments' quarterly “Top Performing Managers” report are provided from Morningstar Inc.'s global separate account/collective investment trust database. For information on the database, please contact [email protected] or call 312-384-4087.