Small-cap growth retains top-performance crown

Small-cap growth strategies again reigned supreme for the year ended Sept. 30, with seven of the top 10 domestic equity strategies in Morningstar Inc.'s separate account/collective investment trust database falling into the category.

This marks the third consecutive quarter of small-cap growth strategies leading the way in the top 10. For the year ended June 30, eight of the top 10 domestic equity strategies were small-cap growth.

Of the remaining three on the list of top-performing U.S. equity strategies for the year ended Sept. 30, one was a technology strategy, one was large-cap growth, and the other was midcap growth. Six of the 10 strategies were carryovers from the previous quarter.

"Growth stocks have really been the place to be," said Tony Thomas, manager research analyst at Morningstar, Chicago, in a telephone interview. "Technology and health care were pretty strong, and small cap have done pretty well for much of 2018, thanks to the strength of the domestic economy."

Mr. Thomas noted that because so much of their business is stateside, U.S. small-cap companies are "a bit more sheltered" from global trading concerns such as terrorism and trade wars.

In addition to technology and health-care stocks, the Morningstar analyst said "the role of consumer stocks, especially on the small-cap end, has been interesting." He noted that Granahan Investment Management Inc. did well with SodaStream International Ltd., while T. Rowe Price New Horizons Fund benefited from Grubhub Inc. and Burlington Stores Inc. The New Horizons Fund had the second-highest 12-month return for Morningstar's collective investment trust universe.

Despite U.S. technology stocks performing well for the year ended Sept. 30, the technology sector has not been playing as well outside of the U.S.

"Some of last year's high-flyers, like Alibaba, struggled, especially in third quarter," Mr. Thomas said.

Particularly noteworthy this quarter was that one strategy new to the top 10 list, Spouting Rock Asset Management LLC's Small-Cap Growth Concentrated strategy, took the No. 1 spot, while Kayne Anderson Rudnick Investment Management LLC's Small-Cap Quality Select strategy, which had occupied the top spot on the list for four consecutive quarters, didn't even rank this time around.

Since Spouting Rock's strategy is heavily invested in health-care and technology stocks, it paid off this quarter. In particular, the strategy, which posted a 71.2% return for the year ended Sept. 30, had large stakes in health-monitoring manufacturer BioTelemetry Inc. and Ligand Pharmaceuticals Inc., which were up 43% and 32.5%, respectively, over the quarter.

Mr. Thomas said health care and technology are currently "hot sectors these days," but they're also very volatile. "So, when they're on, they're on. But if those trades wane, you can go the other way in a hurry," he said.

Kayne Anderson Rudnick's small-cap strategy struggled, due in large part to a 23% drop in the quarter by one of its largest holdings, Autohome Inc. And with Autohome being roughly one-third of the strategy's holdings, it "took the shining off Kayne Anderson Rudnick this quarter," Mr. Thomas said.

Overall, domestic equity strategies in Morningstar's universe returned a median 14.36% for the year. For the 12 months ended Sept. 30, the Russell 2000 growth returned 21.06%. Meanwhile, Morningstar's median return for domestic equity growth strategies for the year ended Sept. 30 was 22.18%. The Russell 3000 returned 15.45% for the year.

Second on the list was Granahan Investment Management's Small-Cap Focused Growth strategy, which posted a gross return of 66.47% for the 12 months ended Sept. 30.

Drew Beja, portfolio manager for the Granahan small-cap strategy, attributed the strong performance to its investments in technology and consumer shares.

"Our methodology combines companies that can sustain high growth throughout economic cycles with stocks that have good risk-reward," Mr. Beja added.

Advisory Research Inc.'s U.S. Small-Cap Growth strategy followed with a 62.76% return for the year.

"The largest sources of performance for the strategy over the last 12 months were stocks from the health-care, consumer discretionary and technology sectors," said Andrew S. Cupps, portfolio manager of the Advisory Research strategy, in an email.

Specifically, Stitch Fix Inc., Carvana Co., Etsy Inc. and GrubHub Inc. did well. Mr. Cupps added that the strategy "also saw strong initial returns for competitively advantaged companies in cloud software, robotics and medical instruments."

Occupying the fourth spot on the list was Next Century Growth Investors LLC's Micro Cap Growth strategy, which returned a gross 61.89% for the year ended Sept. 30. The strategy, which typically holds about 50 stocks, aims to own the highest-quality, fastest-growing U.S. microcap companies with higher, more sustainable earnings growth and revenue than the Russell Microcap Growth index.

Zevenbergen Capital Investments LLC's Genea Growth strategy, a concentrated growth portfolio that looks for companies that are disrupting industries, ranked fifth on the one-year list, returning a gross 59.99%.

Brooke de Boutray, managing director, portfolio manager at Zevenbergen, said that Amazon.com Inc., Netflix Inc., Wayfair Inc. and Shopify Inc. have been "significant contributors" to the strategy's success.

"We invest in companies that have strong secular growth and there are several interesting investment opportunities with long-term horizons," she said.

One such sector, according to Ms. de Boutray, is e-commerce. The other is cannabis.

"We're seeing a global paradigm shift from an illicit market to a legal and taxable industry," she said. "We think it's in the early stages, but we believe there are very compelling investment opportunities." The strategy is invested in Tilray Inc., a Canadian pharmaceutical and cannabis company based in Nanaimo, British Columbia.

Ranked sixth on the top 10 list was Macquarie Investment Management's Small Cap Growth strategy, which returned a gross 59.96%, followed by Fred Alger Management Inc.'s Small Cap Focus Composite strategy, which returned 53.69% for the period.

Amy Zhang, senior vice president and manager of the benchmark-agnostic strategy at Fred Alger, said that she's been "managing the same strategy for 16 years, so it's been the same process."

Ms. Zhang also noted that the strategy does not invest in startups or household names.

"We invest in innovation," she said. "We gravitate toward technology and health care."

And although the strategy saw health care being the largest sector during the quarter in terms of holdings, sector weighting and investment gains, Ms. Zhang pointed out that "the bulk of (the strategy's) alpha still comes from stock selection instead of sector allocation."

Rounding out the top 10 list are Granahan's Small Cap Advantage strategy, returning 49.73%; and Morgan Stanley (MS) Investment Management's Multi Cap Growth and Mid-Cap Growth strategies, returning 48.86% and 46.97%, respectively.

For the five years ended Sept. 30, DOMO Capital Management LLC's Concentrated All Cap Value strategy topped the list with an annualized gross return of 23.86%. Zevenbergen's Genea strategy followed, with a 23.52% return. The two strategies switched places on the rankings from the prior quarter.

The rest of the top five were: MFS Investment Management's Technology Equity strategy, which returned an annualized gross 21.97%; Allianz Global Investors' Global Technology Equity strategy, 21.86%; and Victory Capital Management Inc.'s RS Science and Technology Composite, 21.7%.

The median annualized return in the Morningstar universe for the five years ended Sept. 30 was 11.96%. The median annualized return for growth strategies for the same period was 13.81%; value was 11.06%.

Among collective investment trusts, growth strategies accounted for all of the top 10 CITs for the year ended Sept. 30, with six being large cap, three midcap and one small cap. The top-performing CIT for the period was BlackRock (BLK) Inc. (BLK)'s U.S. Fundamental Large Cap Growth trust, with a net return of 31.35%.

The rest of the top five CITs for the year ended Sept. 30 were:

• T. Rowe Price Group Inc.'s New Horizons CIT, with a net return of 31.17%.
• Wellington Management Co. LLP's CIF II Growth trust, 31.1%.
• MFS' Growth Equity CIT, 30.09%.
• CastleArk Management LLC's Large Cap Growth trust, 29.86%.

The median return for domestic collective investment trusts for the year ended Sept. 30 was 15.86%.

For the five years ended Sept. 30, the highest-returning collective investment trust was State Street Global Advisors' Nasdaq-100 index strategy, with an annualized net return of 20.24%, followed by T. Rowe Price's Blue Chip Growth trust at 17.66%; Wellington Management's CIF II Growth trust at 17.65%; BlackRock's U.S. Fundamental Large Cap Growth trust at 17.04%; and BNY Mellon's MCM Dynamic U.S. Equity Fund at 16.73%.

The median return for domestic collective investment trusts for the five-year period was 11.88%.

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 Nov. 5.