Commentaries

Small Cap Growth

For the Period Ending: 12/31/2018

Portfolio Managers:
Timothy J. Miller, CFA
Kenneth G. McQuade
Bradley P. Halverson, CFA

Market Update

The fourth quarter of 2018 experienced the sharpest correction since 2011, one that spared few asset classes or sectors in the equity market. Size mattered, as small caps fell the most (the Russell 2000 Growth Index declined 21.7%) and large caps the least. Volatility surged, with daily and even inter-day swings reaching dramatic levels. Uncertainty drove the decline, as rising short-term interest rates and trade fears with China seemed to threaten economic growth and corporate profits. Further, the downward momentum of the markets also appears to have been magnified by quantitative, algorithmic trading systems amidst shallow liquidity.

In the small cap markets, some corrections were extreme, with Energy dropping over 40% for the quarter. Growth lagged value in small caps for the quarter but outperformed for the year. The fears seemed most pronounced in economic-sensitive areas such as Materials, Industrials, and cyclical consumer stocks, where lower price earnings multiples provided little safety. Stocks suffered among the higher valued Information Technology and Health Care sectors, but many of the companies with clear growth prospects outperformed on a relative basis.

Portfolio Review

The strategy participated in the market decline during the quarter but outperformed the benchmark. The losses touched every sector, with Health Care the largest detractor, followed by Industrials, Information Technology and Consumer Discretionary all weighing on the index. The portfolio outperformance was primarily driven by our continued underweight to the highly volatile biotechnology and pharmaceutical industries, which experienced a significant correction during the period. Overall positive performance within Health Care was tempered by unfavorable stock selection in health care devices and technology. Despite favorable stock selection within Industrials and Information Technology, particularly software, the overweight to the software industry was an overall negative contribution to performance.

Information Technology continues to carry the largest weighting in the portfolio. During the period, we added to positions as quality companies with strong end markets and good visibility came for sale. Further, two software stocks had nice returns during the quarter due to acquisition. While we plan to ultimately redeploy the proceeds of these acquisitions, their steady price during the market downdraft helped performance. Also, gains from positions in Health Care were redeployed into the Industrials sector, specifically commercial services. No other significant changes impacted sector weights for Consumer Discretionary, Financials or Energy. The portfolio remains underweight Health Care, primarily due to limited exposure to biotechnology, though we seek to add positions within the sector as opportunities present themselves.

Outlook

Until clarity on trade negotiations, central bank polices, and the trajectory of company earnings develops, we expect volatility to remain elevated. The market appears to be pricing in a severe slowdown in economic growth and possibly zero earnings growth for 2019. We believe the stocks within the portfolio can collectively deliver double digit earnings expansion, even in a slower growth scenario, and have the potential to outperform. As further dislocations occur, we expect to initiate new or bolster positions within software, semiconductors, medical equipment and select consumer and industrial niches. We remain committed to our emphasis of selecting companies with strong sales and earnings predictability and believe holding innovative firms serving large markets should continue to deliver promising returns over the market cycle.

The opinions expressed are those of the portfolio manager(s) and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through December 31, 2018 and are subject to change due to market conditions or other factors. Any mention of investment performance refers to gross-of-fees performance, unless otherwise noted.
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Investment Team

Timothy J. Miller, CFA

Senior Vice President, Portfolio Manager

Mr. Miller is co-portfolio manager of the firm’s Small Cap Growth investment strategy. He has been affiliated with the strategy since 2010 as portfolio manager of Ivy Small Cap Growth Fund. He was appointed to the leadership role of the small cap growth team and assumed co-portfolio manager responsibilities for the Small Cap Growth strategy in 2016. He joined the firm in 2008 as vice president and portfolio manager of Ivy and Ivy VIP Small Cap Core Funds.

Prior to joining the organization, Mr. Miller managed his personal funds in a hedged equity style from 2004 to 2007. From 1992 through mid-2004, he was affiliated with INVESCO Funds Group, including serving four years as its chief investment officer, five years as head of the growth funds group, and from 1993-2004 as lead manager of the INVESCO Dynamics Fund.

Mr. Miller earned an MBA from the University of Missouri/St. Louis and a BSBA in Finance from St. Louis University.

Kenneth G. McQuade

Senior Vice President, Portfolio Manager

Mr. McQuade is co-portfolio manager of the firm’s Small Cap Growth investment strategy. He has been affiliated with the strategy since 2006 as portfolio manager of Ivy VIP Small Cap Growth. He was named co-portfolio manager of the strategy in 2016. Mr. McQuade joined the organization in 1997 as an equity investment analyst. He was named assistant portfolio manager of small cap growth institutional accounts in 2003.

Mr. McQuade earned a BS in Finance from Bradley University.

Bradley P. Halverson, CFA

Senior Vice President, Portfolio Manager

Mr. Halverson is co-portfolio manager of the firm’s Small Cap Growth investment strategy. He has been affiliated with the strategy since 2014 as assistant portfolio manager. He was named co-portfolio manager of the strategy in 2016. Mr. Halverson joined the organization in 2008 as an equity investment analyst, providing research analysis on small capitalization securities and industries in the industrials sector.

Mr. Halverson was previously associated with Northpointe Capital as an equity analyst responsible for researching growth stocks across micro, small, and mid cap portfolios.

Mr. Halverson earned an MBA with an emphasis in Finance and Corporate Strategy from the University of Michigan and a BS and MS in Accounting from Brigham Young University.

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