The U.S. small-cap market advanced sharply during the third quarter. The Russell 2000® Index gained 9.05% in the quarter, bringing its year-to-date return to 11.46%. The third-quarter performance surge pushed small-capitalization stocks ahead of large caps year to date, as measured by returns through September for the Russell 1000® Index (+7.92%) and S&P 500® Index (+7.84%). Riskier asset classes led the market’s advance with technology (+17.97%) and health care (+13.59%), driven by biotechnology shares, pacing gains. Perceived defensive areas, including utilities (-4.84%) and consumer staples (-1.87%), lagged.
The Fund produced positive returns in the quarter, though it underperformed the Russell 2000 Index. For the quarter, the portfolio benefited from strong stock selection in the consumer discretionary sector and from an underweight in utilities, while negative stock selection in producer durables and financial services detracted from performance.
Positions that made the biggest positive contributions to performance were Shutterstock and Autohome.
Shutterstock’s recent business results have remained healthy and indicate no erosion in competitive positioning from Adobe’s recent entrance into the market.
Autohome’s new management team is reviewing their approach to the transactions-based segment, which could improve the company’s profitability.
Holdings that contributed the least to performance were Computer Programs & Systems and Exponent.
Computer Programs & Systems’ rural hospital customers are spending less on software systems after having invested considerable sums over the past few years in response to the federal government’s stimulus program.
Exponent’s reactive-work segment slowed, and weakness in energy end-markets hurt current business results.
PURCHASES AND SALES
Trading activity was modest during the quarter, with the Fund adding two new holdings, Polaris and WABCO.
Polaris is a leading manufacturer of recreational and utility vehicles including all-terrain vehicles and snowmobiles. The company has developed a leading brand and an extensive dealer network that represents powerful competitive barriers and could lead to high profitability.
WABCO designs and manufactures braking systems for commercial trucks. The products have a high technical component, are critically important to the safety performance of the vehicle, and enjoy long life cycles. WABCO enjoys high market share and exceptional profitability.
As we enter the final quarter of the year, we continue to face the uncertain outcome of the presidential election and the prospect that the Fed will raise interest rates slightly in December. This will create some short-term uncertainty and headwinds for the market, but we recommend staying the course for the long term. Investors have had plenty of time to process the election and the Fed’s outlook for the rate increase, so we do not believe either will have a meaningful impact on equity prices over the long term.
Our outlook continues to be that the U.S. will grow over the next year at 1.5% to 2.5% in GDP, and that corporate earnings growth will drive equity returns of approximately 6% to 8% over the next 12 months.