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Small-cap star Hatton: why we’ve underperformed in 2015

Small-cap star Hatton: why we’ve underperformed in 2015

Renowned US small-cap equity investor Gary Hatton has pinned his year-to-date underperformance on markets bidding up undeserving stocks amid the hunt for yield.

The Citywire A-rated manager made the comments in a candid second quarter commentary for his Granahan Small Cap Discoveries fund and its Ucits-mirror, the Vanguard US Discoveries fund.

Hatton said he trailed the Russell 2000 Growth index by around three percentage points at the end of June. It returned 5.3% in US dollar terms against a benchmark rise of 8.7%.

The small-cap veteran, who was showcased as a Citywire Global Star Manager at the start of the year for his long-term track record, said he would not be drawn into chasing market momentum.

‘The benchmark’s strong performance came from stocks of many companies that were simply “no good for me”, as they do not represent well-managed businesses that we seek to own in the Discoveries portfolio,’ he said.

‘Many of these companies look like “stock market angels” to investors; however, given the underlying businesses, it’s a “perfect disguise”,’ he added.

Hatton said, according to market research, loss-making companies were up twice as much as those with profits in the first half of 2015. However, he refused to be drawn into these particular areas.

‘The current low-interest rate environment provides a few good places to earn a healthy return in the market. With no alternatives, many investors are bidding up stocks that do not make sense to this investor,’ he said.

Biotech boom

This mainly applies to biotech stocks, Hatton said, which, as a sector, has seen an influx of smaller and more speculative entrants to the market over the start of the year.

‘Over the last year, the biotech industry weighting in the Russell 2000 Growth has increased 33% and at 16.8%, it is at a historic high and represents the largest industry in the index,’ he said.

‘We have benefitted from the strong returns of our biotech holdings. At the same time, our LifeCycle [stock analysis] tool has signalled there is reason for caution in this area.’

‘Market sentiment can feed on itself, and this is when it is most important to stick to our proven investment process. Sentiment will not lead us to invest in companies “no good for me”.’

Healthcare is a major aspect of the Discoveries fund and accounts for over 40% of the sector exposure, which compares to a benchmark weight of around 27%. Elsewhere, Hatton remains largely underweight technology and consumer discretionary stocks.

The Vanguard US Discoveries fund returned 87.9% in US dollar terms over the three years to the end of June 2015. This compares to a rise of 73.28% by its Citywire-assigned benchmark, the Russell 2000 Growth TR, over the same period.

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