William S. Barker

Portfolio Manager

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MFAM Small-Mid Cap Growth Fund Results: Fourth Quarter 2018

January 15, 2019

Morningstar Rating:

Overall rating applies to investor class shares only. Based on risk-adjusted returns, as of 12/31/2018, out of 540 Mid-Cap Growth Funds.

Performance: 

 

Q4 2018

Year to Date

Since Inception (Annualized)

Inception Date: 11/1/2010

Motley Fool Small-Mid Cap Growth Fund (TMFGX)

-20.01%

-11.34%

10.91%

Russell 2500 Growth Index*

-20.08%

-7.47%

11.51%

 

For a standardized list of performance for the Small-Mid Cap Growth Fund, please click here. For fund holdings, please click here.

Commentary:

The MFAM Small-Mid Cap Growth Fund slightly outperformed its benchmark Russell 2500 Growth Index for the fourth quarter of 2018 but underperformed it for the year as a whole, losing -20.01% for the quarter and -11.34% for the year, versus losses of -20.08% for the quarter and -7.47% for the benchmark for the year for the Russell 2500 Growth Index. This was the weakest performance for the fund on an absolute and relative-to-benchmark level during its eight-and-a-half-year history, and by a substantial margin.

The weakness in the stock market in the fourth quarter of 2018 was even greater for small- and mid-cap stocks than for the larger-cap stocks in the S&P 500, and significantly greater for growth stocks than for value stocks. The fund invests in the parts of the market that were hit hardest by selloffs in the fourth quarter, but the underperformance for the quarter and the year doesn’t come down entirely to market cap and growth or value movements. Rather, we portfolio managers had individual positions that were the cause of much of the problem in 2018.

In looking at a few of the largest contributors to our returns for the year, it’s necessary to examine the years that preceded them as well, to narrate how long-term investments look overly bad, or good, when viewed in single-year increments.

This chart shows three large positions in the fund, along with how the stocks of each have performed over the past three calendar years, when the fund first purchased them, when we made the most recent purchase, and total revenue growth over the past three years.

Company

2018

2017

2016

First Purchase

Most Recent Purchase

3-Year Revenue Growth

Thor

-64%

52%

80%

11/1/2010

12/3/2015

28%

IPG Photonics

-47%

117%

10%

11/3/2014

10/23/2015

22%

XPO Logistics

-38%

112%

58%

11/27/2012

3/3/2017

87%

 

Rapid stock-price growth in 2016 and 2017 caused each of these positions to grow very large in the portfolio, and the fund was certainly a beneficiary of having maintained a buy-and-hold discipline on each of these names throughout that time. For the most part, we made the investments almost entirely before, and in some cases years before, their extraordinary performance began. However, if the beginning of 2019 is any indication, it appears we held on to each of these names too long, at the expense of the fund’s shareholders, particularly any investors who weren’t part of the fund until after 2017.

Each of these stocks has grown revenue and profits comfortably more than the stock market or the economy as a whole, and one might believe they should have performed somewhere in the neighborhood of their revenue growth over the investment time period. But that’s been nowhere near the case. 2016 and 2017 rewarded the stocks greatly, not only for the top- and bottom-line growth they had achieved, but also for the continued growth and profits that appeared on the horizon at the time.

2018 saw significant business growth for each of these companies, but as the year wound down, cyclical aspects of the business influenced the stock price, especially during the fourth quarter, and expectations of continuing growth for the companies gave way to fears of a cyclical downturn.

Not all of those fears are unfounded. Although total sales for the RV industry will still be within a hair’s breadth of an all-time record, RV-maker Thor absolutely saw a slowdown in RV shipments in the second half of the year, and its profits took a hit from aluminum and steel tariffs. IPG Photonics saw a slowdown in Chinese sales linger throughout the year, and XPO didn’t complete the type of acquisition that has fueled its previous rapid growth trajectory — although XPO did show nice bottom-line growth for the year.

This recounting isn’t meant to find excuses for the performance of the fund, but rather to try to frame expectations. The market revolted against stocks that had flown too high as 2017 ended, and one might say it exacted revenge on such stocks in 2018, particularly regarding companies for which an economic slowdown would deliver the most pain in the short term. But the stock movements, both on the way up and through the end of 2018 on the way down, vastly overstated the accomplishments of the businesses at first, and it appears to have overshot on the way down.

Our track record for long-term investment illustrates how we weren’t in these stocks simply to catch the momentum of a rising stock price, nor are we overly concerned about today’s lower prices for companies that continue to execute on their long-term business plans. Look for them to remain in our portfolio for the long term.

For the quarter, our bottom performers were XPO Logistics, Align Technology, and GrubHub, each of which fell more than 40%. Positive performers were few and far between, although consumer-staples marketer Church & Dwight (up 11% for the quarter, 32% for 2018) and leading spice producer McCormick & Co. (up 6% for the quarter, 40% for the year) bucked the downward trend of most stocks. Safe havens such as consumer-staples companies on the whole did well – most not as well as these two — but expect 2019 to be less kind to slow-growth companies such as these, as investors shed some of their fear of growth stocks.

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The performance data quoted represents past performance and does not guarantee future results. Current performance may be lower or higher. The investment return and principal of an investment will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. See additional performance information at this link: Small-Mid Cap Growth Fund.

Investments in securities of small-cap companies involve greater risks than do investments in larger, more established companies, because they may lack the management experience, financial resources, product diversification, and competitive strength of larger companies.

Any discussion of individual companies on this page is not intended as a recommendation to buy, hold or sell securities issued by those companies. Holdings may change at any time and are subject to risk. Current and future portfolio holdings are subject to risk.

Note: The Morningstar RatingTM for funds, or ‘star rating’, is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. As of 12/31/2018, the Motley Fool Small-Mid Cap Growth Fund (Investor shares) was rated in the Mid-Cap Growth Funds category, receiving a three-star rating among 540 funds over a three-year period and a three-star rating among 487 funds over a five-year period.

Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10- year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods. Past performance is no guarantee of future results.