361 U.S. Small Cap Equity Fund
After a volatile start to the year, small cap equities rallied in May. The Russell 2000 Index finished with a return of 6.07% for the month (by contrast, larger-cap stocks underperformed, with the S&P 500 Index generating 2.41%). The 361 U.S. Small Cap Equity Fund succeeded in outpacing the benchmark, returning 6.75% in May.
Return drivers for the Fund were varied. Primary to the strategy is our quantitative process surrounding analyst revisions. For the month, that process was able to populate the portfolio with 438 companies that received earnings estimate increases from the sell-side analyst community. That compares favorably to a similarly sized, randomly generated portfolio, which would have experienced 123 such events. The question on the heels of that is did the market reward this behavior? For May, the market rewarded companies that received earnings estimate increases. In fact, relative to prior months, the gap between positive and negative reward to earnings changes widened the most we have measured in recent past. As such, this was a net contributor to performance.
One of the most meaningful contributors was our earnings quality model. The companies that had the most robust earnings, versus those with the worst, handedly outperformed by more than 200 basis points. Secondarily, a moderate exposure to momentum provided an additional tailwind. While we do not exploit momentum as part of the investment process within the 361 U.S. Small Cap Equity Fund, it is a byproduct of the very nature of the philosophy and can be beneficial to the portfolio, as was the case in May.
In a reversal to what has been a persistent and difficult trend, companies with the largest earnings surprises outperformed those with the worst/negative surprises by 10.6%. The portfolio tends to have more exposure to companies that announce larger earnings surprises. For the month, 38 portfolio companies announced positive earnings surprises, compared to a randomly generated portfolio which experienced 22. That ability, coupled with the positive spread to earnings surprises, was beneficial for the month.
As the portfolio is sector neutral, we rely heavily on the stock selection process. Stock picking for the month was robust, with only three sectors detracting on a relative basis: Financials (-0.19%), Health Care (-0.09) and Utilities (-0.01%). The most significant standout was the Industrials sector (+0.47%), followed by Consumer Staples (+0.20%) and Energy (+.19%).