Webcast | Opportunities in small-cap growth | June 25, 2020

Active Equities

Small Cap Growth Fund (Class Y)  (PSYGX)

Seeking to capitalize on growing small companies

Small Cap Growth Fund received an  Overall Morningstar Rating  of  

Q2 2020 | Small Cap Growth Q&A

  • The fund outperformed the benchmark for the quarter as well as for the 1-, 3-, 5-, and 10-year periods ended June 30, 2020.
  • Our investment approach was to focus the majority of the portfolio on companies with strong margins, solid returns, and cash-generating ability.
  • We are already finding that the pandemic has enhanced the growth potential of many small companies, and we are seeking to add them to our portfolio.

Market conditions were volatile in the second quarter. How did the fund perform?

The fund delivered a solid return for the quarter and outperformed its benchmark, the Russell 2000 Growth Index. I am pleased to report that the fund also outperformed its benchmark for the 1-, 3-, 5-, and 10-year periods ended June 30, 2020.

Relative to its small-cap growth benchmark, your portfolio has held up well through this year’s turbulence. What has helped performance?

As growth investors, we don’t seek to build an overly conservative portfolio, so the severe market drawdown in the first quarter was a challenge. However, the fund performed very well relative to our benchmark due in large part to a solid base of high-quality businesses in our portfolio. Our investment approach was to focus the majority of the portfolio on companies with strong margins, solid returns, and cash-generating ability. This proved beneficial as global economies came under severe pressure. Fortunately, as we reassessed our holdings, we did not find many companies with debt levels that were high enough to hamper their future growth prospects.

What was your response to the COVID-19 crisis in terms of positioning the fund?

As the virus evolved from an emerging threat to a global crisis, we implemented a three-step approach. Steps one and two were designed to seek downside protection for the portfolio, while the third step was aimed at finding growth opportunities. First, we focused analysis on the liquidity and debt levels of our holdings to determine which companies could weather this severe shock given it had an unknown duration. Next, we conducted deeper analysis to determine which companies might be structurally weaker in a year or two as a result of the pandemic. Step three in our process is finding companies that will be structurally stronger as a result of the pandemic.

How did you determine which companies may be structurally weaker?

It is worth noting that fewer companies declare bankruptcy than is commonly believed. However, future returns on capital and growth prospects can be diminished if liquidity and debt levels force a company to cut costs too deeply. Here, we focused on areas such as brand power and competitive market positioning, and we tried to forecast the future spending behavior of corporations and consumers.

For example, if an airline cannot fly its planes, which were acquired through loans, the business faces serious challenges. However, in many cases, the long-term impact is not as obvious. Will a regional casino operator, for example, be able to successfully conduct business with fewer patrons? If “yes,” then this could present a compelling opportunity. Many restaurants could be weakened as they are forced to permanently shut locations, but a select few with strong technology and delivery offerings may actually become stronger during this tough period.

You have observed that the pandemic has enhanced growth prospects for many small companies. Can you explain?

While the nature of every crisis is different, they do have one thing in common. Crises tend to accelerate the pace of change that was already occurring — often out of necessity. In our fundamental research, we always consider disruptive change, as it is often the force that enables small companies to compete against their larger peers. We are already finding that the Covid-19 pandemic has enhanced the growth potential of many small companies, and we are seeking to add them to our portfolio.

Among the beneficiaries are companies that specialize in remotely connecting patients and health-care professionals. We believe the adoption rate of telemedicine has advanced by several years as a result of the sudden COVID-19 lockdowns and the need for social distancing. Changes brought on by the pandemic should also benefit businesses with cloud-based software offerings. Examples include companies that provide online learning services and those that enable financial institutions to offer mobile banking services.

Could you provide some more detail on the types of companies you own?

We look for small companies that we believe can grow their earnings and cash flows at a rapid pace for many years. Ideally, we seek small-cap companies that can grow into large-cap businesses over time. We are not typically attracted to companies that have been small for a while and are likely to remain small. We are attracted to businesses in big addressable markets that have products or services that enable them to take market share from peers.

The small-cap asset class can be volatile, especially when targeting the fastest growing companies. For this reason, it is important to note that the largest portion of our portfolio consists of stable, well-established companies that we believe are mispriced by the market. We believe these companies, which typically comprise 60% to 80% of the portfolio, can grow at much higher rates and the market is not pricing in their full profitability potential.

Do you also invest in more aggressive growth stocks?

The remainder of the portfolio is invested in emerging growth and cyclical growth companies. We define emerging growth companies as those that offer disruptive products, services, or technology that will enable them to grow rapidly. They are typically early in their life cycles, and their quality metrics, such as return on capital or margins, may look weak today. However, if they grow at the rates we are projecting, they could mature into high-quality growth leaders. We put less emphasis on cyclical growth companies, but we will add these to the portfolio if we believe the companies are competitively positioned and offer durable growth prospects.

What is your outlook going into the second half of 2020?

While it is well-established that the COVID-19 pandemic is a global health crisis, we are just beginning to see the economic toll it is taking on businesses. For many small-cap companies, the near-term outlook remains highly uncertain. However, we are optimistic about prospects for the asset class over the longer term. We believe the negative shock of the pandemic will reveal the strengths and weaknesses of many business models. At the same time, it should also accelerate the pace of disruptive change that many small companies help to promote.

Highlights

Objective

The fund seeks capital appreciation.

Strategy and process

  • Small companies: Often overlooked by Wall Street analysts, the stocks of small companies can represent attractive opportunities.
  • A focus on growth: Small companies tend to be flexible and innovative, and can often expand their earnings at faster rates than larger companies.
  • A disciplined process: The portfolio manager uses a disciplined bottom-up fundamental investment process that focuses on quality and growth.

Fund price

Yesterday’s close 52-week high 52-week low
Net asset value $65.35
-0.24% | $-0.16
$66.77
10/12/20
$35.04
03/18/20
(Optional)

Fund facts as of 09/30/20

Total net assets
$613.05M
Turnover (fiscal year end)
56%
Dividend frequency
Annually
Number of holdings
90
Fiscal year-end
June
CUSIP / Fund code
746763499 / 1852
Inception date
11/03/03
Class Y  
Category
Growth
Open to new investors
Ticker
PSYGX

Management team

Portfolio Manager


Literature


Disruptive change: A growth driver for small companies
Disruptive change is often the force that enables small companies to compete against their larger peers.

Performance

  • Total return (%) as of 09/30/20

  • Annual performance as of 09/30/20

Annualized Total return (%) as of 09/30/20

Annualized performance 1 yr. 3 yrs. 5 yrs. 10 yrs.
Before sales charge 30.45% 20.10% 17.45% 15.11%
After sales charge N/A N/A N/A N/A
Russell 2000 Growth Index 15.71%8.18%11.42%12.34%

Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results. Share price, principal value, and return will vary, and you may have a gain or loss when you sell your shares. Performance assumes reinvestment of distributions and does not account for taxes. Returns before sales charge do not reflect the current maximum sales charges as indicated below. Had the sales charge been reflected, returns would be lower. Returns at public offering price (after sales charge) for class A and class M shares reflect the current maximum initial sales charges of 5.75% and 3.50% for equity funds and 4.00% and 3.25% for income funds (2.25% for class A of Putnam Floating Rate Income Fund, Short-Term Municipal Income, Short Duration Bond Fund, and Fixed Income Absolute Return Fund), respectively. Class B share returns reflect the applicable contingent deferred sales charge (CDSC), which is 5% in the first year, declining to 1% in the sixth year, and is eliminated thereafter (except for Putnam Floating Rate Income Fund, Putnam Short Duration Bond Fund, Putnam Fixed Income Absolute Return Fund, and Putnam Short-Term Municipal Income Fund, which is 1% in the first year, declining to 0.5% in the second year, and is eliminated thereafter). Class C shares reflect a 1% CDSC the first year that is eliminated thereafter. Performance for class B, C, M, N, R, and Y shares prior to their inception is derived from the historical performance of class A shares, adjusted for the applicable sales charge (or CDSC) and, except for class Y shares, the higher operating expenses for such shares (with the exception of Putnam Tax-Free High Yield Fund and Putnam Strategic Intermediate Municipal Fund, which are based on the historical performance of class B shares). Performance for class A, C, R6, and Y shares of Putnam Mortgage Opportunities Fund before their inception is derived from the historical performance of class I shares, which have been adjusted for the applicable sales charge (or CDSC) and the higher operating expenses for such shares. Returns at public offering price (after sales charge) for class N shares reflect the current maximum initial sales charge of 1.50%. Class R5/R6 shares, available to qualified employee-benefit plans only, are sold without an initial sales charge and have no CDSC. Class Y shares are generally only available for corporate and institutional clients and have no initial sales charge. Performance for class R5/R6 shares before their inception are derived from the historical performance of class Y shares, which have not been adjusted for the lower expenses; had they, returns would have been higher. Class A shares of Putnam money market funds have no initial sales charge. For a portion of the period, some funds had expenses limitations or had been sold on a limited basis with limited assets and expenses, without which returns would be lower.

Performance snapshot

  Before sales charge After sales charge
1 mt. as of 09/30/20 -0.31% -
YTD as of 10/20/20 28.49% -

Risk-adjusted performance as of 09/30/20

Alpha (3 yrs.) 12.36
Sharpe ratio (3 yrs.) 0.84
Treynor ratio (3 yrs.) 19.86
Information ratio (3 yrs.) 2.02

Volatility as of 09/30/20

Standard deviation (3 yrs.) 22.01%
Beta 0.93
R-squared 0.93

Capture ratio as of 09/30/20

Up-market (3 yrs.) 110.47
Down-market (3 yrs.) 73.44

Lipper rankings as of 09/30/20

Time period Rank/Funds in category Percentile ranking
1 yr. 158/648 25%
3 yrs. 92/602 16%
5 yrs. 86/523 17%
10 yrs. 60/391 16%
Lipper category: Small-Cap Growth Funds

Morningstar Ratings as of 09/30/20

Time period Funds in category Morningstar Rating
Overall 579
3 yrs. 579
5 yrs. 513
10 yrs. 384
Morningstar category: Small Growth

Distributions

Record/Ex dividend date 12/05/19
Payable date 12/09/19
Income --
Extra income --
Short-term cap. gain --
Long-term cap. gain $0.945

Lipper rankings are based on total return without sales charge relative to all share classes of funds with similar objectives as determined by Lipper. Past performance is not indicative of future results.

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. 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.

The up-market capture ratio is used to evaluate how well an investment manager performed relative to an index during periods when that index has risen. The ratio is calculated by dividing the manager’s returns by the returns of the index during the up-market, and multiplying that factor by 100. The down-market capture ratio is used to evaluate how well an investment manager performed relative to an index during periods when that index has dropped. The ratio is calculated by dividing the manager’s returns by the returns of the index during the down-market and multiplying that factor by 100.


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Holdings

Quidel Corp 2.56%
Palomar Holdings 2.46%
Cable One 2.39%
R1 Rcm 2.10%
Kinsale Capital Group 2.07%
Emergent Biosolutions 2.02%
Hamilton Lane 1.96%
Mercury Systems 1.94%
Novanta 1.88%
Medpace Holdings 1.88%
Top 10 holdings, percent of portfolio 21.26%



Portfolio composition as of 09/30/20

Common stock 98.83%
Cash and net other assets 1.17%

Equity statistics as of 09/30/20

Median market cap $3.73B
Weighted average market cap $5.25B
Price to book 6.99
Price to earnings 45.95

Fund characteristics will vary over time.

Due to rounding, percentages may not equal 100%.

Consider these risks before investing: Investments in small and/or midsize companies increase the risk of greater price fluctuations. Growth stocks may be more susceptible to earnings disappointments, and the market may not favor growth-style investing. The value of investments in the fund's portfolio may fall or fail to rise over extended periods of time for a variety of reasons, including general economic, political or financial market conditions, investor sentiment and market perceptions, government actions, geopolitical events or changes, and factors related to a specific issuer, geography, industry or sector. These and other factors may lead to increased volatility and reduced liquidity in the fund's portfolio holdings. These risks are generally greater for small and midsize companies. From time to time, the fund may invest a significant portion of its assets in companies in one or more related industries or sectors, which would make the fund more vulnerable to adverse developments affecting those industries or sectors. Our investment techniques, analyses, and judgments may not produce the outcome we intend. The investments we select for the fund may not perform as well as other securities that we do not select for the fund. We, or the fund's other service providers, may experience disruptions or operating errors that could have a negative effect on the fund. You can lose money by investing in the fund.

Top industry sectors as of 09/30/20

Health care 35.64%
Information technology 18.98%
Industrials 14.62%
Consumer discretionary 13.61%
Financials 6.96%
Communication services 3.44%
Real estate 2.67%
Consumer staples 1.62%
Cash and net other assets 1.17%
 
Other
1.29%
Materials 0.88%
Unclassified 0.41%

The unclassified sector (where applicable) includes exchange traded funds and other securities not able to be classified by sector.

Sectors will vary over time.


Expenses

Expense ratio

Class A Class B Class C Class R Class R6 Class Y
Total expense ratio 1.20% 1.95% 1.95% 1.45% 0.79% 0.95%
What you pay 1.20% 1.95% 1.95% 1.45% 0.79% 0.95%

Sales charge

 Breakpoint Class A Class B Class C Class R Class R6 Class Y
$0-$49,999 5.75% / 5.00% 0.00% / 4.00% 0.00% / 1.00% -- -- --
$50,000-$99,999 4.50% / 3.75% 0.00% / 4.00% 0.00% / 1.00% -- -- --
$100,000-$249,999 3.50% / 2.75% -- 0.00% / 1.00% -- -- --
$250,000-$499,999 2.50% / 2.00% -- 0.00% / 1.00% -- -- --
$500,000-$999,999 2.00% / 1.75% -- 0.00% / 1.00% -- -- --
$1M-$4M 0.00% / 1.00% -- -- -- -- --
$4M-$50M 0.00% / 0.50% -- -- -- -- --
$50M+ 0.00% / 0.25% -- -- -- -- --

CDSC

  Class A (sales for $1,000,000+) Class B Class C Class R Class R6 Class Y
0 to 9 mts. 1.00% 5.00% 1.00% -- -- --
9 to 12 mts. 1.00% 5.00% 1.00% -- -- --
2 yrs. 0.00% 4.00% 0.00% -- -- --
3 yrs. 0.00% 3.00% 0.00% -- -- --
4 yrs. 0.00% 3.00% 0.00% -- -- --
5 yrs. 0.00% 2.00% 0.00% -- -- --
6 yrs. 0.00% 1.00% 0.00% -- -- --
7+ yrs. 0.00% 0.00% 0.00% -- -- --

Trail commissions

  Class A Class B Class C Class R Class R6 Class Y
  0.25% 0.25% 1.00% 0.50% 0.00% 0.00%
  NA NA NA NA NA NA
  NA NA NA NA NA NA

For sales and trail commission information on purchases over $1 million and participant-directed qualified retirement plans, see a Putnam fund prospectus and the statement of additional information.

The Russell 2000 Growth Index is an unmanaged index of those companies in the small-cap Russell 2000 Index chosen for their growth orientation. You cannot invest directly in an index.

Consider these risks before investing: Investments in small and/or midsize companies increase the risk of greater price fluctuations. Growth stocks may be more susceptible to earnings disappointments, and the market may not favor growth-style investing. The value of investments in the fund's portfolio may fall or fail to rise over extended periods of time for a variety of reasons, including general economic, political or financial market conditions, investor sentiment and market perceptions, government actions, geopolitical events or changes, and factors related to a specific issuer, geography, industry or sector. These and other factors may lead to increased volatility and reduced liquidity in the fund's portfolio holdings. These risks are generally greater for small and midsize companies. From time to time, the fund may invest a significant portion of its assets in companies in one or more related industries or sectors, which would make the fund more vulnerable to adverse developments affecting those industries or sectors. Our investment techniques, analyses, and judgments may not produce the outcome we intend. The investments we select for the fund may not perform as well as other securities that we do not select for the fund. We, or the fund's other service providers, may experience disruptions or operating errors that could have a negative effect on the fund. You can lose money by investing in the fund.