A strong quarter of performance as market rebound continues

Putnam Investments, 10/20/20


Q3 2020 Putnam Small Cap Growth Fund Q&A

  • The fund outperformed the benchmark for the quarter as well as for the 1-, 3-, 5-, and 10-year periods and the life-of-fund period ended September 30, 2020.
  • We always search for unique growth opportunities across the market landscape, but we are often led to the technology and health-care sectors.
  • As always, we are attracted to businesses in big addressable markets that have products or services that enable them to take market share from peers.

How did the fund perform in the third quarter?

The fund delivered a solid return for the quarter and outperformed its benchmark, the Russell 2000 Growth Index. The fund also outperformed the benchmark for the 1-, 3-, 5-, and 10-year periods and the life-of-fund period ended September 30, 2020.

The fund’s outperformance was driven by positive stock selection in the majority of sectors in the market. The top-contributing sector was health care, followed by communication services and financials. Our stock selection in industrials was a drag on performance for the quarter. Within health care, biotechnology holdings added most to performance, and our underweight position was also beneficial as biotech underperformed the broader market.

How were market conditions in the quarter?

The equity market continued with its remarkable rebound from the pandemic-induced market collapse in March. Equities advanced in July and August, but posted declines in September. Large-cap stocks declined most in September as mega-cap technology stocks pulled back after demonstrating amazing resilience and leadership throughout the year. For the quarter overall, small-cap stocks underperformed their large-cap counterparts.

The September market downturn appeared to be tied to rising numbers of Covid-19 cases in the United States and Europe, which had investors anxious about a potential “second wave” surge of the virus. Additionally, investors were distracted by a contentious presidential election season and sometimes hour-by-hour changes in headlines around a stimulus package from Congress.

What areas of the market look promising to you right now?

We always search for unique growth opportunities across the market landscape, but we are often led to the technology and health-care sectors. They both continue to see a quick pace of change and disruption, which of-ten leads to great investing opportunities in our view. Moreover, the benefits of technology implementation and the ability to analyze massive amounts of data tend to permeate other less obvious sectors. For example, many of our holdings in the consumer and even real estate industries are benefiting from shifts in consumer behavior due to advances in technology.

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.

What is your outlook going into the final quarter of the year?

The remainder of 2020 will likely be volatile for U.S. equity markets. We are dealing with the typical risks associated with an election cycle, compounded by the additional risk of further spreading of COVID-19. This, of course, could be offset by a rapid advance in the development of a vaccine or therapeutics. On the positive side, as we move through the final quarter of 2020, many of these risk factors could abate, and we could conclude the year with a bit more certainty — which is something the financial markets always crave.