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Hartford Schroders US Small Cap Opportunities Fund

August 2018 Monthly Update

Performance (%)
% (as of 9/30/2018)
Average Annual Total Returns % (as of 9/30/2018)
YTD 1YR 3YR 5YR 10YR SI
Hartford Schroders US Small Cap Opportunities  I 7.49 11.68 14.87 10.95 10.85 12.68
Benchmark 11.51 15.24 17.12 11.07 11.11 ---
Morningstar Small Growth Category 18.75 24.33 18.18 11.66 11.98 ---
Performance (%)
% (as of 9/30/2018)
Average Annual Total Returns % (as of 9/30/2018)
YTD 1YR 3YR 5YR 10YR SI
Hartford Schroders US Small Cap Opportunities  I 7.49 11.68 14.87 10.95 10.85 12.68
Benchmark 11.51 15.24 17.12 11.07 11.11 ---
Morningstar Small Growth Category 18.75 24.33 18.18 11.66 11.98 ---
SI = Since Inception. Fund Inception: 08/06/1993
Operating Expenses:   Net 1.14% |  Gross  1.14%

Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted.

 

Market Review

August brought the US both scorching temperatures and stock market. Things heated up as the US stock market surged to end the month. Investors continued to shrug off political headlines and instead focused on the strong US fundamental narrative. The underlying US economy remains strong and more favorable trade headlines that included a deal with Mexico aided investor returns this month. Corporate earnings season was better than expected, and expectations for a record amount of buybacks are high. August commentary from the Federal Reserve (Fed) was also as expected and supports the market thesis of another rate hike in September. Another sign of economic strength: The early Q3 gross domestic product (GDP) estimates from the Atlanta Fed anticipate another 4%+ expansion.

Growth was back with a vengeance in August as the highest growth, lowest quality, and smallest capitalization names were the best performers. According to Bank of America Merrill Lynch, at its current pace growth is slated to outperform value by the widest spread since the tech bubble (1999). Biotechnology rallied again, as did lower return-on-equity and non-earners (not surprising given the number of small cap biotechnology stocks that fall into those two categories).

It was a strong earnings season across the capitalization spectrum with small-, mid-, and large caps in aggregate all reporting over 23% earnings growth. US small caps saw the best earnings growth since 2010 after posting earnings growth of 26.8% and sales growth of 9.8% (source: Jefferies). It was also the first time that small caps beat large caps in the past two years driven by strong growth in healthcare and consumer staples. Estimates for 2019 are also solid for small caps (not as good as 2018, but still growing at a significant rate). 

 

Performance Review

The Fund (Class I Shares) returned 3.55% in August, underperforming its benchmark, the Russell 2000 Index, which returned 4.31%. Underperformance in such a strong month that was driven by the highest growth, lowest quality, and non-earners is not untypical of the strategy, based on historical precedence. Stock selection detracted in consumer staples and healthcare. Within consumer staples, underperformance was isolated in the foods industry. Both allocation and stock selection equally hurt the Fund in healthcare. Holdings in the medical and dental supply industry as well as underweights in biotechnology, healthcare services, and medical equipment weighed on returns. The Fund’s allocation to cash was also a drag on returns.

Stock selection contributed to returns in financial services, materials & processing, as well as technology. An underweight to energy was also added to returns.

In terms of the Fund’s alpha sources, the “Mispriced Growth” group was the only portion of the portfolio to outperform in August, led by holdings Ciena Corporation and K2M Group Holdings, Inc.  Although posting postitive returns, “Steady Eddies” and “Turnarounds” both lagged this month.

Key contributors included Ciena Corporation, K2M Group Holdings, Inc., and Bio-Techne. Provider of network and communication infrastructure, Ciena Corporation outperformed after reporting strong earnings. The company beat expectations for sales, margins, and earnings, and management also raised guidance. K2M Group Holdings, Inc., a global leader of complex spine and minimally invasive solutions, soared as it was announced that they were to be acquired by Stryker Corporation (a competitor) at a significant premium. Bio-Techne Corporation, which manufactures specialized proteins and instruments for the analysis of proteins to the biotechnology research community, rose after reporting strong earnings. The company reported solid top line growth, expanded margins, and the company continues to engage in accretive acquisitions.

Key detractors included SRC Energy, Invacare Corporation, and Hexcel Corporation. SRC Energy Inc, a developer and producer of oil and gas, declined after concerns that potential new regulation in Colorado could limit the number of wells that can be deployed in the region. Invacare Corporation, manufacturer and distributer of medical equipment, underperformed after reporting disappointing earnings. The report reduced investor confidence that the company would realize an inflection in earnings and margins as previously projected by management. Hexcel Corporation, developer of advanced composite materials for industrial markets, sold off after a negative sell-side report was released noting concerns around slowing growth and a high valuation. We continue to maintain conviction in the stock.  

 

 

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Quarterly Fund Outlook & Commentary
Head of US Equities Management at Schroders Fred Schaefer

The Fund seeks capital appreciation by combining three diversified, uncorrelated sources of potential alpha1:

Mispriced Growth
Companies that can offer an unrecognized or underappreciated growth dynamic over the ensuing 2-3 years

Steady Eddies
Companies with stable growth characteristics, slower but more predictable revenues and earnings patterns

Turnarounds
Companies whose growth engine appears to have broken, but there appears to be evidence that growth is returning

1 Alpha is a measure of the performance of a portfolio after adjusting for risk. Alpha is calculated by comparing the volatility of the portfolio and comparing it to some benchmark. The alpha is the excess return of the portfolio over the benchmark.

 

Important Risks: Investing involves risk, including the possible loss of principal. There is no guarantee a fund will achieve its stated objective. Security prices fluctuate in value depending on general market and economic conditions and the prospects of individual companies. ● Small-cap securities can have greater risks and volatility than large-cap securities ● The main risk of real estate related securities is that the value of the underlying real estate may decrease in value. 

The views expressed herein are those of Schroder Investment Management North America Inc. (Schroders) are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. They may not reflect the views of Hartford Funds or any other sub-adviser to our funds and should not be construed as research or investment advice or as an offer or solicitation to buy or sell any security.

 

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