Changing expectations of Federal Reserve policy and economic growth had a significant influence on small-cap stocks in the third quarter, as the Russell 2000® Index hit new peaks. Late in the quarter, following the Feds decision not to taper quantitative easing, expectations for a continuing low-rate environment propelled lower-quality stocks higher. Small-cap stocks outperformed larger-cap stocks in this rally, mostly due to the growth half of the universe.
The Small Cap Core Fund posted a total return of 10.25% for the quarter, compared with 10.21% for the Funds benchmark, the Russell 2000® Index. Stock selection, rather than sector or style selection, drove Fund performance, particularly in the consumer discretionary and industrial sectors. Stock selection was weakest in the strongly performing technology sector, particularly among internet software companies. Many of these companies had historically weak earnings but surprised positively in the quarter. More successfully, the Funds diverse biotechnology holdings helped capture some of the strong performance this industry experienced. In addition, the Funds long-term exposure to micro-caps aided results, offsetting the underperformance stemming from our avoidance of lower-quality stocks, which we exclude from purchase based on our proprietary quality model score. In a continuing trend, stocks with lower earnings, cash flow and margins outperformed. Stocks with higher valuations also outperformed, as the market favored growth.
Going forward, we will continue to invest in a diverse portfolio of small-cap stocks, including those within the smallest segments of the market, in a cost-efficient manner. At the same time, we will seek to avoid stocks with lower-quality characteristics, as indicated by our proprietary quality model.
If you're a more aggressive investor looking for the growth potential offered by the stocks of smaller companies this Fund may be right for you. The Fund employs a quantitative-managed, core style investment approach. It is intended for equity investors with an above-average tolerance for volatility who want to diversify their investments and plan to invest for the long term without concern for current income.
- Follow an active quantitative, core equity strategy to select stocks based on a statistical analysis of historical relationships among small-cap characteristics, stock prices and market capitalization ranges.
- Use a screening process designed to reduce exposure to stocks with negative fundamental indicators.
- Maintain a highly diversified portfolio consistent with small-cap core benchmarks, in an effort to reduce the risks associated with any specific stock or industry.