The Growth Factor
Needham Funds' Commentary by John Barr & Jim Giangrasso
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Volume 19 - June 11, 2015
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John Barr
Portfolio Manager
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Chris Retzler
Portfolio Manager
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" Patient Capital Outperformance: High Active Share Managers Who Trade Infrequently" & The Needham Funds
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In "Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently1," Professors Martijn Cremers of the University of Notre Dame and Ankur Pareek of Rutgers Business School concluded that high Active Share combined with infrequent trading resulted in average annual outperformance of 2.3% over the 19-year period starting in 1995. Cremers and Pareek also wrote, "We find no evidence that even the most active (i.e., high Active Share) mutual funds with short durations or frequent trading were able to outperform their benchmarks on average."
The Needham Funds' mission is to create wealth for long-term investors. In our attempt to accomplish this mission, the Funds combine high Active Share with low turnover and, as shown in the table below, each Fund has outperformed the S&P 500 Total Return Index and Russell 2000 Total Return Index since its inception.
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Needham Funds: Outperformance since Inception
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Performance since Inception:
Needham Funds vs. Benchmarks as of May 31, 2015
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1 Year
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5 Year
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10 Year
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Since Inception
1/1/96
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Since Inception 9/4/01
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Since Inception
5/22/02
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Needham Growth Fund (NEEGX)
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15.6%
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14.1%
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9.8%
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14.0%
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Needham Aggressive
Growth Fund (NEAGX)
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16.2%
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14.4%
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11.4%
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10.0%
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Needham Small Cap
Growth Fund (NESGX)
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11.5%
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9.2%
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7.3%
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10.5%
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S&P 500 Total Return
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11.8%
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16.5%
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8.1%
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8.6%
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6.7%
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7.4%
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Russell 2000 Total Return
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11.3%
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15.0%
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8.7%
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8.8%
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8.8%
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8.8%
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(Source: Needham Funds)
investment returns and principal value will fluctuate, and when redeemed, shares may be worth more or less than their original cost. Shares held 60 days or less are subject to a short-term redemption fee of 2%. Past performance does not guarantee future results and current performance may be higher or lower than these results. Current month-end performance and a copy of the prospectus are available at www.needhamfunds.com.
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Active Share measures and aggregates the differences between the weights of individual portfolio holdings versus their weights in the benchmark index. More simply put, Active Share is the percentage of the portfolio that is different from the benchmark. Since short positions are by definition "active," the Needham Funds are able to achieve Active Share in excess of 100%.
The Cremers-Pareek study divided funds into quintiles based on high Active Share and fund turnover. The top quintile of Active Share was above 92%, while the bottom quintile was under 62%. The Needham Funds' portfolios have Active Share percentages of over 100% as compared to both the S&P 500 Total Return and Russell 2000 Total Return, their benchmarks.
Needham Funds Active Share as of May 31, 2015
Active Share
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Vs.
S&P 500
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Vs.
Russell 2000
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NEEGX
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101.9%
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105.4%
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NEAGX
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104.4%
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108.5%
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NESGX
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109.1%
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108.6%
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(Source: FactSet, Needham Funds)
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As a result of our high Active Share, the Needham Funds are not highly correlated with the markets as evidenced by each Fund's relatively low R2 and beta statistics. R2 is the percentage of variation in a manager's returns which are explained by or attributable to their benchmark's returns, while beta measures the sensitivity of the manager's returns to the movements in their benchmark. The following table shows the R2 and beta of the Needham Funds compared to their Morningstar Category averages. These calculations were made using the Russell 2000 trailing three year results.
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Needham Funds' Correlation to their Benchmarks as of May 31, 2015
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R2 vs.
Russell 2000 TR
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R2 vs. S&P 500 TR
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Beta vs. Russell 2000 TR
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Beta vs. S&P 500 TR
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NEEGX
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87.00
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53.38
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0.72
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0.89
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Morningstar Mid-Cap Growth Category Average
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65.85
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1.01
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R2 vs.
Russell 2000 TR
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R2 vs. S&P 500 TR
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Beta vs. Russell 2000 TR
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Beta vs. S&P 500 TR
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NEAGX
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76.97
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41.96
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0.83
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0.97
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Morningstar Small-Cap Growth Category Average
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51.83
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1.09
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R2 vs.
Morningstar Small Growth TR Index
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R2 vs. S&P 500 TR
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Beta vs. Morningstar Small Growth TR Index
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Beta vs. S&P 500 TR
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NESGX
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73.47
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39.24
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0.85
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0.93
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Morningstar Small-Cap Growth Category Average
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51.83
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1.09
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The mispricing of securities that long-term investors recognize may only become apparent over time. With low turnover, fund managers are able to hold onto their concentrated positions through market and company-specific volatility.
The Needham Funds combine concentrated portfolios with low turnover. To be in the lowest quintile of the Cremers-Pareek study, a fund needed turnover of 27% or less. As of December 31, 2014, the Needham Growth Fund had trailing 12-month turnover of 12% and The Needham Aggressive Growth Fund had turnover of 19%. The Needham Small Cap Growth Fund had 69% turnover, below the Morningstar average for small cap growth funds of 83%.
Needham Funds' 12 month Trailing Turnover as of December 31, 2014
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Turnover
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Cremers & Pareek Lowest Quintile
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27% and below
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NEEGX
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12%
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NEAGX
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19%
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NESGX
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69%
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Morningstar Small-Cap Growth Average
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83%
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Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently
gives a good sense of what it takes to create wealth over the long-term. Cremers and Pareek showed that high Active Share and low turnover funds outperform the market over the long-term.
The Needham Funds match this profile. However, funds with high Active Share may exhibit short-term volatility. Over time, our Funds have exhibited lower volatility and less correlation than our Morningstar peers and the Russell 2000. They have also outperformed the S&P 500 and the Russell 2000 since inception, however past performance does not guarantee future results and current performance may be higher or lower than these results.
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1Cremers, Martijn and Pareek, Ankur, Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently (September 19, 2014). Available at SSRN: http://ssrn.com/abstract=2498743 or http://dx.doi.org/10.2139/ssrn.2498743
The information presented in this commentary is not intended as personalized investment advice and does not constitute a recommendation to buy or sell a particular security or other investments.
This message is not an offer of the Needham Growth Fund, the Needham Aggressive Growth Fund or the Needham Small Cap Growth Fund. Shares are sold only through the currently effective prospectus. Please read the prospectus and consider the investment objectives, risks, and charges and expenses of the Fund carefully before you invest. The prospectus contains this and other information about the Fund.
Current month-end performance and a copy of the prospectus are available at www.needhamfunds.com or by contacting the Fund's transfer agent, U.S. Bancorp Fund Services, LLC at 1-800-625-7071.
The Needham Funds have substantial exposure to small and micro capitalized companies. Funds holding smaller capitalized companies are subject to greater price fluctuation than those of larger companies. Also, the Needham Funds are permitted to engage in short sales, options, futures, and leveraged trading strategies. The Funds' use of short sales, options, futures strategies and leverage may result in significant capital loss. Total return figures include reinvestment of all dividends and capital gains. Needham & Company, LLC, member FINRA/ SIPC, is the distributor of The Needham Funds, Inc.
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Copyright � 2015. All Rights Reserved.
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