U.S. Equity Funds: Third-Quarter Wrap-Up

Although U.S. stock indexes rose to all-time highs in early September, they quickly sold off on concerns about the Delta variant, a potential federal debt default, and a big housing sector crisis in China. Overall, the Morningstar U.S. Market Index eked out a 0.3% gain in the third quarter, lagging its international counterpart, the Morningstar Global Markets ex U.S. Index, which gained 0.94% over the same period.

Technology led the way, with the Morningstar U.S. Technology Index gaining 2.0%. Energy’s big rebound earlier this year lost some stream in the third quarter as the pandemic’s resurgence muddied the outlook for near-term demand. The Morningstar U.S. Energy Index declined 1.1%, but remains the clear winner so far this year, up 45%. Other sectors posted small single-digit gains or losses, except the Morningstar U.S. Basic Materials and Morningstar U.S. Industrials indexes, which were the worst performers with 3.8% and 4.0% declines, respectively.

After enjoying a strong resurgence versus growth stocks in the first quarter, value stocks underperformed in the second and third. The Morningstar U.S. Value Index posted a 1.5% loss in the third quarter, while the Morningstar U.S. Growth Index gained 1.1%, enough to overtake value in year-to-date performance. Growth led across the market-cap spectrum and among non-U.S. stock funds.

Winners

Conestoga Small Cap CCASX

The managers at Conestoga Small Cap target firms that can steadily grow earnings or generate strong returns on equity over several years, and they have considerable flexibility in constructing the portfolio. The fund earns a Morningstar Analyst Rating of Silver and has one of the largest allocations to tech stocks in the small-growth Morningstar Category. At 35% of assets, it's 10 percentage points more than its average category peer and the Russell 2000 Growth Index. The sector’s strong performance powered the fund to a 4.0% gain last quarter, beating all but a few peers. Several top software holdings were big contributors: Paylocity Holding PCTY and SPS Commerce SPSC gained 47% and 62%, respectively, while The Descartes Systems Group DSGX gained 18%.

Polen Growth POLRX

Stylistic tailwinds helped Polen Growth gain 2.5% last quarter and beat most large-growth category peers. The managers on this Silver-rated fund seek businesses with defensible franchises, high revenue growth, and enduring returns. A willingness to pay up for these characteristics has given the portfolio a consistent growth tilt versus peers. That was a headwind in 2021’s first quarter when growth was out of favor and the fund languished in the middle of the pack, but it helped last quarter. All told, the fund has delivered excellent long-term results.

Losers

Longleaf Partners LLPFX

Energy was the main culprit behind a 5.7% loss for Longleaf Partners last quarter. At 11.3% of assets, the Neutral-rated deep-value fund has among the largest stakes in energy stocks in the large-value category and about twice that of the Russell 1000 Value Index. CNX Resources CNX fell nearly 7.6% and was a top detractor as the portfolio’s concentration (it holds just 16 stocks) did little to mitigate the decline. Weak performance among holdings in other areas also hurt, particularly in industrials and materials, where FedEx FDX, CK Hutchison CKHUY, and Holcim HOLN posted double-digit losses.

Neuberger Berman Intrinsic Value NINCX

Neuberger Berman Intrinsic Value’s 4.6% decline last quarter was among the largest in the small-blend category. This Silver and Bronze-rated fund (depending on share class) uses a benchmark-agnostic approach that searches for small-cap companies trading at temporarily depressed prices. The managers' willingness to stick with out-of-favor picks means the fund often looks out of sync with its benchmark and peers. Many tech holdings, such as Quantum QMCO, Itron ITRI, Conduent CNDT, and Xperi Holdings XPER, had double-digit declines. The portfolio’s value tilt didn’t help either, but the managers and approach have proved themselves over the long term.