Published on December 28, 2020

The coronavirus pandemic is a once-in-a-lifetime event that transformed society and the economy almost overnight. We believe some of the most significant changes are likely here to stay, and we are focusing our investments on the secular growth trends we expect to strengthen as life returns to normal.

The coronavirus pandemic was much more than a public health disaster – it was a seismic societal event that upended long established norms and wreaked havoc on the economy. Businesses and consumers spent most of 2020 struggling to adjust to lockdowns, shortages, and travel restrictions in real time, which supercharged some industries and drove others to the brink.

As we look ahead to a vaccinated 2021, we expect some of the economic distortions of the past year will begin to recede, and we believe a few sectors will recover quite quickly. On the other hand, we think many of the bigger changes from 2020 are likely permanent, as the pandemic accelerated a digital transformation that was already underway.

We are currently focusing our investments on the secular growth trends from 2020 that we expect to continue in the new year, and we are also looking at new trends fueled by the recovery. As always, our objective is to invest in companies that are experiencing rapid revenue growth driven by increasing demand for their products, and in this piece we examine five secular growth trends we expect to strengthen in 2021.

Remote Work Technology

As we’ve written previously, the pandemic created a surge in demand for technologies that enabled organizations to employ a decentralized workforce, and we expect that trend to continue. We think the hypergrowth of 2020 may cool a bit, but we believe the shift toward working remotely is permanent.

Our view is shared by Microsoft co-founder Bill Gates. During a recent New York Times’ Dealbook conference, Gates said, “My prediction would be that over 50% of business travel and over 30% of days in the office will go away.” In his view, remote meetings will be normalized as the cost savings are too substantial to ignore. He also thinks companies will eventually start sharing offices on a rotating basis. While that last prediction may take some time, it drives home the point that telecommuting is likely here to stay.

One of the companies in our portfolio that should continue to benefit from this trend is Five9.

Five9

Five9 sells cloud-based contact center software that allows service reps to interact with customers through a variety of communications channels. Although the technology was not originally designed to support a distributed workforce, its cloud-native architecture has allowed it to seamlessly transition into a remote solution. The system provides extensive monitoring and reporting capabilities, which reduces the importance of employees sitting in the same physical location as management. We believe the company has significant upside, as it is well-positioned to displace legacy, on-premise systems in a $24 billion market. The company’s third quarter revenues grew 34% year-over-year, which was its highest growth rate ever.

Precision Oncology

Health care stocks were top of mind in 2020 for obvious reasons, but most of the focus was on vaccine-related opportunities. We have been focusing on an entirely different secular growth trend in health care – precision oncology – that we believe will continue to gain momentum in 2021.

Precision oncology is a next-generation approach to treating cancer that operates at the genetic level. In our view the industry is currently experiencing the so-called flywheel effect, as multiple factors are converging simultaneously to advance the field and create better patient outcomes. Perhaps most importantly, complementary companies are entering the space to create an ecosystem that benefits all participants. For example, the costs of gene sequencing have fallen exponentially in the past few years, opening the door for a wide range of innovations.

Two companies from this space that we currently own are Turning Point Therapeutics (TPTX) and Guardant Health (GH).

Turning Point Therapeutics

TPTX is a precision oncology company developing therapies that target the genetic drivers of cancer. The company’s leading lung cancer drug was recently granted “breakthrough therapy designation” by the FDA, an important milestone that expedites the agency’s regulatory review process. And in its ongoing Phase 2 trial, the treatment has been 86% effective, which is a very strong result. TPTX also has a deep pipeline of promising therapies in development, solidifying its position as a leader in the space and laying the foundation for long-term revenue growth.

Guardant Health

Guardant Health is a precision oncology company that develops next-generation diagnostic technology that allows physicians to analyze the specific genetic mutations in a patient’s cancer. Based on the results, they can prescribe the appropriate treatment (i.e., precision oncology therapies from companies like TPTX). What’s exciting about Guardant’s approach is that mutations can be discovered with a simple blood draw rather than a tissue biopsy. The company is very well positioned for long-term growth, as its user-friendly technology is an essential component of the precision oncology treatment process. Guardant’s revenues increased 23% year-over-year as of the third quarter, despite the headwinds created by the pandemic.

Renewable Energy

Renewable energy is an important secular growth trend that we believe is still in its early days and is gaining strength. Despite the pandemic, consumption of renewable energy increased markedly in 2020. According to a recent study by Deloitte, in the U.S. more energy was generated by renewables than by coal 153 days in 2020 compared with just 39 days in 2019. We expect this trajectory will continue for the foreseeable future as production capacity increases and costs decline.

The primary driver behind the renewable energy trend is growing concern about climate change. Businesses and consumers are both looking for ways to reduce their carbon footprint, which has caused a sharp increase in demand. Innovative technology companies have responded by developing clean energy sources for both residential and commercial use.

We think the trend is likely to accelerate in 2021 as the incoming Biden administration has made climate change is a top priority of its agenda. During his campaign the President Elect talked about investing $2 trillion in clean energy, and even if the actual amount is well short of that mark it is still likely to be significant.

We currently hold one renewable energy company, Enphase.

Enphase

Enphase Energy is an energy technology company that designs and manufactures software-driven residential solar energy solutions. The company manufactures an integrated system that generates, stores, and manages solar energy. In the event of a blackout, users can easily disconnect from the grid and continue receiving electricity from their own battery just by pushing a button on their smartphone. This is particularly important to homeowners in the western U.S., particularly California, where planned power outages due to wildfires have become commonplace. The company also has several new products in the pipeline, and we think it is in a strong position to generate sustainable growth for the near to medium term.

On-Demand Dining

Fewer industries were hit harder by the pandemic than restaurants. According to the National Restaurant Association, roughly three million employees lost their jobs, 100,000 establishments closed permanently, and the industry lost $240 billion in sales.

The lone bright spot in the sector was the strong growth in on-demand dining. Nationwide lockdowns drove consumers to online delivery services in record numbers, creating a lifeline for desperate eateries. In 2020, GrubHub added 90,000 new partners, UberEats increased its partner program by 70%, and DoorDash added 50,000 new partners in just the few months prior to its recent initial public offering.

In our view, the secular trend toward on-demand dining closely parallels the trend toward working remotely. We expect that the hypergrowth will taper a little as people are able to return to their favorite restaurants, but the convenience of on-demand dining will remain popular.

It seems that the industry shares our view. One of the under-the-radar stories of 2020 was that private investors poured over a billion dollars into “ghost kitchen” startups. These new businesses build and manage large commercial kitchens with no dining room where food from multiple restaurants is prepared simultaneously. Because they are designed exclusively for delivery, they are extremely efficient, which increases profitability for both the restaurant and the delivery service, and it decreases the time customers must wait to receive their meal. We expect the rapidly expanding network of ghost kitchens will support the growth of on-demand dining for the foreseeable future.

We are currently invested in one company, Wingstop, that is directly benefitting from this trend.

Wingstop

Wingstop is an international chain specializing in chicken wings, fries, and sides. In our view, the company has always been a little ahead of its time. Established in 1994, it was originally designed as a take-out business with limited onsite seating. This strategic decision simultaneously reduced real estate costs and made it easier to expand into premium locations. They have continued to grow rapidly during the pandemic, led by their digital and delivery revenues. Over 62% of total sales have come through online channels – more than double last year’s level, and over 20% of sales came from their delivery partnership with DoorDash. With over 1,500 restaurants worldwide, an expanding digital presence, and a skilled management team, we believe the company has plenty of runway for additional growth.

Short-term Vacation Rentals

Like restaurants, travel and tourism were both hit extremely hard by the pandemic. According to the U.S. Travel Association, the industry suffered $491 billion in cumulative losses in 2020.

One of the few areas that held up relatively well was short-term vacation rentals. Cautious travelers avoided hotels and their requisite communal spaces (lobbies, elevators, hallways, etc.) and instead gravitated to private rentals from sites like AirBnB and VRBO, which pushed their market share from 10% in 2019 to over 25% in 2020.

Another segment of the short-term rental market that fared surprisingly well in 2020 was the old-fashioned timeshare industry. Timeshares have been around since the 1970s, but they have received renewed attention recently as several startups have created online marketplaces that allow owners to easily rent available units to the general public.

Although we anticipate a recovery for hotels once people begin to feel more comfortable in shared spaces, we believe the increased use of short-term rentals will continue. In addition, we expect pent up demand for vacations will be a tailwind for the entire industry. In a recent survey by Hilton, over 60% of respondents said they plan to make travel “a priority” in the new year. But with Covid concerns lingering, we expect many travelers will continue to prefer short-term rentals over hotels.

We recently purchased a leisure company that we think will benefit from this trend.

Final Thoughts

Although we feel these five secular trends are particularly well-positioned for growth in the new year, we are also investing in several others that we have not discussed here (eCommerce, home improvement, etc.). Moreover, we believe the economic landscape will be somewhat fluid in 2021 as the vaccine is rolled out, so we will continue to monitor the markets to identify additional trends that can drive our returns in the future.

James Callinan, CFA

Chief Investment Officer – Emerging Growth

Small Cap Growth Composite (as of 12/31/23)

  QTD YTD 1 YR 3 YR 5 YR 7 YR 10 YR 15 YR INCEP
(7/1/2006)
Small Cap Growth Composite (gross) 12.46% 25.42% 25.42% -3.78% 16.39% 15.98% 12.51% 17.76% 14.00%
Small Cap Growth Composite (net) 12.20 24.27 24.27 -4.68 15.31 14.86 11.42 16.62 12.88
Russell 2000 Growth Index 12.75 18.66 18.66 -3.50 9.22 8.08 7.16 12.07 8.06
Swipe Table for Full Data

Past performance does not guarantee future results.

Rates of return for periods greater than one year are annualized. The information given for this composite is historic and should not be taken as an indication of future performance. Performance returns are presented both before and after the deduction of advisory fees. Portfolio returns are calculated daily, reflecting a time weighted return method. Portfolio returns reflect the reinvestment of dividends and other income and the deduction of brokerage fees, other commissions if any, and foreign withholding taxes. For the period 10/1/2012-12/31/2015, gross and net portfolio returns reflect the deduction of custodial, administrative, audit, legal, operating, and other expenses. Composite returns are calculated monthly by weighting portfolio returns by the beginning market value. Net return calculation:
A. For the period 7/1/2006-3/31/2014, composite net returns reflect the monthly deduction of an annual model advisory fee of 1.00%:

A1. For the period 7/1/2006-9/30/2012, one or more accounts paid a fee higher than the 1.00% model fee. During this period, the composite net return using the model fee of 1.00% was 10.95%. The composite net return using actual fees paid was 10.61%.
A2. For the period 10/1/2012-3/31/2014, no account in the composite paid a fee higher than the 1.00% model fee.

B. For the period 4/1/2014-12/31/2019, the composite net return is calculated using actual advisory fees with the following exception: one member of the composite was a mutual fund portfolio whose fee was partially waived due to an expense limitation agreement. The composite net return shown during this period does not reflect this waiver and is therefore lower than the actual return.
C. From 1/1/2020 onward, the composite net return is calculated using actual advisory fees, including any applicable mutual fund fee waivers.
D. Our fees may vary between accounts due to portfolio size, client type, or other factors.

Performance for the periods 7/1/2006-9/30/2012 and 10/1/2012-3/31/2016 represents the results of portfolios managed by the investment team while at RS Investment Management Co. LLC and Callinan Asset Management LLC, respectively, and employing the same investment strategy being used at OCM.

The Russell 2000 Growth Index (Russell 2000G) is a market-capitalization-weighted index representing the small cap growth segment of U.S. equities.

Clients invested in separately managed emerging growth accounts are subject to various risks including potential loss of principal, general market risk, small and medium-sized company risk, foreign securities and emerging markets risk and default risk. For a complete discussion of the risks involved, please see our Form ADV Brochure and refer to Item 8.

The Small Cap Growth Composite includes all fee-paying separately managed accounts, limited partnerships, and mutual funds that are predominantly invested in a concentrated selection of the equity securities of small and medium capitalization companies that can rapidly grow revenues and earnings. Portfolios normally remain primarily invested in equity securities except in times of unusual market stress when a more defensive allocation may be deemed prudent. The non-equity portion may be invested in holdings such as cash, cash equivalents, short-term debt securities, mutual funds, and ETFs. The benchmark is the Russell 2000® Growth Index.

References to specific companies, market sectors, or investment themes herein do not constitute recommendations to buy or sell any particular securities.

There can be no assurance that any specific security, strategy, or product referenced directly or indirectly in this commentary will be profitable in the future or suitable for your financial circumstances. Due to various factors, including changes to market conditions and/or applicable laws, this content may no longer reflect our current advice or opinion. You should not assume any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from Osterweis Capital Management.

Holdings and sector allocations may change at any time due to ongoing portfolio management. You can view complete holdings for a representative account for the Osterweis Small Cap Growth strategy as of the most recent quarter end here.

Opinions expressed are those of the author, are subject to change at any time, are not guaranteed and should not be considered investment advice.