Small Cap Growth – Q1 2025 Commentary

U.S. equity markets declined in the first quarter, pressured by a mix of policy shifts and increasing market uncertainty. The new presidential administration announced tariffs targeting Canada, Mexico, and China, some of which were implemented, while others were delayed or rolled back. The shifting nature of these actions introduced uncertainty around import costs and supply chains. At the same time, monetary policy remained unchanged, though commentary from the Fed acknowledged building inflationary pressures. Together, these factors contributed to a weaker backdrop for equities. During this 3-month period large caps outperformed small caps, with the Russell 1000® Index down 4.49%, compared to the Russell 2000® Index down 9.48%. And within small caps, value outperformed growth, with the Russell 2000® Value (R2V) Index down 7.74% vs. the Russell 2000® Growth (R2G) Index down 11.12%.

Performance:

The KCM Small Cap Growth (SCG) composite declined 12.30% (gross of fees) and 12.41% (net of fees) for the first quarter of 2025, underperforming the Russell 2000® Growth (R2G) Index, which decreased 11.12%, by 118 bps (gross of fees) and 130 bps (net of fees). Additional performance information included in the table below.

Data as of 3/31/2025

On a relative basis, Consumer Discretionary and Financials were the best-performing sectors versus the benchmark in the quarter. Consumer Discretionary benefited from our position in a manufacturer and retailer of factory-built housing. The company reported a strong quarter, with improving gross margins, as the consumer trade-down in finish options stabilized and mix benefited from higher sales through their captive retail channel. While the pace of sales recovery will depend on macro variables, we own the stock because we believe it is secularly well positioned to gain market share by addressing the growing housing affordability gap with more affordable home ownership solutions. The outperformance in Financials was led by an insurance brokerage company. The company recovered from a pull-back in Q4 as they continued to execute on strong, double-digit, organic revenue growth, while benefitting from the decision to pause acquisition activity in order to reduce leverage and fix the cost of debt.

The largest detractors to relative performance for the quarter were Information Technology and Health Care. Information Technology was negatively impacted by a semiconductor company supplying high-speed connectivity solutions to datacenters. Although the company is addressing key AI bottlenecks and successfully executing on a product expansion roadmap that could meaningfully increase revenue potential, the stock saw a significant correction as the entire semiconductor industry pulled back on tariff, cyclical, and data center spending concerns. Within Health Care, the largest detractor was a provider of clinical research outsourcing services to pharmaceutical and biotechnology companies. The company announced that, following their transition to a new ERP system, an analysis identified that the backlog from pre-spin bookings would be longer duration & lower margin than initially anticipated, due primarily to lack of proper billing for change orders. While the post-spin new bookings are strong and at good margins, this will meaningfully depress earnings vs. our previous expectations for the next two years as they work through the older contracts.

Outlook:

The greater scale and more aggressive implementation of several new presidential administration policies related to trade and immigration have introduced even more challenges to earnings growth and market conditions than we had previously anticipated. While some policies may eventually bolster economic growth, the tariff chaos is having immediate business disruption impacts, increasing planning uncertainty & pushes any incremental monetary policy to the sidelines due to higher inflation risks. This all adds to the challenges of what was already a slowing economy and increases the probability of recession. As we write, however, stocks have also already reacted to this new reality with many small caps down over 20% or more. While we recognize that near-term risks are elevated, we also know that, historically, the most compelling long-term opportunities will present themselves in times of increased volatility and uncertainty. The core of our strategy remains focused on identifying companies with unique opportunities to gain market share and/or expand their end markets meaningfully with good economic returns. We are incorporating the potential impacts of these new policies into our scenario analysis and will continue to adjust the portfolio to lean into the best risk/reward opportunities that the market provides. As in the past, we believe this will allow us to navigate any additional near-term pressures while slowly re-positioning the portfolio to benefit from an eventual recovery.

Thank you for your continued confidence in the Kennedy Capital team. Should you have any additional questions, please do not hesitate to contact us.

Sincerely,

Portfolio Manager

Assistant Portfolio Managers

Important Disclosures

Kennedy Capital Management LLC (“KCM”) is a Delaware limited liability company headquartered in Missouri.  KCM is registered as an investment adviser with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Registration with the SEC does not imply any level of skill or training. Clients of the Firm include U.S. corporations, pension and profit sharing funds, colleges and universities, trusts, not-for-profit organizations, foundations, and individuals. KCM claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. GIPS® are a set of standardized, industry-wide ethical principles that provide investment firms with guidance on calculating and reporting their investment results to prospective clients to ensure fair representation and full disclosure of an investment firm’s performance history.

Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. A complete list of all securities recommended by KCM in the preceding year, a fully compliant GIPS composite report, and the list of composite descriptions are available upon request from KCM at 10829 Olive Blvd., Suite 100. St. Louis, MO, 63141.

The Small Cap Growth Composite invests in growth securities of predominately small companies that generally have a market capitalization that is reflective of the Russell 2000® Growth Index. The Manager seeks companies with durable business models able to deploy assets into growing sets of opportunities providing superior rates of return. For comparison purposes the composite is measured against the Russell 2000® Growth Index. The U.S. Dollar is the currency used to express performance.

Composite specific data provided within this presentation has been calculated from accounts that are discretionary as defined in this paragraph. The assets shown are derived only from discretionary accounts. Non-discretionary accounts, as defined by KCM, are accounts that are not included in the composite due to one or any combination of the following criteria: there were significant cash inflows or outflows within the account; the account’s asset level did not meet the minimum requirement to remain in the composite; the account assets are managed by others using our non-discretionary model. The temporary removal of such an account occurs at the beginning of the month and the account re-enters the composite the month after the criteria has been met.

Performance returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross of fee returns reflect the deduction of transaction costs and custodian fees but do not reflect the deduction of investment advisory fees. Net of fee performance is calculated using gross returns less the actual applicable annual management fee applied monthly. Past performance is not indicative of future results. A client’s return will be reduced by the advisory fees as described in Form ADV Part 2A and other expenses incurred by the account. For example, an annual advisory fee of 1% compounded quarterly over 10 years will reduce a gross 14.44% annual return to a net 13.32% annual return. Form ADV Part 2A is available upon request.

The performance figures reported herein are unaudited, may be based upon information obtained via electronic data sources (”feeds”) and may be subject to change. Data feeds from many of KCM clients’ selected custodians are obtained through third party sources, and are used to compare custodial data to KCM’s client account records as frequently as daily. Monthly, KCM reviews clients’ account holdings along with cash and share quantities against the custodial statements. In some instances, variances may exist between final audited custodial information and the information KCM obtains via such data feeds. Generally, any such variances are researched and reconciled within thirty days of the period end.

The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in a KCM portfolio at the time you receive this letter or that securities sold have not been repurchased. Allocations among industries, sectors and securities may vary and are subject to change without notice. Any securities discussed do not represent an account’s entire portfolio and, in the aggregate, may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the industry or sector allocation decisions mentioned, or securities transactions or holdings discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

Sector Weightings are subject to change at any time.  Sectors are based on the Global Industry Classification Standard (“GICS”) classification scheme and are measured as a percentage of the total composite in terms of asset value as of the date indicated above.  Individual client portfolios may be different based on variations in security purchase price and date, and individual client restrictions. 

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Allocations to various assets classes change over time and deviate from any stated or targeted percentages of a total portfolio as a result of market conditions and reallocation decisions. Therefore, nothing herein reflects a static portfolio allocation that will remain the same or match stated target allocations of asset classes.

Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto.  The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited.  This is a presentation of Kennedy Capital Management.  Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in Kennedy Capital Management’s presentation thereof. 

The Russell 1000® Index measures the performance of the large-cap segment of the US equity universe. It is a subset of the Russell 3000® Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 93% of the US market. The Russell 1000® Index is constructed to provide a comprehensive and unbiased barometer for the large-cap segment and is completely reconstituted annually to ensure new and growing equities are included.

The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000®  Index is a subset of the Russell 3000® Index representing approximately 7% of the total market capitalization of that index, as of the most recent reconstitution. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000® is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.

The Russell 2000® Value Index measures the performance of small-cap value segment of the U.S. equity universe. It includes those Russell 2000® companies with relatively lower price-to-book ratios, lower I/B/E/S  forecast  medium term (2 year) growth and lower sales per share historical growth (5 year) . The Russell 2000® Value Index is constructed to provide a comprehensive and unbiased barometer for the small-cap value segment. The Index is completely reconstituted annually to ensure new and growing equites are included and that the represented companies continue to reflect value characteristics.

The Russell 2000® Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000® companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium term (2 year) growth and higher sales per share historical growth (5 year). The Russell 2000® Growth Index is constructed to provide comprehensive and unbiased barometer for the small-cap growth segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 2000® Growth Index is used as the benchmark.  The Index is unmanaged and represents total returns including reinvestment of dividends.  The benchmark is used for comparative purposes only and generally reflects the comparable risk or investment style of the Firm’s strategy.  The investment portfolios underlying the Index are different from the investments in the portfolios managed by the Firm.  Certain accounts may also use other benchmarks not listed in the GIPS composite report. The Verification and Performance Examination Report does not cover the benchmark returns included in the GIPS composite report.  Investors cannot invest directly in an Index.