Micro Cap Opportunities – Q3 2025 Commentary

Market Review

The Russell Microcap® Index returned 17.03% in the third quarter of 2025 and is now up 15.74% on a year-to-date basis.  This is a dramatic recovery from the 14.39% decline the index experienced in the first quarter of the year.  The primary driver behind this resurgence in index performance has been the performance of stocks tied to the artificial intelligence theme, largely focused on data center development, nuclear power, AI applications, and the repositioning of bitcoin miners to run AI workloads.  Energy was the best performing sector in the index during the quarter, returning 37.09% due to strong performance from companies exposed to nuclear power.  The worst performing sector was Communication Services, which declined 1.66%. 

Performance Recap

The KCM Microcap Opportunities Composite returned 11.33% (gross of fees) and 11.19% (net of fees) in Q325, underperforming the Russell Microcap® Index by 571 basis points (gross) and 584 basis points (net). Stock selection (-451bps) was the driver of underperformance this quarter. The strongest performing sector on a relative basis was Financials, which added 55bps, entirely driven by stock selection (+85bps). The biggest detractor during the quarter was Health Care, with 286bps of relative underperformance with biotechnology and pharmaceuticals being the primary areas of weakness. Within biotechnology, the KCM strategy actually outperformed the benchmark from a return perspective (KCM Microcap Opportunities strategy was up 41.21% vs. benchmark up 38.47%); however, our underweight vs. benchmark was the driver of relative underperformance. Underperformance in Pharmaceuticals was driven by one negative data readout of an owned name, compounded by our underweight vs. benchmark.  Additional performance information is included in the table below.

Data as of 09/30/2025

The largest individual detractor from relative portfolio performance in Q3 was a developer and operator of data centers, primarily in North Dakota.  The stock is a benchmark constituent that is not owned in the portfolio.  The company’s stock rallied in Q3 – returning nearly 128% – as investors priced in more value for the company’s existing footprint and future development plans.  The stock detracted 57 bps from relative performance in the quarter.

The strongest-performing stock (+68bps) in the quarter was a provider of semiconductor equipment used in testing substrates for chip manufacturers. Management launched a new wafer-level testing system for semiconductor chip manufacturers. The potential of this product could be significant allowing chip manufacturers to improve overall yields by identifying faulty wafers before a chip is completely manufactured. During the quarter, management announced a few pilot programs that we believe could turn into sizeable orders next year. Given the significant outperformance in the quarter, we did partially trim the position but continue to hold a sizeable weight in the strategy.

Outlook

For the past two quarters, the Russell Microcap Index performance has been dominated by the AI theme.  At 10/10/25, 9 of the 10 largest weightings in the index are either AI application companies or “AI enablers” – companies in the power or data center space.  These 10 companies now represent nearly 10% of the index and have a weighted average market cap of $5.4B.   While we believe that AI is a game changing technology with differentiated growth prospects, most of these businesses don’t align well with our investment and valuation approach.

While the portfolio isn’t completely without holdings that benefit from the AI theme, underexposure of the portfolio to the AI-oriented stocks has weighed on relative performance over the past two quarters.  Our team continues to assess the prospects of these businesses and while we don’t rule out making selective investments in this space in the future, we would expect the portfolio to remain underweight in the near term.  The basis for this stance is our assessment of a reasonable set of scenarios for the next few years compared to the implied valuations being assigned to these businesses.

We continue to strive to identify companies that are misunderstood or are implementing company-specific changes that are likely to drive improvements over the intermediate term.  This approach has served us well over time, and we expect it to add value for clients in the long term.

As always, we thank you for your support, and please don’t hesitate to reach out with any questions or concerns. 

Sincerely,

Sean McMahon

Portfolio Manager

Anna Bunn, Ph.D.

Assistant Portfolio Manager

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. 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 full 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.

Investing in the stock market involves gains and losses and may not be suitable for all investors. Investing in equity securities is speculative and involves substantial risk.  Small cap and micro-cap securities may involve more risk than larger-cap securities.  Investments concentrated in sector or specific industry may involve greater risk and volatility than more diversified investments.  

The Micro Cap Opportunities Composite contains fully discretionary micro cap accounts that are invested primarily in micro cap companies (market cap generally in line with Russell Microcap® index) that have opportunities to grow within their respective markets. For comparison purposes the composite is measured against the Russell Microcap® 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. Both 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 KCM. Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in KCM’s presentation thereof.

The Russell Microcap® Index measures the performance of the microcap segment of the U.S. equity universe. Microcap stocks make up less than 2% of the U.S. equity market (by market cap, as of the most recent reconstitution) and consist of the smallest 1,000 securities in the small-cap Russell 2000® Index, plus the next 1,000 smallest eligible securities by market cap. The Russell Microcap® Index is constructed to provide a comprehensive and unbiased barometer for the microcap segment trading on national exchanges, while excluding lesser-regulated OTC bulletin board securities and pink-sheet stocks due to their failure to meet national exchange listing requirements. The Index is completely reconstituted annually to ensure new and growing equities are reflected and companies continue to reflect appropriate capitalization and value characteristics.

The Russell Microcap® 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.