ESG SMID Cap – Q2 2022 Commentary

The Russell 2500™ index declined nearly 17% in the second quarter of 2022, as inflation worries, higher interest rates, and investor anticipation of a pending recession all weighed on equity prices.  Our intra-quarter conversations with portfolio companies and prospective holdings indicate that the primary area of demand weakness resides only in certain consumer-oriented industries at this time.  However, we are cognizant of building risks across sectors as government stimulus wanes and plans to combat inflation are implemented.  One bright spot in the quarter was a return to some degree of post-COVID normalcy, with many in-person meetings with company management teams and prospective new clients.

During the first quarter, the portfolio was most overweight the Industrials and Information Technology sectors, while our largest underweights remained Energy and Materials.  It’s worth noting that the Energy sector’s weighting in the Russell 2500™ – which increased significantly in the first half of 2022 – dropped meaningfully at the end of the quarter due to the annual index reconstitution.

Performance & Characteristics

The ESG SMID Cap portfolio returned (13.95)% in Q2 2022 (gross of fees) and (14.11)% (net of fees), outperforming the benchmark by 303 bps on a gross basis and 287 bps on a net basis.  Over the trailing 12-months, the portfolio has outperformed its benchmark by 722 bps (gross of fees) and 661 bps (net).  Our best performing sector this quarter was Consumer Discretionary, with stock selection adding to relative performance.  The worst performing sector vs. the benchmark was Energy, detracting from relative portfolio performance.

Regarding portfolio characteristics, as of 6/30/22 the ESG SMID Cap portfolio had weighted average carbon emissions (Scope 1, reported and estimated) of 94,413 metric tons, an 85% reduction from the weighted average emissions of the benchmark.  The portfolio had zero carbon reserves, while the benchmark had reserves that equate to over 638 million metric tons of potential future emissions.  The weighted average governance score of the portfolio (based on Institutional Shareholder Services’ Quality Score metric) was 3.42 compared with 4.15 for the Russell 2500™, or 18% more attractive (lower score is better).

We remain confident in our ability to construct a portfolio with attractive Environmental, Social, and Governance characteristics that delivers relative investment outperformance over the long-term.  As always, we appreciate the confidence you place in our team.  Please don’t hesitate to contact us with any questions regarding Kennedy Capital Management or our investment process.

Sincerely,

Chris McDonald, CFA®

Portfolio Manager

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