Micro Cap Opportunities – Q4 2025 Commentary

Market Review

The Russell Microcap® Index returned nearly 23% in 2025, outperforming both large and small cap US equity indices during the year (see Figure 1).  The underpinnings of this robust performance were concentrated in early-stage businesses, with Biotech/Pharma contributing 10.2 ppts (approx. 44% of the total return) while a group of 9 companies tied to Artificial Intelligence (AI) infrastructure investment theme added another 5.7 ppts (approx. 25% of the total return).

Figure 1: 2025 Returns – Major US Indices

Sources: S&P Dow Jones Indices LLC and Russell Investment Group, Data as of 12/31/2025

During the 4th quarter of 2025, the Russell Microcap® Index returned 6.25%.  This performance was essentially driven by Biotechnology (+41%, 4.9 ppts of return) and Pharmaceuticals (+37%, 2.0 ppts of return), with the remainder of the Russell Microcap® declining in aggregate.  The worst-performing sector was Consumer Staples, which declined 9.91% in the quarter.

Performance Recap

The KCM Microcap Opportunities Composite returned 3.71% (gross of fees) and 3.55% (net of fees) in Q425, underperforming the Russell Microcap® Index by 254 basis points (gross) and 270 basis points (net). While in 2025, the KCM Microcap Opportunities strategies return in biotechnology (+67%) and pharmaceuticals (+107%) outperformed Russell Microcap® index returns, the underweight in these two groups had an overwhelming impact and represented more than 100% of the relative underperformance to the benchmark in the year.  This unfavorable allocation was disappointing given the strong stock selection within these two groups; however, positive stock selection in Industrials and Information Technology sectors also helped to offset some of the impact during the quarter.  Additional performance information is included in the table below.

Data as of 12/31/2025

The biggest detractor from Q425 relative performance, was a provider of advanced diagnostic, prognostic, and monitoring tests for autoimmune and rheumatic diseases. The stock detracted 91 bps to relative portfolio performance in the quarter. Shares rose in 2025, but fell after a key client loss and lower than expected ASPs were disclosed on their Q3 earnings call. Although this setback was unexpected, we believe it will be temporary as management’s new tests gain adoption and increased commercial reimbursement coverage in the future, which should support improved cash collections and higher average selling prices. We continue to hold the stock.

The largest individual contributor to relative portfolio performance in the quarter was a biotechnology company with two late-stage clinical programs which both reported positive data in 2025. The company is now focused on regulatory filings for their KIT tyrosine kinase inhibitor, to treat gastrointestinal stromal tumors (GIST) and systemic mastocytosis (SM). These indications are both rare, potentially fatal diseases with few alternative treatment options. Recent clinical data suggest a competitive efficacy and safety profile in SM and favorable comparative outcomes in GIST, based on publicly disclosed trial results. One New Drug Application has already been submitted to the U.S. Food and Drug Administration, with two additional NDA submissions expected in the first half of 2026. Given the strength of the data presented in Q4 and optimism around approvability and ultimate market share, the stock responded positively. We believe these applications will be approved by the FDA and plan to hold through at least the first approval, which could come as soon as mid-2026.  The stock added 54 bps to relative portfolio performance in the quarter.

Outlook

We enter 2026 with lower interest rates, generally stable US unemployment, and meaningful fiscal stimulus from recent federal tax and spending legislation.  This creates a favorable backdrop for microcap equity performance, particularly if the direction of inflation allows for further interest rate cuts by the US Federal Reserve. 

Investor sentiment regarding Biotech/Pharma spending and the ongoing AI build out are important considerations when assessing 2026, particularly in the microcap space.  While our investment philosophy leads the portfolio to be underweight these areas relative to the benchmark, we continue to find attractive biotech ideas and have maintained holdings that are benefitting from the AI investment cycle in a more indirect manner.

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 asset 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.

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 3000® Index measures the performance of the largest 3,000 US companies designed to represent approximately 98% of the investable US equity market. The Russell 3000 Index is constructed to provide a comprehensive, unbiased and stable barometer of the broad market and is completely reconstituted annually to ensure new and growing equities are included.

 The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

 The S&P SmallCap 600® seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.