Small Cap Core – Q2 2023 Commentary

The Market 

The second quarter of 2023 witnessed several significant market events that shaped the U.S. economy.  First, the broader market surged, driven by robust corporate earnings and positive economic indicators, propelling major indices to all-time highs.  However, concerns over inflation and rising short-term interest rates led to increased market volatility, with investors closely monitoring Federal Reserve decisions.  The technology sector rebounded strongly, fueled by innovations in artificial intelligence. While the housing market has cooled since its post-COVID boom, building permits have begun to show signs of resurgence.  Additionally, the labor market remains resilient despite some of the other economic concerns.  Overall, the quarter reflected a delicate balancing act between optimism for economic growth and caution regarding potential headwinds in the U.S. financial landscape.

Performance Recap

For the second quarter of 2023, the KCM Small Cap Core Composite rose +0.97% (gross of fees) and 0.74% (net of fees), compared to the Russell 2000® Index, which rose 5.21%.  This was a disappointing quarter, although we continue to outperform our benchmark over 3 and 5 years as shown below. Additional performance information is included in the table below.

Data as of 6/30/2023

Within the Small Cap Core Composite, sectors that we most heavily overweighted versus the benchmark were Industrials, Real Estate, and Consumer Staples.  Sectors that were significantly underweighted included Materials, Communication Services, and Information Technology.

During the second quarter, our strongest relative outperformance was achieved in Financials, Real Estate, and Communication Services.  On the negative side, Industrials, Health Care, and Consumer Staples had an unfavorable impact on performance.  Stock selection was a negative factor during the quarter, particularly within the Industrials sector. We were overweight the sector and saw our owned stocks fall more than 2%, while those in our benchmark rose.

The three stocks that were the largest detractors from relative performance during the quarter were a provider of voice, chat, and email customer experience solutions through contact centers, a distributor of natural and organic foods, and a company in the aerospace and defense industry.

The contact center solutions company has seen growth slow down along with the cooling of global economic growth.  We have been investors in the company indirectly through the former parent corporation before it was spun off late in 2020 continuing through its time as an independent, publicly traded company. We are attracted to the returns generated in this business and believe that growth opportunities will be prevalent for many years.  However, we did not properly anticipate the slowing earnings for 2023 and the resultant market dissatisfaction. We believe the cash flows generated by the business and the ability to create a stronger company through a recently announced acquisition will bear fruit and drive the stock higher over time.

The large domestic distributor of natural and organic foods has reported disappointing earnings recently.  We continue to believe that a leading provider in this segment should have secular tailwinds looking forward; however, we have some concerns about management’s ability to navigate profitably.  We have had several recent discussions with senior management and are actively evaluating our position.

Finally, the technology company in the aerospace and defense industry has been unable to execute its business in a manner that we had expected.  Supply chain challenges have played a part in their travails, but wider operational questions have developed as well. The company recently went through an examination of strategic direction and made some changes to management, which all appeared to weigh on the stock. We believe the company has a valuable franchise, but we are cognizant of the operational decline and are actively evaluating the company’s likely path and our holdings.

Our best-performing stocks during the quarter included a provider of engineered equipment for the industrial gas, energy, and biomedical industries, a technology oriented defense company, and a narcolepsy focused pharmaceutical company.

The provider of engineered equipment for the industrial gas, energy, and biomedical industries announced a large acquisition during the fourth quarter of 2022.  This seemed to drive a sharp refocusing of the markets – from the fundamentals of their business to the newly acquired leverage on their balance sheet and increasing European focus. The stock fell sharply at that time, but we appreciated the merits of the purchase and continued to own it, anticipating that their unique expertise and market positioning would eventually gain further recognition.  It is therefore encouraging to see the stock on our top contributors list for the second quarter of 2023.

The defense company, which develops products for the U.S. military and others, has been a steady contributor to the portfolio since we added it in late 2022.  We believe that the unusual structure of the business may have deterred some investors from the story when it first came to market in 2022.  The market seems to have come to appreciate the merits of their business during 2023, and we have enjoyed a meaningful move higher in the stock as a result.

Finally, the pharmaceutical company that develops products to treat narcolepsy has shown excellent performance quickly.  We purchased a small position during April 2023 and saw the stock move substantially higher by the end of the quarter.  We believe that FDA approval of one of their products, along with designation as an “orphan drug,” helped to drive increased enthusiasm by the investment community.


As we look forward, the US economy faces several significant risks that could potentially impact its stability and growth.  One of the key risks is the ongoing threat of inflation, which can clearly erode purchasing power, squeeze consumer spending, and disrupt business operations.  At the same time, risks lie in the continued tightening of monetary policy.  Poorly executed monetary tightening could have adverse effects on financial markets and on borrowing costs for businesses and consumers.  It requires careful navigation by the central bank to strike the right balance between controlling inflation and maintaining economic growth.

Geopolitical tensions and economic isolationism represent additional risks.  Ongoing hostilities, such as trade disputes between the US and China, have disrupted global supply chains and may hinder international trade.  In addition to the horrible toll on human lives, the ongoing conflict between Ukraine and Russia has disrupted global economics and led to periodic increases in market volatility and investor uncertainty.

Finally, the potential for cybersecurity threats poses a significant risk to the US economy.  As reliance on technology and digital infrastructure grows, the vulnerability to cyberattacks increases. A large-scale cyber breach targeting critical sectors like finance, energy, or transportation could disrupt operations, leading to financial losses, and undermine confidence in the economy.

To navigate these challenges, we employ a team of investment professionals here at Kennedy Capital Management.  While we are not naïve enough to claim immunity to these threats, our awareness of them helps us to question the management teams of those companies we are researching.  In addition to probing discussions about their inherent business prospects, we also work to understand how they are positioned to withstand these larger global concerns.  We are certain that the companies in our portfolios will be subject to risks beyond their control, but we do work to create a portfolio that diversifies our exposure.

We have begun to see a resurgence in small cap markets even in advance of a clear economic recovery.  This helps to remind us that the stock market is not merely a gauge on how our economy is currently faring, but more an amalgamation of what has happened, what is expected, and what other opportunities for investment exist. We look forward to researching, analyzing, and investing in these markets, and we thank you for allowing us to continue managing your assets.


Donald Cobin, CFA®

Portfolio Manager

Alex Mosman, CFA®

Assistant Portfolio Manager

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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 Core Composite invests in a mix of small cap value and small cap growth companies, which KCM believes to have strong intrinsic value and growth rates above the Russell 2000® Index. For comparison purposes the composite is measured against the Russell 2000® 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. 

GICS was developed by and is the exclusive property and a service mark of Morgan Stanley Capital International, Inc. (”MSCI”) and Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (”S&P”) and is licensed for the use by KCM. Neither MSCI, S&P, nor any other party involved in making or compiling the GICS or any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results thereof),and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability, and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

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, Inc.  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 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® 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.