Small Cap Core – Q3 2022 Commentary

The Market 

This quarter has been a downbeat one for small cap stocks and other asset classes.  Small cap stocks, as measured by the Russell 2000®, have lost about 25% of their value this year.  The Federal Reserve has endeavored to quell inflation after a challenging stretch.  Yet, month after month in 2022, the CPI readings are reported and remain well above levels from recent years.  This causes some to lose faith in our policy makers, which, in turn, can translate into market unsteadiness.  As we step through this and other minefields such as supply chain imbalances, weakening consumers, and leverage fears, it can be unnerving.  Quarterly earnings periods tend to be particularly acute, as management teams are forced to reassess their outlooks and adjust expectations.

Performance Recap

For the third quarter of 2022, the KCM Small Cap Core Composite returned -3.87% (gross of fees) and -4.09% (net of fees), compared to the Russell 2000® Index, which fell 2.19%.  On a year-to-date basis, the respective gross, net, and benchmark numbers are -22.71%, -23.23%, and -25.10%.  While we are pleased to have earned returns for our clients that compare favorably to our benchmark on a year-to-date basis, we are disappointed that our clients have not fared better this year.  The following discussion will provide some context around the weightings and individual stock performance that drove performance during the third quarter.  Additional performance information is included in the table below.

Data as of 9/30/2022

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

During the third quarter, our strongest relative outperformance was achieved in the Industrials, Communication Services, and Consumer Staples.  On the negative side, Health Care, Energy, and Consumer Discretionary had an unfavorable impact on performance.  Stock selection was a negative factor during the quarter, although it remained the primary factor driving relative outperformance on a year-to-date basis.

The three stocks that were the most significant detriments to performance in the quarter were an aerospace and defense company, a digital consulting firm and a global medical company. We believed that the aerospace and defense company has suffered through supply chain challenges and resultant cash flow pressures.  They have also shown poor organic growth related to one of their acquisitions.  We continue to believe that their expertise can drive long term growth in revenue and profitability that supports an investment in the stock, and we continue to hold our position.   The digital consulting firm continued to grow, but investors had become accustomed to them outperforming their guidance.  With macro-economic concerns growing, we view management as becoming more cautious, which we believe has weighed on the stock.  Finally, the global medical technology company has underperformed our expectations.  We are enthused by several of the company’s product lines but believe that the technology they are developing to treat depression could become a meaningful value creator for the company.  The trial related to this product has gone slower than we expected, and we believe this has been a key negative driver for the stock.  Without this success, we believe the stock is fairly valued, but a positive trial could lead to upside.

The three best performing stocks in the portfolio were a manufacturer of metal products, an operator of portable storage solutions and an energy exploration and production firm. The first company manufactures engineered fabricated metal products, including irrigation systems for farming and utility poles.  We believe the company has managed its costs and supply chain well but has also benefited from global demand strength across many products.  We have been pleased to see rising earnings over the past year and expect this trend to continue.  The second referenced company, which provides modular and portable storage services, has successfully engineered a merger and managed the company well, in our view, throughout these challenging economic times.  They have raised expectations multiple times over the past year, and the stock has benefited.  Finally, the energy exploration and production company, has been a key beneficiary of higher oil prices.  In our view, the company’s decision to focus its efforts on free cash flow generation, rather than strictly on growth, has also buoyed the stock, adding to its allure.  We continue to favor energy companies with this cash flow discipline.


We find ourselves in a troubling economic situation.  Fiscal and monetary challenges such as rising government debt and stubbornly high inflation make for difficult navigation towards a smoother economy.  While the U.S. has been moving towards a more self-reliant state – one can debate the merits of that – we remain interconnected to the global economy.  The clear challenges faced in Europe will doubtless continue to weigh on many countries, including ours.  We take solace in the forward-looking focus of the markets.  While the economic outlook appears bleak now, we believe that is well incorporated into equity prices.  This does not necessarily imply that stock prices will rise from here, but we have been through many difficult economic times and see them as opportunistic times to invest.  We believe we will continue to be able to discover situations where investors are failing to capture appropriate company values.  Therefore, we are confident in the positioning of the portfolio we are managing for you.  As always, we thank you for the opportunity to manage your account.


Donald Cobin, CFA®

Portfolio Manager

  Download PDF

Important Disclosures

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.

Kennedy Capital Management LLC (“KCM”) is a Missouri corporation 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.

The Small Cap Core Composite contains fully discretionary small cap core accounts that are invested 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.

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.

Portfolio Sector Weightings are subject to change at any time.  Sector weightings are based on the Global Industry Classification Standard (“GICS”) classification scheme and are measured as a percentage of the total portfolio 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 use by Kennedy Capital Management.  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.

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 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.