Small Cap Select – Q2 2023 Commentary

The Market In General:

The second quarter of 2023 proved to be a period of strong gains for the US equity markets, driven by a combination of factors that bolstered investor confidence.  Notably, there were significant declines in both headline and core inflation metrics, prompting the US Federal Reserve to take a measured approach and implement a relatively conservative quarter-point increase in interest rates. This move, coupled with the central bank’s signal that rate hikes were nearing their conclusion, contributed to positive market sentiment. Furthermore, the robustness of the labor markets added to the overall optimism surrounding the US economy. The market also responded favorably to the potential economic advantages associated with generative artificial intelligence (AI), as well as the successful debt ceiling agreement reached by the US government, which resulted in only minimal cuts to federal spending.

An interesting observation worth highlighting is that the S&P 500® performance was driven by the seven largest companies in the index. When excluding these, the remaining 493 large firms underperformed in comparison to the small-cap indices both in the second quarter and year-to-date. This divergence emphasizes the importance of considering company-specific valuation factors and the significance of stock selection in a dynamic market environment.


For the second quarter of 2023, the Select Composite experienced a return of 5.26% (gross of fees) and 5.03% (net of fees) compared to the Russell 2000®, which returned 5.21%. Year-to-date, the Select Composite experienced a return of 9.33% (gross of fees) and 8.87% (net of fees) compared to the Russell 2000®, which returned 8.09%. Certain account performance may vary from this composite performance due to client-initiated account restrictions on certain types of holdings or due to client cash flows.  Additional performance information is included in the table below.

Data as of 6/30/2023

During the quarter, our best-performing sector was Industrials, reflecting our overweight position in the space and the outperformance of our selected stocks. Among them, a freight transportation services provider stood out as our best-performing investment. Initially, we invested in the company with the expectation that they would strategically divest parts of the business, streamlining their operations to focus primarily on less-than-truckload freight operations. While this transformation occurred over the past year, the stock price did not reflect the positive changes, prompting us to increase our position earlier this year. The combination of an attractive valuation, market share gains, and new management hires from industry-leading firms fueled investor optimism regarding the potential for significant earnings growth over time. We remain invested in the stock. Our second-best performer was a technology provider that automates the buying and selling of digital advertising inventory. The digital advertising market has resumed its growth trajectory, and the company is well-positioned to benefit, particularly due to their strong presence in the connected TV market. We continue to hold our investment in this stock.

During the quarter, our worst-performing sector was Information Technology, reflecting our underweight position in the group and the underperformance of our selected stocks compared to the benchmark’s strong performance. Among our holdings, a provider of business process management services was the largest detractor from our overall performance. Despite consistently strong operational results and earnings, the prevailing narrative surrounding the capabilities of generative AI has put pressure on companies in this industry. There are concerns that these new technologies may disrupt existing and new customer engagements or erode pricing. However, having been invested in the stock for many years, we have witnessed the company embrace various productivity-enhancing technologies. As of now, we view the emergence of these AI capabilities as a neutral to positive development for the company and its industry. The technical expertise necessary to train, maintain, and expand these new AI models presents a unique opportunity for companies in the business process management industry to leverage their relationships and skills to benefit their customers. We remain invested in the company. Another underperforming stock was a software company that offers automated incident management solutions. The company experienced a slowdown in revenue growth during the first half of the year due to the uncertain macroeconomic outlook. Despite the short-term challenges, the company continued to improve its margins and profitability. We maintain our investment in the stock, considering the company’s ongoing efforts to enhance its financial performance.

Portfolio, New Investments, and Positions Exited:

During the quarter, we increased our weighting to cyclical industries, but remain underweight compared to the benchmark. We are overweight the Industrials and Consumer Discretionary sectors. We are underweight the Information Technologies and Real Estate sectors.

The Future:

With equities moving higher, it’s tempting to craft a bullish narrative of economic improvement and strength. We believe this thought process holds true for inflation and, currently, the strength of the job market supports continued economic expansion. We also recognize that the direction of other economic indicators remains in flux, whether it’s the duration of higher interest rates, the pace of wage growth, availability of credit, or the absolute level of consumer spending. If some of these metrics weaken, we believe it would ultimately show in labor market pressure as firms seek to reduce costs via layoffs. At present, we view this mostly as a potential, not expected, risk. Given the various paths the future can take, we are maintaining a balanced position on the portfolio’s economic sensitivity.  With that said, we believe the outlook for small cap stocks is quite favorable as many valuation metrics are at multi-year lows when compared to their large cap peers. As always, we remain committed to identifying and investing capital in companies that can execute their own value-enhancing initiatives.

Thank you for your continued confidence in us. Should you have any questions or concerns, never hesitate to call.


Alex Mosman, CFA®

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 Select Composite invests in small cap value and small cap growth companies that demonstrate valuation below, return on assets above and return on equity above those of the Russell 2000® Index, while observing tax sensitivity strategies. 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.

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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 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.