SMID Cap Growth – Q2 2023 Commentary

U.S. equity markets shook off the brief “banking crisis” and a lackluster earnings reporting period to continue their march toward recovery, ending the half closing in on early 2022 highs with growth stocks outperforming in both large and small caps. This positive development unfolded as each subsequent month’s macro-economic data reports showed the rate of inflation subsiding (largely as expected, but good news nonetheless) while employment levels and total consumer spending remain strong (better than expected). In addition, Nvidia sparked excitement within the technology sector with early proof of strong investments in artificial intelligence (AI) capabilities. With long-term rates moving sideways since their peak last October and improved equity valuations, the market now appears to be forecasting that a “goldilocks” scenario is indeed possible this time; in other words, inflation can be tamed without breaking the economy. If that is the case, we can expect the Fed Funds rate to peak soon while avoiding a full-blown recession. As with everything, time will tell if this is correct, but it certainly is possible given all the unusual comparisons due to COVID, government stimulus, and extremely low interest rates. Employment levels remain the key macro datapoint that we are tracking to evaluate this outcome.

While there were positive returns across all market caps and styles in U.S. equity markets in Q2, the areas of outperformance were actually quite narrow. In large caps, as represented by the S&P 500®  (SPX), the newly monikered “magnificent 7” (i.e. Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta Holdings) drove more than half of the gains and all the outperformance of that index vs. the rest of the market (Q2 gains for SPX +8.7% vs. SPX excluding the “magnificent 7” at +4.1% and the Russell 2000® (+5.2%). Likewise, in small caps the Russell 2000® Growth Index’s return of +7.1% outperformed the Russell 2000® Index (+5.2%) & the Russell 2000® Value Index (+3.2%) due to just three industry sub-groups (Biotechnology, Technology Hardware & Equipment, and Transports) representing a mere 15% of the index that were all up a very strong 18.7% combined.  Excluding these three groups, the remaining 85% of the Russell 2000® Growth Index was up +4.3%. Factor analysis on the Russell 2000® Growth Index also showed that several low-quality factors outperformed meaningfully, including companies that are unprofitable and/or highly shorted. Typically, these types of narrow markets are difficult environments for active managers to outperform and that proved to be the case in Q2. And unfortunately, we did not fare any better. Our quality bias (higher ROIC) and structural underweight of biotechnology were headwinds. In addition, we did not anticipate the excitement around potential AI investment spending and thus did not benefit from that thematic stock trend.


The KCM SMID Cap Growth (SMIDG) composite increased +4.89% (gross of fees) and +4.72% (net of fees) for the 2nd quarter of 2023, underperforming the Russell 2500™ Growth (R25G) Index, which increased +6.41%, by -152 bps (gross of fees) and -169 bps (net of fees). Year-to-date, the KCM SMIDG composite increased +14.11% (gross of fees) and +13.75% (net of fees), outperforming the Russell 2500™ Growth (R25G) Index, which increased +13.38%, by +73 bps (gross of fees) and +37 bps (net of fees). Additional performance information is included in the table below.

Data as of 6/30/2023

On a relative basis, Communication Services and Consumer Staples were the best-performing sectors versus the benchmark. The strength in Communication Services was led by a provider of technology solutions that automates the purchase and sale of digital advertising inventory with a leading position in connected TV. The company has been impacted by the cyclical decline in advertising spending over the past year, but continued to execute on their platform integration and rollout of new products and are gaining share. The Consumer Staples result was again led by a provider of branded, affordable cosmetic and skin-care products that has continued to demonstrate strong sales momentum primarily due to the launch of new products and brands. The company has also been successful in increasing prices, which is benefiting margins as supply chain cost pressures ease.

Our largest detractors to relative performance for the quarter were Information Technology and Consumer Discretionary. The poor performance in Information Technology was primarily due to the Technology Hardware & Equipment subsector and a combination of both what we didn’t own performing strongly (i.e., several AI investment beneficiaries) and absolute weakness in our owned names. In particular, a provider of optical networking solutions saw its stock decline on a weaker Q2 outlook due to order timing and generally softer customer spending, despite reiterating their expectations for a stronger H2 rebound and their multi-year targets. Skepticism remains over whether they are really gaining market share with their 800 MHz product rollout or if last year’s gains were simply short-term due to a competitor’s supply constraints. The next couple of quarters will provide critical evidence for that thesis. Within Consumer Discretionary, the largest detractor was a manufacturer of modular homes. The company underperformed after providing a weaker FYQ1 outlook due to labor supply & permitting bottlenecks delaying shipments to their community & homebuilder partners. We believe this is largely temporary and the stock will recover as shipments catch up with demand. The stock has meaningfully underperformed the site-built homebuilders and now trades at a discount, which we believe is unwarranted given their higher returns over the cycle.


We continue to be incrementally constructive on equity markets and expect that the positive performance will broaden out as/if the macro-economic backdrop stabilizes. That said, we are mindful that overall markets have come a long way back already and near-term valuations are no longer particularly cheap. That puts more of the risk on earnings execution. We believe that our strategy of investing in companies with higher CFROIs (cash flow return on investment) and higher asset growth (i.e., re-investment opportunities) will mean that they are better positioned to deliver on earnings growth expectations over the next year or two. In the short-term relative performance is much harder to predict, but assuming our companies can execute against their growth opportunities, we believe this should be a recipe for longer-term outperformance.

Thank you for your continued confidence in the Kennedy Capital team. Should you have any additional questions, please do not hesitate to contact us.


Jean Barnard, CFA®

Portfolio Manager

Ryan Dunnegan, CPA

Portfolio Manager

  Download PDF

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 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.

The SMID Cap Growth Composite invests in growth securities of predominately small and mid cap companies that generally have a market capitalization that is reflective of the Russell 2500™ Growth Index. The Manager seeks companies with durable business models able to deploy assets into growing sets of opportunities providing superior rates of return. For comparison purposes the composite is measured against the Russell 2500™ Growth 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.  Due to rounding, Sector Weighting’s total percentages my not equal 100%.

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 2500™ Growth Index measures the performance of the small to mid-cap growth segment of the U.S. equity universe. It includes those Russell 2500™ companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium term (2 year) growth and higher sales per share historical growth (5 year) The Russell 2500™ Growth Index is constructed to provide a comprehensive and unbiased barometer of the small to mid-cap growth market. The Index is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small to mid-cap opportunity set and that the represented companies continue to reflect growth characteristics.

The Russell 2500™ Growth 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.