SMID Cap Value – Q2 2026 Commentary

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Equity markets were robust during the 2nd quarter of 2026.  The Russell 2500™ Value (R25V) Index increased 18.50% and the Russell 2500™ Growth (R25G) Index increased 24.02%.  Small caps outperformed large caps, with the Russell 2000® Index up 22.49%, compared to the Russell 1000 Index® up 15.13%.

Q2 SMID cap market performance was narrow, with index returns concentrated in a handful of industries.  The technology sector is the clearest example: at less than 17% of the Russell 2500™ Value Index by weight, it drove over 50% of the index’s total return for the quarter.  A single stock, a producer of commodity storage and memory products – surged 229% and accounted for nearly a quarter of the index return on its own.  As the chart below shows, this degree of concentration sits well outside the historical data norm, and reflects the unusual market environment shaped in large part by enthusiasm around AI.

Source: Furey Research Partners and FactSet. Data as of 6/30/2026. Only for R2000 quarters with a 10+% return.

The Kennedy Capital SMID Cap Value (SMCV) composite returned 20.35% (net of fees) during the quarter, outperforming the R25V by 1.85%.  For the rolling 12-month period, the SMCV composite returned 29.97% (net of fees), compared to the R25V’s return of 38.54%, underperforming by 8.57%. Additional performance information included in the table below.

Data as of 6/30/2026.

Industrials was the best performing sector relative to the benchmark during the quarter, contributing 235 bps. A leading freight brokerage and logistics company was the sector’s largest positive contributor. A tightening truckload supply/demand environment is lifting both volumes and pricing across its platform. We believe the market underappreciates the company’s leverage to a recovering freight market, which should translate into expanding returns on capital in the years ahead.  A supplier of electronics and systems for the defense industry was also a top contributor. Robust defense spending is driving an acceleration in revenue and backlog growth, while a pivot to higher-margin programs is enhancing profitability and returns.

An underweight in the Energy sector was also a positive contributor, adding 54 bps to relative performance. Signs of de-escalation in the Middle East conflict pushed crude oil down to ~$70 by quarter-end, weighing on share prices across the sector. We remain comfortable with our positioning and believe our holdings still generate solid cash flow returns at current commodity prices.

Stock selection in the Financials sector was the largest headwind to relative returns in the quarter, detracting 125 bps.  Positions in a diversified financial services firm, and a wealth management platform, were among our largest detractors.  Both stocks declined on concerns that the spread of artificial intelligence will erode the value of traditional financial advisory models.  We think these fears are overdone.  The scale, breadth of offerings, and deep client relationships at both firms should continue to drive growth and attractive returns for years to come.

The Information Technology sector was also a notable headwind, negatively impacting relative performance by 100 bps.  AI dominated the quarter, driving the Technology sector up over 70% within the R25V.  Hyperscaler capital spending to build out AI data centers — Meta, Alphabet, Microsoft, and Amazon — is climbing at an unprecedented pace, expected to eclipse $700 billion this year, up from $358 billion in 2025. This spending boom is driving a step function change in revenues and profitability for a broad swathe of companies that operate in the technology supply chain and industrial infrastructure space.  While we did not keep pace with the broader Technology sector return, the SMCV portfolio had several holdings that benefited from data center strength.  We took advantage of the strong sector return to sell down positions where market expectations now appropriately reflect robust fundamentals.

SMID Cap Value Portfolio – New & Exited Positions:

Below, we highlight three of our largest new investments and our three largest complete sells during the quarter:

We bought:

A southeast-based regional bank.  Having assembled an attractive franchise in high growth markets through multiple acquisitions, we believe the company is well positioned to utilize their increased scale to expand returns and drive above-average loan growth.

A distributor of steel and other metal products.  The company should continue to generate above-average returns on capital, supported by steady volume growth and ongoing cost efficiencies, while expanding its capital base through accretive M&A.

A Midwest-based regional bank.  Steady loan growth, a conservative approach to credit, and an attractive mix of fee-based income should enable the company to continue driving solid return on assets and steady book value growth.

We exited:

A manufacturer of optical components and lasers. Shares surged as data center customers drove exceptional demand for the company’s products. We exited the position with market expectations now looking stretched and its market capitalization having climbed above the top end of our targeted Small/Mid range.

A supplier of specialty metals serving a range of niche end markets, most notably aerospace. The stock advanced on the strength of a powerful aerospace demand cycle. We sold our shares, viewing the valuation as having reached fair value.

A leading provider of ATM products and services to banks and retailers worldwide. We closed the position following the announcement that the company will be acquired by an industry peer.

Looking forward

The US economy remains on steady footing, which should translate to durable earnings growth for small and mid-cap companies. Consumer spending has stayed resilient despite higher commodity prices, the unemployment rate is hovering near cycle lows, and the industrial economy — outside of AI — is showing signs of improvement. On the negative side, inflation remains above the Federal Reserve’s target, putting upward pressure on long-term interest rates. This has yet to make a meaningful dent in the broader economy, but it’s a dynamic that bears watching.

As we think about the road ahead, we can’t predict the future — but our valuation process can serve as a guide for avoiding stocks that are priced for perfection.  We continue to adjust the portfolio towards stocks that balance sound fundamentals with attractive valuation.  When market breadth returns, we believe our diversified approach and disciplined valuation framework should be well positioned to benefit.

Sincerely,

McAfee Burke, CFA® & Frank Latuda, Jr., CFA® (CIO)

Portfolio Managers
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The SMID Cap Value Composite will be invested in value securities of predominately small and mid cap companies that generally have a market capitalization that is reflective of the Russell 2500™ Value Index.  The Investment Manager generally looks for undervalued companies generating cash flow returns on invested capital greater than industry peers.  SMID Cap Value portfolios generally demonstrate valuations below and growth characteristics at or above those of the benchmark.  The weighted average market capitalization of the Portfolio will generally be reflective of the average market capitalization of the Russell 2500™ Value 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.

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The Russell 2500™ Value Index measures the performance of small to mid-cap value segment of the U.S. equity universe. It includes those Russell 2500™ companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium term (2 year) growth and lower sales per share historical growth (5 year). The Russell 2500™ Value Index is constructed to provide a comprehensive and unbiased barometer for 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 value characteristics.

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™ Value 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.  Investors cannot invest directly in an Index.

The Russell 1000® Index measures the performance of the large-cap segment of the US equity universe. It is a subset of the Russell 3000® Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 93% of the US market. The Russell 1000® Index is constructed to provide a comprehensive and unbiased barometer for the large-cap segment and is completely reconstituted annually to ensure new and growing equities are included.

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