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QTD SMID Cap – 2Q2023 vs. R2500

Market Observations & Portfolio Commentary

SMID Cap – 2Q2023 vs. R2500


Quarterly Market Update

U.S. stocks posted positive returns during Q2, with most of the gains generated during the month of June. The broader market, as measured by the Russell 3000 Index, returned 8.4%. Slowing inflation, optimism around the potential benefits of artificial intelligence (AI), and better than expected economic news driven by solid consumer spending combined to lift the market higher. While growth of the overall economy has slowed, a strong labor market with rising wages has allowed the economy to avoid a much anticipated recession.

Shares of larger, technology related companies led the equity market. Market leadership was narrow as seven large cap companies drove the Core and Growth indices. Market performance was bifurcated across the market cap spectrum, with Large and Mega Cap stocks materially outperforming. Style, sector, and factor leadership largely mimicked Q1. Growth continued to dominate Value, and the Growth-oriented Info Technology, Cons. Discretionary and Comm. Service sectors generally led across the market cap spectrum. Turning to market factors, companies exposed to Growth and Volatility factors (higher beta) posted the best results, while Yield and Value factors were laggards. Quality and Momentum factors had a mixed impact.


Key Performance Takeaways

  • The London Company Small-Mid Cap portfolio returned 8.5% gross (8.3% net) during the quarter vs. a 5.2% increase in the Russell 2500 Index. Stock selection was positive, partially offset by headwinds from sector exposure.

  • The SMID portfolio outperformed the Russell 2500 in Q2, and exceeded our 85-90% upside capture expectations. Despite headwinds from factor performance, the portfolio outperformed the benchmark in a strong market environment. As fundamentals have come under pressure down the market capitalization spectrum, our Quality orientation has stood out.


Top 3 Contributors to Relative Performance 

  • Entegris (ENTG) – ENTG outperformed during Q2, gaining share in its end markets, while highlighting an improving outlook with a potential recovery later this year. Strong demand for mission-critical products, such as liquid filters, and the easing of supply chain constraints were highlights. Its value-added offerings allow for above-average growth relative to the rest of the industry across all cycles. ENTG has drastically increased its size and scale to become one of the most diversified players in the semi-materials industry. Management remains focused on debt reduction. We remain attracted to the industry’s high barriers to entry, limited competitors, and high switching costs.

  • Trex Company (TREX) – TREX outperformed in Q2, reflecting better sentiment around macro conditions. Meanwhile, operations are tracking a bit better than expected. We initiated a position in the stock in late 2022, after the valuation had adjusted to reflect slower demand and de-stocking in the channel. Fundamentals do not appear to have deteriorated further, and the company has done a good job of controlling the things it can control. TREX entered the slowdown with a strong balance sheet, and responded quickly with cost reductions to protect margin and opportunistic share repurchases. We believe the company’s position as the market leader in composite decking is stable, and we believe that the penetration trend driving the growth of the category remains intact. We continue to view TREX as a solid business that is likely to get stronger over time.

  • Deckers Outdoor (DECK) – DECK manages top brands in the footwear industry, which has allowed them to generate resilient results in the current environment. UGG and HOKA are benefitting from brand heat, and management has done a thoughtful job of acquiring and retaining customers. The company continues to diversify revenue through the growth of HOKA (non-seasonal), and the expansion of UGG into new categories. The cash balance sheet with no debt is an additional element of downside protection.


Top 3 Detractors from Relative Performance 

  • Hanover Insurance Group (THG) – Shares of THG lagged the broader market reflecting exposure to commercial real estate (CRE).  THG has broad exposure to CRE through ownership of commercial mortgage backed securities. While there is certainly risk within the office space, we do not believe the broader CRE asset class as a whole is in significant danger; additionally, THG has significant tranche seniority in their mortgage backed securities book. Investment portfolio aside, we continue to have confidence in THG’s discipline and strategy in navigating this challenging underwriting environment.

  • UniFirst (UNF) – UNF experienced a challenging environment with higher costs (rental garments and one-time items) and management reduced guidance reflecting sustained cost pressures. Margins remain meaningfully compressed relative to pre-pandemic levels. On a positive note, pricing remains strong, as customers seem to understand the justification of higher cost of service. We believe UNF should be able to normalize margin over time, due to the oligopolistic nature of the industry.

  • Sensata Technologies (ST) – ST underperformed the broader market in Q2 as margins declined reflecting the impact of recent acquisitions, as well as softer demand in its end markets. ST has repositioned its portfolio with a focus on electrification for the auto and industrial industries. ST should benefit from tailwinds including higher content per vehicle and sticky client contracts. Management recently increased the dividend, and plans to continue to reduce company debt.


Sector Influence

We are bottom-up stock pickers, but sector exposures influenced relative performance as follows:

  • What Helped: Underweight Utilities & Financials (two weaker performing sectors)

  • What Hurt: Overweight Cons. Staples (a weaker performing sector) & underweight Info. Technology (a better performing sector)


Trades During the Quarter

  • There were no trades during the quarter


Looking Ahead

Uncertainty remains high as we enter the second half of 2023. Continued progress on the inflation front is encouraging, and labor market strength may continue to underpin consumer resilience. That said, we note that core inflation remains above the Federal Reserve’s long-term target of 2%, and it is likely the Fed maintains a restrictive posture if the labor market strength continues. Importantly, monetary policy works with a lag, and we have probably not felt the full impact of prior rate increases or the full effects of tighter lending standards. We remain cautious, as the odds of a recession are still high and the risks of a credit crunch are elevated.

Narrow markets can be quite fragile. The concentrated, top-heavy nature of the market creates an environment prone to risk reversals, and we continue to expect greater volatility in the months ahead. In addition, valuations appear relatively high vs. history, despite concerns about a pending recession and higher interest rates. As inflation concerns subside, we believe growth and employment will come into greater focus. Since the October 2022 bear market low, 100% of the market’s rally has been attributable to P/E valuation multiple expansion. Meanwhile, earnings growth has been weak, and it could weaken further if we enter a recession. We may experience muted returns in the near term, given recession odds and elevated valuations. In that environment, companies that are higher quality, reasonably valued, and prudently returning capital to shareholders are likely better positioned. By that measure, we believe the attractive shareholder yields, quality value orientation, and high active share of our portfolios provide us with a compelling advantage in a fragile market environment with elevated uncertainty.


As we face an economic slowdown with a higher cost of capital environment, we believe companies with strong balance sheets and the ability to self-fund their operations should have a tangible advantage in 2023 and beyond.

Annualized Returns 

As of 6/30/2023

SMID Cap - 2Q2023 vs. R2500 Annualized Returns

Inception date: 3/31/2009. Past performance should not be taken as a guarantee of future results. Performance is preliminary. Subject to change.

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