Lower-Quality Bias Losing Ground to Focus on...

Lower-Quality Bias Losing Ground to Focus on Fundamentals

Small Cap Core Review of the Third Quarter of 2021 | KayneCast 166

November 2, 2021

Lower quality equities have led the market in the small-cap space since Q2 2020 when the announcement of effective vaccines boosted the momentum of many of these stocks. After a strong Q1 2021 for the Russell 2000, things started to cool off during Q2 with a further decline during Q3. Jon Christensen, Senior Portfolio Manager and Analyst for KAR’s Small Cap Core strategy, notes that while the market fell, it was still mixed in terms of high vs. low quality, with higher quality doing better, but not by much.

Overall, the market year to date is still lower quality biased. However, Christensen believes fundamentals and business strength are coming into focus as businesses try to sustain these high valuations past the lifespan of their pandemic-related boosts, and as a result, he believes this should swing the pendulum toward higher quality equities.

Key Contributors and Detractors in Small Cap Core 

Listen to the podcast above to learn about the top contributors and detractors in KAR’s Small Cap Core strategy for Q3 2021.

Opportunities Exist in Temporary Valuation Disconnects 

At this point in 2021, we are moving closer to the goal of a normal economy than we were a year ago, and progress continues as the country gets vaccinated. Christensen believes the market has taken this into account with strong returns over the past year.

“As I said before, valuations are being stretched as a result. So, the businesses with higher than usual valuations have high expectations built into them – and some may be able to grow and sustain that – while others with small or no competitive moats may struggle to meet these expectations.”

“Our goal is to buy those businesses that have temporary valuation disconnects so that we can take advantage. We need to have patience and diligence in researching these companies while monitoring our existing holdings for changes in their investment stories. The post-COVID world will look very different in the years to come versus pre-COVID. The opportunity set is promising; we just need to be clear and consistent in our mandate to focus on high-quality businesses.”


Learn more about our small cap core portfolio today. 

This information is being provided by Kayne Anderson Rudnick Investment Management, LLC (“KAR”) for illustrative purposes only. Information contained in this material is not intended by KAR to be interpreted as investment advice, a recommendation or solicitation to purchase securities, or a recommendation of a particular course of action and has not been updated since the date of the material, and KAR does not undertake to update the information presented should it change. This information is based on KAR’s opinions at the time of the recording of this material and are subject to change based on market activity. There is no guarantee that any forecasts made will come to pass. KAR makes no warranty as to the accuracy or reliability of the information contained herein.