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Is It a Comeback of the Fundamentals? Well, A...

Is It a Comeback of the Fundamentals? Well, A Mixed Bag

Small Cap Quality Value Review of the Third Quarter of 2021 | KayneCast 164

October 20, 2021

The first half of 2021 was led by lower quality equities, but fundamentals may have become more of a focus in the third quarter. It was a “somewhat mixed picture,” according to Small Cap Quality Value Portfolio Manager and Senior Analyst Julie Kutasov, “especially when it comes to smaller cap stocks.” Names with lower earnings and balance sheet quality still led the Russell 2000 benchmark during the quarter. However, companies with lower volatility and higher returns on equity did outperform.

Kutasov believes the drivers towards fundamentals during this quarter included the inevitable return to post-pandemic normalcy and, more importantly, a change in the interest rate outlook. It became more apparent during the third quarter that the inflationary pressures of supply chain disruptions and labor shortages will have a more meaningful and long-lasting impact than originally anticipated, in part due to the Delta variant, potentially forcing the Fed to raise interest rates sooner rather than later.

Key Contributors and Detractors in Small Cap Quality Value

Listen to the podcast above to learn more about the top 5 contributors and detractors in KAR’s Small Cap Value strategy for Q3 2021.

Rest-of-Year Considerations – Two “I”s and a Wild Card

Interest Rates and Inflation Expectations

Inflation may come or not, but KAR’s Small Cap Quality Value strategy stays away from capital-intensive and direct commodity exposures, and the leading market positioning of its companies gives them solid pricing power to survive inflation.

As for interest rate concerns, KAR’s Small Cap Quality Value companies are likely to be better protected from inflation concerns than their competition. “We seek companies that are strong free cash flow generators (self-funding entities that do not rely on external capital for growth),- so for them, a less accommodative rate environment tends to serve as a tailwind from a competitive standpoint,” says Kutasov.

The Wild Card

According to Kutasov, COVID-19 has proven to be an unpredictable enemy, as evidenced by the Delta variant, so she believes it’ll remain a “wild card” at least in the near term.

DISCLOSURE

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.

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