Conestoga Capital Advisors released its “Micro Cap Strategy” fourth-quarter 2023 investor letter. Despite growing by 12.70% net of fees in the fourth quarter, the strategy did not match the 15.64% return of the Russell Micro Cap Growth Index. Underperformance was mostly caused by poor stock selection in the Health Care and Industrials, data shows.
The Micro Cap Composite declined -1.02% net-of-fees, trailing the Russell Micro Cap Growth Index’s gain of 9.11% for 2023. Positive effects on sector allocation and stock selection in the technology and basic materials sectors helped the portfolio. The majority of the underperformance was mostly centered in the consumer discretionary, health care, and industrial sectors, where choosing stocks proved to be difficult.
As of Dec. 31, Conestoga’s total assets were $7.8 billion. Assets within their four primary institutional investment strategies were:
- Small Cap Growth: $6.3 billion
- SMid Cap Growth: $1.5 billion
- Micro Cap Growth: $41 million
- Mid Cap Growth: $22 million
“The market’s rally has raised valuations to more normal levels, and we note that investors may have become too comfortable in their outlook for the year ahead,” the firm wrote in the letter. “While the current economic indicators do indeed look favorable, a number of risks remain. Perhaps none is more obvious than a simple overenthusiasm for the economy, inflation and interest rates.”
Conestoga added that conversation with the management teams of companies in its portfolio, particularly those in the Industrials sector, reveals that many are concerned about a weakening economy.
“Could the soft landing turn out to be a bit bumpy – absolutely,” the firm noted. “Similarly, it is easy to imagine an economy that is stronger or inflation that is stickier than expected, causing the Federal Reserve to slow the pace of interest rate cuts. Geopolitics, global conflicts and domestic politics will likely also be factors affecting investor sentiment in the year ahead.”
Forecasts of a recession failed to be realized in 2023 and were replaced by expectations for a soft landing and cooling inflation pressures in 2024. As 2023 came to a close, investors recalibrated their expectations for interest rates to include several cuts by the Federal Reserve over the year ahead.
Yields on the benchmark U.S. Treasury 10-Year Bond fell from a high of nearly 5% in October to just under 4% at the end of the year. Stocks reacted enthusiastically and surged in the fourth quarter, with both the S&P 500 and Russell 2000 indices rising over 10% in the period. While small cap stocks outperformed in the fourth quarter, large cap stocks bested their smaller cap brethren for the full year.
Conestoga’s four primary investment strategies posted mixed results for the full year 2023, with its Small Cap Growth and SMid Cap Growth strategies outperforming while the Micro Cap Growth and Mid Cap Growth strategies underperformed. Read more.
