Needham Aggressive Growth Fund – 3Q23 Commentary

Download PDF

MARKET REVIEW

  • In 3Q23, the Russell 2000 Growth and Russell 2000 Indices were down 7.32% and 5.13%, respectively, and the S&P 500 lost 3.27%.
  • In July, the Federal Reserve raised interest rates 25 bps to 5.25% – 5.50% and then paused in September. The Fed indicates that there could be one more rate increase in 2023.1
  • 10-year Treasury yields increased from 3.8% to 4.6%, the highest level since 2007.

 

MACRO OBSERVATIONS

  • The economy continued to move forward with estimated 3Q23 GDP growth of 5.8%, well above 2Q23’s 1.7%. This marks the fifth successive growth quarter. 3Q23 is estimated to be the fifth quarter of 3-4% consumer price index inflation, after 5-7% the preceding four quarters.
  • We were shocked and saddened by the Hamas terror attack on Israel on October 7. Our portfolio companies have employees in Israel, and every one of those employees is affected. We believe Israel will prevail over those that seek its destruction.
  • Our investment focus on the reshoring of U.S. manufacturing and infrastructure seems all the more relevant. We consider Israel to be an important participant in providing technology and products for its own infrastructure and for that of the United States.

IMPACTS ON PORTFOLIO PERFORMANCE

  • In 3Q23, the Fund’s Institutional (NEAIX) and Retail (NEAGX) classes returned -1.84% and -1.95%, respectively, outperforming the Russell 2000 Growth’s -7.32%.
  • The Fund’s top two contributors in 3Q23 were Vertiv Holdings Co. (VRT) and Super Micro Computer, Inc. (SMCI). Both supply “picks and shovels” to data centers2 and have seen strong results from customer spending on artificial intelligence.
  • Vertiv supplies power, cooling, and infrastructure management systems for data centers. Vertiv is a newer position, as we first purchased in 2021.
  • Super Micro was again one of the Fund’s top contributors. Super Micro designs and manufactures servers. It reported strong results driven by its high-growth Artificial Intelligence GPU (graphics processing units) and rack-scale solutions. Super Micro was the Fund’s largest position at 6.58% of net assets as of September 30. The Fund has owned the stock since 2009.
  • The Fund’s top detractor in 3Q23 was PDF Solutions, Inc. (PDFS). PDF’s Exensio® data analytics platform helps customers across the electronics manufacturing industry improve manufacturing yield. PDF reported strong 2Q23 earnings, but analysts’ estimates of second half revenue growth were reduced from 18% to 13%. We took advantage of the market weakness and added to our position.
  • KVH Industries, Inc. (KVHI) was the second leading detractor. On its earnings call, KVH announced that the Board of Directors had concluded its review of strategic alternatives without changes. The market was expecting a merger or sale to take advantage of economies of scale. We believe KVH now needs to improve profitability and seek consolidation.
  • With 9% turnover, the Fund does not rotate into or out of sectors but invests in companies we believe can outperform over the long term.

PORTFOLIO CHANGES

  • The Fund made several new investments and added to a number of existing holdings. It also sold a few small positions and reduced one major holding.
  • New purchases:
    • The largest new holding is Carter’s, Inc. (CRI), the leader in children’s apparel. The stock and business have suffered due to the weak consumer cycle. We believe it is a durable, growing company with great management.
    • Alteryx, Inc. (AYX) – a data analytics software company that we believe is undergoing a misunderstood transition to SaaS.
    • Fortrea Holdings, Inc. (FTRE) – Fortrea performs randomized drug trials. The Fund received shares from its spin-out from Laboratory Corporation of America Holdings (LH) and purchased additional shares.
    • Genius Sports Limited (GENI) – an analytics and technology partner for sports leagues and gaming companies. We think it could benefit as online gaming expands and as sports leagues look to enhance the viewing experience.
  • Major additions:
    • Vishay Precision Group, Inc. (VPG) – a specialty sensor company and top 10 holding of the Fund.
    • FARO Technologies, Inc. (FARO) – a metrology company serving engineering, manufacturing, and public safety markets.
    • Vicor Corporation (VICR) – a top 10 holding for years. Vicor makes power conversion devices used for data centers, electric vehicles, and more. We added on weakness.
  • Reduced position:
    • ESI Group SA (ESI-FR) – the Fund sold about 40% of its holding in ESI as we await the completion of its acquisition byKeysight Technologies, Inc. (KEYS). We believe the acquisition may close in 1Q24.

RECOMMENDED READING – Outlive by Peter Attia, MD

  • I’d like to close with an optimistic note. Some think that the investment story of 2023 is not AI, but the GLP-1 (glucagon-like peptide) agonist drugs, such as Novo Nordisk’s Ozempic and Wegovy, and Eli Lilly’s Mounjaro. These “miracle drugs” are credited with managing diabetes and weight loss and have ongoing studies for the treatment of other chronic diseases. These drugs help the body deal with glucose, and their rapid adoption has affected stocks for medical devices, retailers, and even food companies.
  • However, the benefits of GLP-1s reverse when one stops taking them, and their long-term side effects are unknown. The drugs are so expensive that they could overwhelm government and private payors. We see GLP-1s as providing benefits for patients without alternatives. However, there is an alternative for many
  • My favorite private company is Virta Health3, which has a mission to reduce Type-2 diabetes in millions of people through nutrition, coaching, and education. We featured Virta in The Growth Factor 28.4
  • I recommend Dr. Peter Attia’s Outlive5, which presents the case for a different healthcare model built around exercise, nutrition, sleep, and emotional health. Our legacy healthcare model – built on hospitals, specialists, and drugs like GLP-1 – attempts to address acute diseases but is terrible at adding years of functional life. It is incredibly hopeful to imagine a future with true, functional health and enough cost savings to eliminate the Federal deficit. For more information, we recommend the writings and podcasts featuring Virta’s CEO, Sam Inkinen6 and Dr. Attia’s, The Drive podcast. I believe there will be more to follow on this topic in future commentaries and Growth Factors.

[1] https://www.barrons.com/livecoverage/fed-september-meeting-rate-decision-powell-speech-today/card/fed-s-dot-plot-points-to-one-more-rate-increase-this-year-VVKoDxho88efLql5BdQY
[2] Growth Factor 37: Investing in the “Picks and Shovels”
[3] https://www.virtahealth.com/join/benefits?utm_source=Googlead&utm_medium=GA-Brand-Exact-Search&utm_campaign=2022-Q3-Brand-Exact&utm_content=GA-BrandExact&campaignid=16934261972&adgroupid=135659886717&adid=593274558903&gad=1&gclid=EAIaIQobChMI2eTh7erzgQMV1lBHAR2aGA8tEAAYASAAEgJ7KPD_BwE
[4] https://www.needhamfunds.com/gf_commentary/private-company-profile-virta-health-inc/
[5] Attia, Peter, and Bill Gifford. Outlive: The Science & Art of Longevity. Vermilion, 2023.
[6] https://www.ncqa.org/videos/quality-talks-2022-sami-inkinen-on-taking-diabetes-reversal-mainstream/

DEFINITIONS AND DISCLOSURES

The information presented in this commentary is not intended as personalized investment advice and does not constitute a recommendation to buy or sell a particular security or other investments. This message is not an offer of the Needham Growth Fund, the Needham Aggressive Growth Fund or the Needham Small Cap Growth Fund (each a "Fund" and collectively, the "Funds"). Shares are sold only through the currently effective prospectus, which must precede or accompany this report. Please read the prospectus or summary prospectus and carefully consider the investment objectives, risks and charges and expenses of the Funds before you invest. To obtain a copy of the Fund's current prospectus, please visit www.needhamfunds.com or contact the Fund's transfer agent, U.S. Bancorp Fund Services, LLC at 1-800-625-7071.

All three of the Needham Funds have substantial exposure to small and micro capitalized companies. Funds holding smaller capitalized companies are subject to greater price fluctuation than those of larger companies. Needham Aggressive Growth Fund's ownership as a percentage of net assets in the stated securities as of September 30, 2023: VRT: 2.87%, SMCI: 6.58%, PDFS: 4.16%, KVHI: 1.15%, CRI: 1.13%, AYX: 0.71%, FTRE: 0.24%, LH: 0.85%, GENI: 0.18%, VPG: 2.39%, FARO: 0.65%, VICR: 3.55%, ESI-FR: 2.50%, KEYS: 0.00%, NVO: 0.00%, LLY: 0.00% and Virta Health (Private): 0.00%.

The Global Industry Classification Standard (GICS®) was developed by and/or is the exclusive property of MSCI, Inc. and Standard & Poor’s Financial Services LLC (“S&P”). GICS is a service mark of MSCI and S&P and has been licensed for use by U.S. Bancorp FundServices, LLC. The S&P 500 Index is a broad unmanaged measure of the U.S. stock market. The Russell 2000 Index is a broad unmanaged index composed of the smallest 2,000 companies in the Russell 3000 Index. The Russell 2000 Growth Index includes those Russell 2000 Index companies with higher price-to-value ratios and higher forecasted growth values. An investor cannot invest directly in an index. Needham & Company, LLC is a wholly owned subsidiary of The Needham Group, Inc. Needham & Company, LLC, member FINRA/SIPC, is the distributor of The Needham Funds, Inc.

The source of the data for each of the Russell 2000 Index and the Russell 3000 Index (together, the “Indexes”) is the London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2023. All rights in the Indexes vest in the relevant LSE Group company which owns the Index. The Indexes are calculated by or on behalf of FTSE International Limited or its affiliate, agent or partner. Neither the LSE Group nor its licensors accept any liability for any errors or omissions in the Indexes; no party may rely on the Index returns shown; and the LSE Group makes no claim, prediction, warranty or representation about the Fund or the suitability of the Indexes with respect to the Fund. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group is not connected to the Fund and does not promote, sponsor or endorse the Fund or the content of this prospectus.