Needham Growth Fund – 4Q22 Commentary

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MARKET REVIEW

  • Despite the market’s terrible angst and performance in 2022, the major indices were all higher in the second half of 2022. In Q4, the S&P 500 returned 7.56% and the Russell 2000 Growth returned 4.13%.
  • As anticipated, the Federal Reserve raised interest rates by 75 bps to 3.75 – 4.00% on November 2nd and by 50 bps to 4.25 – 4.50% on December 14th. The Fed has indicated plans to increase rates by another 25bps in February. The Fund’s Institutional (NEAIX) and Retail (NEAGX) classes returned 4.63% and 4.44%, respectively, in 4Q22, outperforming the Russell 2000 Growth’s 4.13% return. As manufacturing continues its process of reshoring to the U.S., over half of the Fund’s top contributors are positioned well to continue to benefit.1 2

MACRO OBSERVATIONS

  • Economic announcements in 4Q22 went largely as expected. Year-over-year inflation dropped below 8.0% – historically a very high level, but below the level of Q3. Unemployment remained very low, below 4.0%, as it has all year. Manufacturing and healthcare were areas of strength in the labor market. Real GDP increased at an annual rate of 3.2% in Q3 after a negative Q2.3
  • During 4Q22 the dollar was weak. The DXY index, which measures the U.S. dollar versus a basket of foreign currencies, declined by 7.38% during the quarter.4 Foreign central banks spoke of raising interest rates just as the United States is approaching the end of its rate hike cycle. A weak dollar makes it less expensive for customers in foreign countries to buy goods priced in U.S. dollars.
  • We continue to see atrocities from the Russian assault on civilians in Ukraine. Given the conflict does not seem to have an end insight, countries and regions must shorten supply chains and become self-sufficient in energy and manufacturing.

IMPACTS ON PORTFOLIO PERFORMANCE

  • The Fund’s Institutional (NEEIX) and Retail (NEEGX) classes returned 4.06% and 3.97%, respectively, in 4Q22, underperforming the S&P 500’s 7.56% return.
  • The top contributor was long-time holding Super Micro Computer, Inc. (SMCI). Super Micro designs and manufactures servers. It reported very strong Q3 results, sustained by growth from the large internet companies, which operate their own large data centers.
  • PDF Solutions, Inc. (PDFS) was the second-best contributor and is the second largest position in the Fund at 8.02% of net assets. PDF Solutions saw strong orders for its Exensio® big data analytics software. Exensio® helps customers across the electronics manufacturing industry improve manufacturing yield. PDF Solutions is benefitting from the resurgence of activity in building semiconductor manufacturing plants in the United States.
  • The Fund’s top detractor was Entegris, Inc. (ENTG). Entegris supplies filters, specialty materials, chemicals, and delivery systems used primarily for semiconductor manufacturing. Entegris reported an earnings and guidance shortfall partially due to the United States’ federal restrictions on trade with China.
  • AXT, Inc. (AXTI) was the second largest detractor. AXT manufactures Gallium Arsenide (GaAs) and Indium Phosphide (InP) wafers used to make compound semiconductors. Electrons move much faster in these semiconductors, which enables applications such as high-speed processing for silicon photonics and facial recognition. AXT’s end markets suffered in 3Q22, and the company reported weak earnings and 4Q22 guidance.
  • With 14% 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 targets investments that we perceive to have significant, unrecognized growth opportunities. COVID-19 hastened the revolutionary development in technology and life sciences; the Fund is a long-term investor in companies that enable research and manufacturing to bring these developments to market.
  • The most significant changes to the portfolio were reductions in position sizes. The largest sale was PDF Solutions, where we sold 65,200 shares to end at 338,900. This sale was to manage the position size. The second largest sale was in small cap company Telos Corporation (TLS). Telos has struggled to execute its new product sales. We sold 140,000 shares to end at 120,000. We reduced about 10 other positions for tax planning and strategic reasons.
  • The Fund exited a few of its smaller holdings, including Taiwan Semiconductor Manufacturing Co., Ltd. (TSM). Over the
    long term, we think TSMC may experience challenges as it builds out manufacturing capacity outside of Taiwan.
  • The Fund did not add any new positions in 4Q22 but took advantage of market weakness to add to a few existing positions. The largest addition was to Aspen Aerogels, Inc. (ASPN), which was a very disappointing stock in 2022. The company was selected by General Motors Company (GM), Toyota Motor Corp. (TM), and other electric vehicle makers to provide aerogel insulation to prevent fires in lithium-ion batteries. However, the company needs to build a plant to meet the demand and needed to raise capital to build the plant. We added 35,000 shares in the company’s secondary stock offering in November.

LOOKING AHEAD & OPPORTUNITIES

  • We continue to see opportunities in the reshoring of manufacturing in the United States. We recommend reading The Titanium Economy: How Industrial Technology Can Create a Better, Faster and Stronger America by Asutosh Padhi, Gaurav Batra, and Nick Santhaman of McKinsey and Company.5 Portfolio holding Clean Harbors, Inc. (CLH) is featured in the book. Over half of the Fund’s top contributors in 4Q22 are part of the industrial technology universe.
  • Many of our largest portfolio holdings have made multi-year investments that we believe positions them to deliver growth and positive returns over the next few years. We believe if these investments succeed, they could provide a hedge against macroeconomic factors, such as inflation.

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.


Investment returns and principal value will fluctuate, and when redeemed, shares may be worth more or less than their original cost. Performance data quoted represents past performance and does not guarantee future results. Current performance may be higher or lower than these results. Performance current to the most recent month-end may be obtained by calling our transfer agent at 1-800-625-7071. Total return figures include reinvestment of all dividends and capital gains.

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 12/31/22: Needham Growth Fund's ownership as a percentage of net assets in the stated securities as of 12/31/22: SMCI: 3.92%, PDFS: 8.02%, ENTG: 5.39%, AXTI: 1.22%, TLS: 0.51%, TSM: 0.00%, ASPN: 3.91%, GM: 0.00%, TM: 0.00% and CLH: 1.13%.


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 2022. 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.