Needham Small Cap Growth Fund – 3Q23 Commentary

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MACRO OBSERVATIONS

  • Inflation has improved, but the challenges of elevated costs in housing, food, and labor remain. We anticipate that the Federal Reserve may raise rates one more time, although the long end of the yield curve has risen substantially.
  • The next few quarters should allow the economy to digest the impact of higher interest rates, and global economic growth should continue to slow as the impact of the higher capital costs filters throughout the economy. Liquidity and credit availability have been reduced, which puts pressure on risk assets.
  • Corporate layoffs continue, as management teams prepare for the possibility of a weaker economy and slower business opportunities.
  • Companies continue to adjust inventory levels to meet lower demand and higher cost of capital.
  • Unfortunately, geopolitical risks have escalated, which we expect will persist for an extended period.

IMPACTS ON PORTFOLIO PERFORMANCE

  • The Fund’s Institutional (NESIX) and Retail classes (NESGX) returned -10.15% and -10.30%, respectively, in the third quarter, underperforming the Russell 2000 Growth’s -7.32%.
  • The Fund continued to be under pressure in the quarter, as small-cap companies remained out of favor with investors. The Fund maintained a high level of cash in expectation of more attractive valuation levels for deployment. We expect the upcoming earnings season to remain challenging and tax loss selling season to further pressure underperforming equities.
  • Finally, after years of selling pressure and investor avoidance, we believe there is significant value within the asset class. We look forward to 2024, as management teams focus on improving cost structures and balance sheets. However, the transition to this improved profile is not over yet.
  • The Fund’s top five performers in 3Q23 were: Standard BioTools, Inc. (LAB), Vicor Corp. (VICR), New Relic, Inc. (NEWR), Aspen Aerogels, Inc. (ASPN) and SiTime Corp. (SITM).
  • The Fund’s top five detractors in 3Q23 were: Cambium Networks Corp. (CMBM), Akoustis Technologies, Inc. (AKTS), nLIGHT, Inc. (LASR), Adtran Holdings, Inc. (ADTN) and KVH Industries, Inc. (KVHI).

OUTLOOK

  • Higher interest rates are impacting economic activity; companies are focused on their balance sheets and stockpiling cash. Investments are delayed, which impacts supply chains. The recent auto union strikes will pressure activity within their suppliers, and we are hopeful that a resolution will be reached soon.
  • The financial meltdown we experienced in March reminded us of the fragility and interconnectedness of our financial system. Higher interest rates may cause further stress within the regional banking system, but it is hard to predict if we will experience a repeat of March. We remain concerned about the continued ripple effects from the crisis and the lower expected liquidity for both retail investors and the financial markets.
  • Capital markets continue to face challenges, and companies needing to raise funds are finding that the cost of capital is substantially higher than in past years. The higher cost of capital weighs substantially on equity valuations.
  • Technology remains a long-term strength of the economy, and several major secular trends remain firmly in place to support continued growth. Areas of long-term investment that we continue to like are mobile electrification, communications infrastructure, defense, AI, cloud computing, 5G devices and wireless connectivity, software and security, and specialty material manufacturers. Innovation within our portfolio companies continues, and over the long term, we believe these investments will benefit the Fund.

DISCLOSURES AND DEFINITIONS

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 Small Cap Growth Fund's ownership as a percentage of net assets in the stated securities as of September 30, 2023: LAB: 2.41%, VICR: 4.94%, NEWR: 2.84%, ASPN: 7.96%, SITM: 0.09%, CMBM: 3.78%, AKTS: 0.26%, LASR: 4.00%, ADTN: 6.71%, KVHI: 1.75%.

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.