Needham Small Cap Growth Fund – 4Q23 Commentary

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MACRO OBSERVATIONS

  • Inflation has significantly improved, but the headwinds of elevated costs in housing, food, and labor remain. We believe the Federal Reserve is finished raising rates and will begin to cut rates in summer 2024.
  • The next few quarters should allow the economy to continue digesting the impact of higher interest rates. Global economic growth should continue to slow as the impact of the higher cost of capital filters throughout the economy. We do not expect a major recession.
  • Corporate layoffs continue as management teams prepare for the possibility of a weaker economy and slower business opportunities. Higher unemployment would support the argument for interest rate cuts later in 2024.
  • Companies continue to adjust inventory levels to meet lower demand and the higher cost of capital needed to retain inventory levels. We expect inventory levels to stabilize over the first half of 2024, leading to a more balanced supply and demand relationship.
  • Unfortunately, geopolitical risks around the world have escalated, and we expect will persist for an extended period. The U.S. presidential election in November will also add volatility and uncertainty.

IMPACTS ON PORTFOLIO PERFORMANCE

  • The Fund’s Institutional (NESIX) and Retail classes (NESGX) returned 14.73% and 14.63% in the fourth quarter, compared to the Russell 2000 Growth’s 12.75%.
  • The Fund started the quarter under pressure. However, by mid-quarter and into year-end, the appetite for small-cap stocks rallied substantially. We deployed the majority of our cash position on the market pullback in October and ended the year with a historically low cash position.
  • We believe there is significant value within the small-cap asset class after years of selling pressure and investor avoidance. We look forward to 2024 and investing in management teams that focus on improving cost structures and strengthening balance sheets. However, the transition to this improved profile is not over yet.
  • The Fund’s top five performers in 4Q23 were: Aspen Aerogels, Inc. (ASPN), TTM Technologies, Inc. (TTMI), nLIGHT, Inc. (LASR), Alteryx, Inc. (AYX), and Frequency Electronics, Inc. (FEIM).
  • The Fund’s top five detractors in 4Q23 were: Vicor Corp. (VICR), ADTRAN Holdings, Inc. (ADTN), Cambium Networks Corp. (CMBM), Standard BioTools, Inc (LAB), and Akoustis Technologies, Inc. (AKTS).

OUTLOOK

  • Higher interest rates are impacting economic activity as companies are focused on their balance sheets and hoarding cash. Investments are being delayed, which impacts supply chains. The financial meltdown we experienced last March highlighted the fragility of our financial system and the interconnectedness of financial institutions. Higher interest rates may cause further stress within the economy, as real interest rates increase as inflation decreases.
  • 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. We expect capital markets to show signs of recovery in 2024, as the expectation of lower Fed Funds rates is more visible on the horizon.
  • 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, wireless connectivity, software and security, and specialty material manufacturers. Innovation within our portfolio companies continues, and long-term, we believe these investments will benefit the Fund.

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 December 31, 2023: ASPN: 12.72%, TTMI: 6.18%, LASR: 4.46%, AYX: 4.50%, FEIM: 2.12%, VICR: 4.32%, ADTN: 4.19%, CMBM: 2.66%, LAB: 1.45% and AKTS: 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.