Julie Kutasov

Julie Kutasov
Portfolio Manager and Senior Research Analyst
Kayne Anderson Rudnick

KAR portfolio manager Julie Kutasov reviews the performance of small-cap value equities in the first quarter, the largest contributors and detractors in the KAR Small-Cap Value strategy, and expectations for earnings growth.

Listen Now


BEN FALCONE: Hello, this is Ben Falcone, managing director with Kayne Anderson Rudnick, and with me today, I have Julie Kutasov, portfolio manager of the KAR Small Cap Quality Value strategy. Welcome, Julie. 

JULIE KUTASOV: Hello, Ben. Happy to be here. 

BEN FALCONE: Julie, market returns were broadly positive again in the first quarter even though many issues, including clarity on future Fed movements, geopolitical risk in an upcoming presidential election, even though heavily debated, still remain. Amidst the talk as well about the potential broadening of returns, the first quarter reverted right back to concentrated returns in the S&P leading the market with mid caps a solid second and then a fewer smaller AI-related growth companies driving returns for the broader small-cap index. Can you provide our listeners with your perspective on markets for the start of 2024?

JULIE KUTASOV: Sure. U.S. stocks had a solid first quarter with the S&P 500® Index up over 10%, driven by a highly concentrated group of companies, as you mentioned. Larger--cap names outperformed smaller caps and growth companies, many of these AI-driven as you noted, outperformed value counterparts. It was primarily an expectation of upcoming reductions in interest rates that drove equities’ performance during the quarter. Recall that the rally initially began in early November, driven by an improved inflation outlook and continued following the Fed's December meeting, but investors interpreted Chairman Powell's comments to mean that the Federal Reserve was ready to stop rate hikes and even cut and pivot from higher-for-longer expectations previously.

Inflation in the U.S. did in fact come down meaningfully as supply chains had normalized and as labor markets had cooled. And consumer spending, the key driver of the U.S. economy, held up well as easing inflation and strong wage growth boosted purchasing power. While improved, inflation remains elevated, however, and as recent CPI data suggests, may be more stubborn than anticipated. In addition, oil prices rose during the quarter, adding to inflationary pressures. As such, central bankers may potentially reduce the number of rate cuts or push them further into the future. 

The first quarter's performance of the Russell 2000® Value Index, the strategy’s benchmark, was driven by companies with low earnings quality, weaker balance sheets, and high volatility—an unfavorable environment for us as investors in high-quality companies. 

Despite these headwinds, the strategy outperformed the benchmark during the quarter primarily as we benefited from our underweight exposure to the underperforming banking segment and an overweight position in the outperforming industrial sector. We have a structural lower position in the banking segment due to its inherent capital intensity. Banks represent a sizable, nearly 16% weight, in the Russell 2000 Value benchmark, and were down over 6% during the quarter as investors became less certain of the timing of the Federal Reserve's interest rate reductions.

BEN FALCONE: Julie, can you discuss a few of the portfolio holdings that were key contributors and detractors to performance for the first quarter of 2024?

JULIE KUTASOV: Construction Partners was our highest stock contributor for the quarter. Other top contributors were Armstrong World Industries, Primerica, Hillman Solutions, and Houlihan Lokey. 

Construction Partners engages in construction of roadways and highways. The company focuses on smaller road resurfacing and maintenance projects where competition is typically limited to local players. Hot asphalt must remain above a certain temperature, limiting the distance it can be transported to the construction site. This creates niche geographical markets with Construction Partners holding a leading position in each of its markets. Shares performed strongly as the company continued to gain market share and benefit from strong road infrastructure spending. Profitability also improved as most of the work completed during the quarter came from a high margin post-inflationary backlog. 

Bank of Hawaii was our weakest performer during the quarter. Other detractors included Azenta, RBC Bearings, UniFirst Corp., and National Beverage Corp.

Bank of Hawaii is the second largest bank by deposits in the state of Hawaii. The bank has strong brand recognition among Hawaiians who tend to be loyal bank customers. The remoteness and high real estate costs of the islands create significant barriers to entry. In the past, some of the largest mainland banks tried and failed in building a presence in Hawaii. Shares lagged, along with those of other regional banks, as investors became less certain of the timing of the Federal Reserve's interest rate reductions. Importantly, recent quarterly results showed continued stability in the bank's deposit franchise and asset quality.

BEN FALCONE: Julie, we know that longer-term earnings drive performance. Can you speak about this particular strategy and what you see in terms of current earnings growth, as well as longer-term expectations?

JULIE KUTASOV: We run a focused portfolio of high-conviction, high-quality names. We're looking for solid business models and strong under-leveraged balance sheets, which are the result of the self-funding abilities of these companies, certainly important in a high interest rate environment like the one we're facing today. 

Consistency is also very important to us, particularly as it relates to companies’ performance during challenging periods, such as the Great Recession or the pandemic. We spend a lot of time trying to understand what drives these companies’ earnings resilience and what makes the strong financial results sustainable into the future.

The strategy's investment objective remains unchanged. Over an economic cycle, we strive to achieve returns that are meaningfully above those of the Russell 2000 Value benchmark, but with low overall risk, and we believe that the portfolio is well positioned to achieve this goal. Holdings in the strategy have had return on equity averaging nearly 22% over the past five years—more than twice that of the Russell 2000 Value index. Importantly, unlike the benchmark, these companies achieve these ROE’s with under-leveraged balance sheets. Over the past 10 years, the consistency of our company's earnings not only outpaced the Russell 2000 Value Index, but also the S&P 500. Even more importantly, capital generation, the source of future growth, also significantly exceeds that of the benchmark. 

As the widely anticipated downturn failed to materialize, recession fears have given way to a soft landing outlook. History tells us, however, that it does take time for interest rate increases to ripple through the economy. In the past 11 Fed rate-hiking cycles, recessions typically started about two years after the central bank began raising rates. This cycle started in March 2022. While we have been impressed and quite frankly surprised by the resilience of the U.S. economy, an economic slowdown remains a key risk in our view, particularly considering continuing inflationary pressures and growing tensions on the geopolitical front. 

As I mentioned, inflation may prove to be more stubborn than expected and there are concerns that it could surge again, mirroring the second wave that characterized the high inflation of the 1970’s. While the environment remains uncertain, we believe that our focus on high-quality companies, differentiated businesses, self-funding entities producing stellar returns on capital from strong balance sheets is particularly relevant today.

BEN FALCONE: Julie, as always, thanks for taking the time to provide your insight to our KayneCast listeners. 

JULIE KUTASOV: Thanks, Ben.  

Investment Partner

Kayne Anderson Rudnick Investment Management, LLC (KAR) Logo 960x600 Transparent Primary

This information is being provided by Kayne Anderson Rudnick Investment Management, LLC (“KAR”) for illustrative purposes only. Information contained in this material is not intended by KAR to be interpreted as investment advice, a recommendation or solicitation to purchase securities, or a recommendation for a particular course of action and has not been updated since the date of the material, and KAR does not undertake to update the information presented should it change. This information is based on KAR’s opinions at the time of the recording of this material and are subject to change based on market activity. There is no guarantee that any forecasts made will come to pass. KAR makes no warranty as to the accuracy or reliability of the information contained herein.

Investing is subject to risk, including the risk of possible loss of principal.

Past performance is no guarantee of future results.