Q4 KAR Mid-Cap Core Portfolio Review Podcast

Transcript

JORDAN GREENHOUSE: Hello, this is Jordan Greenhouse, managing director with Kayne Anderson Rudnick, and with me today I have Jon Christensen, portfolio manager and senior research analyst with the Kayne Anderson Rudnick Mid-Cap Core portfolio. Jon, thanks for being here today.

Jon, the fourth quarter of 2022 saw some improvements in equity returns, supported by the expectations of the Fed potentially slowing down their tightening cycle. Can you discuss some of the conditional factors that support these returns?

JON CHRISTENSEN: Of course. 2022 has been a real rollercoaster for the markets with the first three quarters feeling like an endless fall before Q4 was a positive, but when you look at the individual months in 2022, we had five positive months and seven negative ones, so a rollercoaster I think is a good analogy.

As we’ve moved through the year, investors have worried about everything from inflation, to war, to supply chain delays, to recession fears, to atmospheric rivers and cyclone bombs that are impacting the drought-ridden western U.S., but you’re correct in that Q4 felt like investors were getting more comfortable with an impending recession and hoped that the Fed will become less hawkish.

So, the combination of investors putting money to work after being down three straight quarters, as well as taking the longer-term look for the economy, enhanced returns for the Russell Midcap® Index in Q4, which rose 9.2%.

We are not completely out of the woods yet in terms of the markets. As you know, last year at this time we had unexpected events such as the Ukraine war throw expectations into chaos.

Even within Q4, it was volatile as the year was. The Russell Midcap was up 8.9% in October, then up 6% in November, but fell 5.4% in December. Again, a rollercoaster not unlike 2022 as a whole.

When looking at the overall attribution in Q4 for the Russell Midcap, energy, healthcare, and industrials were the sectors that held up the best. Metrics between low and high quality, it was skewed toward lower quality in the quarter overall when looking at statistics such as S&P stock rankings, beta, and balance sheet strength. So, the volatility in the market that showed up in the lower-quality names doing better, which is historically what has happened.

JORDAN GREENHOUSE: Jon, what were some of the names that detracted most from the performance during the quarter, and what were some of the names that contributed positively?

JON CHRISTENSEN: In terms of detractors from the portfolio in the quarter, they were Aspen Technologies, First Financial, Monolithic Power Systems, Broadridge Financials, and West Pharmaceutical.

Let’s look for a moment at West. West Pharmaceutical Services manufactures and markets pharmaceuticals, biologics, vaccines, and consumer healthcare products. It operates through the following business segments: proprietary products and contract-manufactured products.

West continues to report strong demand for its core products that has been offset by continued decline in COVID-related revenue. The drops have been more substantial than investors had predicted, most likely because the steep increases were less than well understood. That said, execution and profitability remain strong, and the company has many design wins for 2023 that we believe should preserve long-term growth for the company.

Discussing the positive contributors to Mid-Cap Core in Q4, they were AMETEK, Ross Stores, Azenta, Globus Medical, and CooperCompanies.*

Regarding AMETEK, AMETEK manufactures nuanced and niche electronic products such as sensors and process control systems, which are primarily used for industrial, aerospace, and energy applications.

The shares were strong in the quarter after reporting solid financial results that showed the company’s ability to pass through pricing in this difficult inflationary environment. After weakness earlier in the year, the stock has been solid as investor confidence returns due to solid execution on the supply chain issues, as well as ongoing consistent demand from its end markets.

JORDAN GREENHOUSE: Lastly, as we move into the first quarter, what are some of the key considerations you and the team are evaluating from a portfolio perspective?

JON CHRISTENSEN: As we move into the new year, inflation and supply chain issues continue to impact markets, and the ongoing Russia-Ukraine conflict has only added to the uncertainties and enhanced volatility. The Fed feels like it's setting the stage for easing down the road. Inflation feels like it is subsiding or at least peaking.

If we do indeed have a recession, the question is how long does it endure and how hard of a landing will the economy have? These conflicts are showing up in the market performance described above – a rollercoaster of up and down months.

We continue to believe that we are well positioned to ride out the turbulence. Our goal is to find solid companies with business models that can react and persevere in reaction to these pricing pressures and volatility by creating and maintaining competitive moats. These are companies that have the ability to pass through pricing while maintaining high customer retention through their value add of their products to its customers. From our perspective, these solid revenue characteristics should mitigate some of the heavy impact they are seeing from these higher input costs.

This means we need to have patience and diligence in researching for these companies while monitoring our existing holdings for changes in their structural investment stories, especially now.

But our mandate is clear and consistent, as we focus on high-quality businesses that we believe should outgrow their markets over the long term and take advantage of this market volatility.

JORDAN GREENHOUSE: Jon, as always, thank you very much for your time and the perspectives you provide our listeners.