Mutual Fund Commentary

Intrepid Small Cap Fund

1Q 2024

April 1, 2024

Dear Fellow Shareholders,

After closing 2023 with a blistering pace, small caps continued to grind higher in the first quarter of calendar 2024.

Investors appeared to fully embrace the “no landing” scenario in which the economy avoids a recession despite rates remaining higher. All major equity indices moved higher in spite of increases in the 10-year treasury rate and inflation expectations (evidenced by 10-year breakeven rates).

Risk appetite also seemed to return:

  • Growth and momentum-driven strategies excelled. The MSCI USA Momentum Index tallied its second-best quarter in the last 20 years. Q1 of 2024 trailed only Q2 of 2020, which notably followed the steep pandemicdriven decline of Q1 2020 (-15%) – a much easier comparison than the strong returns from Q4 of 2023 (+13%).

  • Bitcoin returned 66% during the quarter, while a handful of other more speculative crypto coins went vertical. Coinbase, a good barometer of the overall cryptocurrency ecosystem, returned 52%.
  • Nvidia (NVDA) added over $1 trillion in market cap (+92%). To be fair, the fundamental outlook for the company has improved tremendously. Still, it’s hard to overstate the sheer size and speed of such an increase. In the span of three months, the company added market value roughly equivalent to the entire GDP of the Netherlands.
  • Credit spreads vs 10-year Treasury rates declined to 2-year lows

As noted in prior letters, we have not taken a view on the broader economy, nor have we tried to select stocks that we expect to perform in a particular macro environment. We take a bottoms-up perspective and seek businesses that (1) have the balance sheet and competitive position to endure any environment and (2) trade at attractive levels relative to long-term fundamentals.

During the quarter ended March 31, 2024, the Intrepid Small Cap Fund (“the Fund”) returned 3.15%, compared to 5.69% for the benchmark Morningstar Small Cap Index. Historically, the Fund has underperformed broader equity indices during periods when momentum stocks and growth stocks have thrived.

It’s also worth noting that the Fund’s performance relative to its benchmark has been less correlated than normal recently. Over the last three quarters, monthly tracking error has averaged over 2%, which is the highest level since Q3 of 2021 (when market volatility was markedly higher). We normally expect higher tracking error than peers given our high active share and concentrated position sizes. The recent more elevated levels – perhaps due to the trend following that seems more prevalent today – could partially explain some of the difference this quarter.

The top three contributors to performance this quarter were Becle SAB De CV (CUERVO), Valvoline (VVV), and Acuity Brands (AYI).

The top three detractors to performance were WNS Holdings (WNS), Keyword Studios (KWS LN), and Dropbox, Inc. – Class A (DBX). WNS, a business process outsourcing (BPO) firm, has been a thorn in the side of the Fund for a few quarters now and is worth a more detailed discussion. Its stock has fallen victim to the narrative that AI will totally disrupt its business model. To make matters worse, it lost a major customer during the quarter, which is a very rare occurrence given how integrated they become with their customers. While we are believers in the enormous potential for companies adopting AI, we think that the market’s punishment of WNS stock is misplaced. Our view is that firms like WNS will also adopt these artificial intelligence (AI) solutions and integrate them into their client service models. We think this is a much cheaper and more efficient solutions for clients than terminating the relationship and suddenly in-sourcing these non-core functions that have long been outsourced. Indeed, this is how prior technology cycles have played out in the BPO industry. Although these AI solutions might create more pricing pressure for the outsourcers, we believe there will also be some offset from lower labor costs. Finally, and most importantly, the company is not seeing any evidence of client churn related to AI solutions. The stock trades for less than a 12x price-to-earnings ratio, has net cash on the balance sheet, has historically experienced revenue growth in a range of 10-15%, and the company is buying back shares.

We purchased one new holding during the quarter – The Simply Good Foods Company (SMPL). Simply Good Foods is a branded food wholesaler focused on the niche healthy snacking category. It owns two brands: Qwest and Atkins.

The healthy snacking category has historically grown faster than most food categories through increased consumer adoption and shelf space. However, the recent emergence the GLP-1 drugs has created concerns that health-related snacks won’t be as popular going forward, driving a decline in the company’s valuation at the same time as the legacy Atkins brand has had disappointing results. However, the flagship Qwest brand continues to grow nicely, and the company has managed margins and profitability well – using its ample cash flow to pay down debt.

The Fund ended the quarter nearly fully invested, and we remain confident in the outlook for the remainder of the year.

Despite the stellar performance of many blue-chip large cap stocks, many of the stocks we follow are trading at some of their most attractive levels in years. While many investors seem preoccupied with how many times the Fed might cut rates this year, we will continue to focus on quality small cap businesses that get left behind in the excitement.

Thank you for your investment.

 

 

 

Matt Parker, CFA, CPA
Intrepid Endurance Fund Co-Portfolio Manager

 

 

 

Joe Van Cavage, CFA
Intrepid Endurance Fund Co-Portfolio Manager

Past performance is not a guarantee of future results.
Mutual Fund investing involves risk. Principal loss is possible. The Fund is subject to special risks including volatility due to investments in smaller companies, which involve additional risks such as limited liquidity and greater volatility. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. The risks of owning ETFs generally reflect the risks of owning the underlying securities they are designed to track. ETFs also have management fees that increase their costs versus the costs of owning the underlying securities directly.
The Funds’ investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the investment company. Please read it carefully before investing. A hard copy of the prospectus can be requested by calling 866-996-FUND (3863).
The Morningstar Small Cap Index tracks the performance of U.S. small-cap stocks that fall between 90th and 97th percentile in market capitalization of the investable universe. You cannot invest directly in an index. The Russell 2000 Index is a market index comprised of 2,000 small-cap companies.
Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice or recommendations to buy or sell any security.
The Intrepid Capital Funds are distributed by Quasar Distributors, LLC.
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