July 1, 2024
Dear Fellow Shareholders,
Small cap stocks fell by low single digits in the second quarter of calendar 2024, giving up most of their gains tallied in the first quarter. While not a terrible result in absolute terms, it was a disappointment compared to large cap stocks.
The S&P 500 and Nasdaq indices grabbed most of the headlines during the quarter, as they consistently made new highs. By contrast, the widely followed Russell 2000 index that represents small cap stocks still remains below the highs set in 2021.
But this relative underperformance only tells part of the story. Despite the overall large cap indexes grinding higher, the average stock has not fared as well. It has instead been the stellar performance of a handful of megacap stocks – the so called “magnificent seven” – that have helped propel the overall market higher.
One can compare the S&P 500 Equal Weighted Index with the standard market-cap-weighted S&P 500 Index to get a sense of this
phenomenon. For the 18 months ended June 30, 2024, the equal weighted index has trailed the standard index by a staggering 26.0%. The Russell 2000, whose underperformance versus large caps is often highlighted by the financial media, has actually performed remarkably similar to the equal weighted S&P index over this time (see chart below). In other words, after adjusting for the outsized weights of the big winners, the much-maligned small cap index has performed similarly to large caps during this stretch.
You may recall similar headlines about the “FAANG” stocks disproportionately driving overall returns in prior years. It would therefore be reasonable to question whether this recent narrow market breadth is an anomaly or just a normal feature of stock market returns.
Comparing the S&P 500 to the Equally Weighted S&P 500 over a longer period shows that the recent trend has been unusual. Since 1990, the S&P 500 Equal Weighted index has outperformed the conventional index by 0.55% annualized. However, this has been punctuated by a few periods – like the late 90’s and the last 18 months – of disproportionate contribution of return from a few big winners.
We find the above interesting and not always understood by many investors. However, we prefer not to wade into the debate about whether we are on the brink of mean reversion, or if this time is different. Instead, we find it more useful to focus on the handful of businesses that we understand well and can value with a high degree of confidence.
For the quarter ended June 30, 2024, the Intrepid Small Cap Fund returned -4.48% compared to -3.64% for the benchmark Morningstar Small Cap Index. The top-3 contributors to performance were Keywords Studios (KWS LN), Fabrinet (FN) and Jefferies Financial Group (JEF). The top-3 detractors to performance were the AdvisorShares Cannabis ETF (MSOS), Becle SAB (CUERVO MM), and Carter’s Inc (CRI).
We did not make many significant changes to the portfolio during the quarter. The only position that was completely exited was the video game outsourcing business Keywords Studios. The company disclosed a buyout offer from a Swedish private equity firm in May, which sent the shares sharply higher. We sold as they crossed our estimate of intrinsic value.
The only new position we added was Rithm Capital (RITM). Rithm is a mortgage REIT that was formerly controlled by the PE firm Fortress Group and was called New Residential Investment (NRZ). The company has historically focused on mortgage servicing rights (MSR). We think these assets have durable value today due to what we believe is unusually low prepayment risk resulting from the large spread between higher current mortgage rates and the lower rates of the mortgagees in their MSRs. In addition, the business is diversifying into more fee-based asset management which tends to garner higher market multiples. Management is not happy with their stock price, and has expressed a willingness to pursue shareholder-friendly transactions to unlock value. RITM shares sell for about 10% below tangible book value, which we believe undervalues the company’s earnings power and gives minimal credit for additional value created through growth in their fee-based business. The shares pay a dividend of over 9%.
As always, we remain focused on unearthing opportunities in high quality small caps trading at attractive prices, while we allow our existing positions to compound. Our underwriting is based on a full market cycle perspective, rather than a view on what the near-term macro environment may bring.
If you have any questions or would like to discuss any of our holdings in more detail, please don’t hesitate to give us a call.
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