Q&A with Don Collins, Ironwood Executive Managing Partner and Chief Investment Officer
Question 1: There’s been a lot of talk about potential interest rate cuts by the Federal Reserve. How do you see this impacting small cap stocks?
Answer: We’ve completed extensive analysis on this topic – historically, small cap stocks have shown a tendency to outperform their large cap counterparts during periods of declining interest rates. This pattern repeats in various economic cycles, including the post-dot com era, the 2008 financial crisis, and more recently in July 2024 when the mere discussion of a potential rate cut led to a significant jump in small cap performance. For instance, in July 2024, the Russell 2000 Small Cap Index increased by 10.2% compared to just 1.0% for the S&P 500. This outperformance of 920 basis points in a single month highlights the potential opportunity in small caps as we approach a possible rate cut. I encourage you to read the blog post on this exact topic that we just published.
Question 2: Ironwood has been investing in small caps for over 25 years. How does your experience inform your strategy in this changing interest rate environment?
Answer: Our quarter-century of experience in small cap investing has allowed us to refine our approach through multiple market cycles. Our Small Cap Core strategy, launched in 1999, has delivered approximately 12% gross of fees in average annual returns since inception, outperforming the Russell 2000 benchmark by 378 basis points. This track record demonstrates our ability to navigate various market conditions. See more on our track record of performance here.
In the current environment, we’re leveraging our expertise to identify what we call “High I-Q” companies – these are companies that not only might benefit from a short-term rate-driven rally but also possess the fundamental strength to deliver long-term value. Additionally, we see volatility as a potential source of alpha in our strategy. In our view, markets often over-react to short-term events and conditions. Unlocking long-term value requires patience and prudence, which I believe we have demonstrated with our multi-decade track record.
Question 3: Can you elaborate on what you mean by “High I-Q” companies and how this concept applies in the context of potential rate cuts?
Answer: “High I-Q” stands for High Ironwood-Quality. These are companies with exceptional management teams, excellent current market positions, and promising future opportunities. They typically have solid financial foundations, leading competitive positions, and sustainable business models.
In the context of rate cuts, we believe these High I-Q companies are better positioned to capitalize on the potential economic tailwinds. High I-Q companies typically will have the financial flexibility to invest in growth opportunities that may arise from lower borrowing costs, while also possessing the resilience to navigate any market volatility that might accompany policy changes.
Question 4: Some investors might be wary of small caps due to perceived higher risk. How do you address this concern, especially in light of potential economic shifts?
Answer: It’s a valid concern, but it’s important to look at the broader picture. While small caps can indeed be more volatile in the short term, they’ve historically offered superior long-term returns compared to large caps in times of falling interest rates. Our approach for the Ironwood Small Cap Core strategy is designed to mitigate some of the inherent risk through careful stock selection and portfolio construction. We maintain a diversified portfolio of 60-80 positions, with strict guidelines on position sizes and sector exposures. Moreover, our focus on High I-Q companies often leads us to invest in businesses with strong balance sheets and proven management teams, which can provide some downside protection during market turbulence.
Question 5: Looking ahead, what advice would you give to investors considering small cap exposure in anticipation of interest rate cuts?
Answer: My advice would be to consider small cap allocation as part of a balanced, long-term investment strategy. While the potential for outperformance during rate cuts is exciting, it’s crucial not to view this as a short-term trading opportunity. Instead, investors should focus on the long-term growth potential of well-managed, high-quality small companies.
It’s also important to work with experienced managers who have a verified track record in navigating the complexities of small cap investing. I’m extremely proud of our recent record as the #1 ranked strategy in the PSN Small Cap Core Universe for 2023 and the #1 ranking in the NASDAQ eVestment Small Cap Core Universe for the first six months of 2024.¹ At Ironwood, we’ve demonstrated our ability to identify opportunities and manage risks across various market cycles.
As we approach this potentially favorable environment for small caps, we believe our disciplined approach and deep expertise position us well to capitalize on the opportunities that may arise.
FOOTNOTE
- Awarded May 21, 2024. PSN is not a client, and no compensation was paid or received in exchange for the ranking. Register for free to view the full PSN Top Guns recipient list and award methodology: PSN Top Guns: https://psn.fi.informais.com/.
PERFORMANCE DATA AND DISCLOSURES
Performance Statistics as of 6/30/2024
Ironwood Investment Management®, LLC (Ironwood) is an independently managed investment advisory firm providing investment advisory services to institutional clients, mutual funds and high-net-worth clients. The firm is a registered investment adviser with the Securities and Exchange Commission. SEC Registration does not imply a certain level of skill or training. Accounts in the Small Cap Core composite include separately managed, fully discretionary, fee-paying portfolios. Portfolios are invested in undervalued securities, the majority of which will have market capitalizations under $2.5 billion at cost, including securities with growth and/or value characteristics. Securities are considered undervalued when management believes the current share price does not accurately reflect the long-term economic value of the underlying company. Ironwood Investment Management, LLC claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Ironwood Investment Management, LLC has been independently verified for the periods January 1, 1999 through December 31, 2021. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Small Cap Core composite has had a performance examination for the periods July 1, 2002 to December 31, 2021. The verification and performance examination reports are available upon request. GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. The creation date of the composite: July 2002. Performance inception date of the composite: January 1, 1999. Prior to July 2002, portfolios were included in the composite when at least 75% of the portfolio was invested in equity securities and when at least 75% of the portfolio was invested according to the investment style of the composite. Subsequent to July, 2002, portfolios are included in the composite after the first full month of being fully invested. Returns are presented gross and net of management fees and include the reinvestment of all income. Net returns are calculated based on the highest fee of 1.00%. Investment management fees are 1.00% on the first $25 million, 0.90% on the next $25 million, 0.80% on the next $50 million, and 0.75% over $100 million on an annual basis and a client’s return will be reduced by these and other related expenses. The actual fee charged to an individual portfolio may vary by size and type of portfolio and may be negotiated. Actual investment advisory fees incurred by clients may vary. The Russell 2000 Index consists of the 2000 smallest stocks in the Russell 3000 Index that represents approximately 8% of the U.S. equity market capitalization. The indices have been reconstituted annually since 1989. Ironwood returns and Index performance reflect reinvested interest income and dividends, in U.S. dollars. A list of composite descriptions and a list of limited distribution pooled fund descriptions are available upon request. Past performance is not indicative of future results. Policies for valuing investments, calculating performance and preparing GIPS Reports are available upon request. Prior to May 2006, the Firm was known as Ironwood Capital Management, LLC.