First Eagle Small Cap Opportunity Fund Q4 2024 Commentary (undefined:FESAX)
March 5, 2025 | by ltcinsuranceshopper
Ta Nu
Market Overview
Equity market performance in the fourth quarter was consistent with the trend in place for about two years now, with index-level performance driven of a small handful of very large tech-oriented US stocks. The NYSE FANG+ Index gained more than 15% in the fourth quarter, the cherry on top of a 51% annual gain.1
The S&P 500 Index was able to share in some of the spoils, advancing 2.4% for the quarter and 25% for the year, while smaller stocks generally remained unloved. The Russell 2000 Value Index fell 1.1% during the fourth quarter on its way to an 8.1% gain for the year.2
Strong Economy May Bolster Already Robust Balance Sheets
Data flow throughout the quarter showed continuing economic growth and stubbornly above-target inflation in the US. GDP growth increased at rate of 3.1% in the third quarter, slightly ahead of the second quarter’s 3.0% expansion. The labor market, in particular, has demonstrated resilience following sluggish midyear readings; most notable was the December jobs report in which new jobs came in at 256,000, about 65% higher than the consensus estimate, while unemployment ticked down to 4.1%. Though inflation continued to improve over 2024, its trajectory has flattened; at 2.8% in its November print, the price index for personal consumption expenditures is down from its 3.1% level to start the year but has bounced around between 2.6% and 2.8% since May.3
These dynamics may have inspired a hawkish tilt at the Fed only a few months into its rate-cut cycle. While 100 basis points worth of cuts since September brought the Fed’s key policy rate 4.25–4.50% by year-end 2024, its December dot plot calls for only 50 basis points more in 2025, down from 100 basis points in September.4 The central bank’s less accommodative forecast is consistent with its assessment that upside risks to inflation had increased, and that achieving its 2% target could take longer than previously anticipated due to “higher-than-expected readings on inflation, and the effects of potential changes in trade and immigration policy.”5
Given our experience that small cap/large cap leadership cycles tend to last around 10 years, the current string of small cap underperformance—in place since 2010—has us on pins and needles waiting for a catalyst to turn the tide. There are signs that potential tailwinds for improved performance may be mounting. Continued economic growth should support underlying demand even as central bank rhetoric suggests a more measured approach to rate cuts in 2025. Meanwhile, small cap balance sheets are the strongest they’ve been since the global financial crisis, in our view, with or without additional rate relief. Improved supply-chain management post-Covid has helped managers rationalize inventories and reduce working capital. Some companies have been able to leverage the proliferation of cloud applications to reduce the capital intensity of their businesses and improve operating leverage; specifically, what had been large, fixed-hardware infrastructure investments financed through capital expenditures become variable operational costs.
These factors may enable smaller companies to finally demonstrate the financial vitality investors have prized in the large cap arena. After two mostly sluggish years, there are expectations for meaningful growth in both revenues and earnings among small companies in 2025, with incremental improvements each quarter. For example, aggregate earnings for the Russell 2000 are expected to grow 49% year-over-year in 2025, more than double 2024’s rate.6
Potential Tailwinds May Be Building
In November, we witnessed a market dynamic that was evident several times this year—namely, a sharp rally in smaller stocks followed by a selloff. These dynamics suggest that investors are willing to invest in smaller stocks, but quick to abandon them if the enthusiasm doesn’t spread. A true shift in sentiment requires consistent buying interest among market participants that perceive the same bargain pricing in the space we do. Often, this takes the form of mergers and acquisition activity. Strategic buyers, in particular, are often willing to pay attractive premiums for companies that have rationalized their cost structures, survived difficult times and possess sound business models and responsible balance sheets.
Meanwhile, the installation of more business-friendly leadership in such offices as the Department of Justice and Federal Trade Commission with the incoming Trump administration may grease the wheels for merger and acquisition (M&A) activity, as well-financed businesses perceive fewer impediments to growth through strategic acquisitions of smaller companies. Initial public offerings (IPOs), too, could see an uptick. For example, reduced regulation may facilitate the development of new drugs/therapeutics, increasing private market valuations for biotech companies and incenting early investors to cash out through a public listing. In the industrial space, new “pick and shovel” companies may emerge to provide essential services and support to facilitate the propagation of new technologies like artificial intelligence (AI), not unlike the late-1990s facilitators of the internet boom.
The depressed valuations of smaller stocks have enabled us to refine the portfolio and ensure we are oriented toward those opportunities we believe represent the most compelling risk-reward scenarios available. With revenue and earnings growth seemingly poised to accelerate through 2025, we believe we are well positioned to benefit.
Portfolio Review
Small Cap Opportunity Fund A Shares (without sales charge*) posted a return of -1.72% in fourth quarter 2024. Financials, consumer staples and communication services were the only contributors among equity sectors; materials, consumer discretionary and health care were the largest detractors. The Fund underperformed the Russell 2000 Value Index in the period.
Leading contributors in the First Eagle Small Cap Opportunity Fund this quarter included TTM Technologies, Inc. (TTMI), Graham Corporation (GHM), Remitly Global, Inc. (RELY), Universal Technical Institute, Inc. (UTI) and Air Transport Services Group, Inc (ATSG).
TTM Technologies manufactures electronic components, including advanced printed circuit boards, radio frequency components and microwave/microelectronic assemblies. The company has been executing on a plan to grow its higher-margin engineered product business and reduce exposure to its cyclical consumer-oriented commodity business. It reported strong results for its most recent quarter, with growth in the higher-margin aerospace/defense and data center computing end markets. TTM has also been increasing its production capabilities with the opening of a new printed circuit board manufacturing plant in Malaysia. The company appears well positioned to benefit from investment in artificial intelligence, and we believe the ongoing execution of this growth plan will support valuation expansion.
Graham Corporation manufactures mission-critical fluid, power, heat transfer and vacuum technologies for the defense, space, energy and process industries. The company reported strong sales, margin improvement and a growing backlog for its most recent quarter and raised its forward earnings outlook. These results were attributable to the successful acquisition of specialty turbomachinery maker Barber-Nichols in 2021, which helped expand Graham’s defense and space business. We like the company’s strong financial position and disciplined approach to balancing growth initiatives with returning cash to shareholders through stock buyback.
Remitly Global is an online remittance service that provides money transfers to over 150 countries. The company reported better-than-expected results for its most recent quarter and raised its forward guidance. These results eased concerns that the company’s large marketing spend would not generate sufficient revenue growth. Assuming continued strong execution, Remitly should continue to grow sales and earnings.
Universal Technical Institute offers transportation and skilled-trades training programs, as well as continuing education programs in the allied health, dental, nursing, patient care and diagnostic fields. The company is undergoing a multiphase “North Star Strategy” to accelerate growth, diversification and optimization; this plan includes new programs and geographic expansion, higher investment in marketing and admissions, and workforce optimization and facilities utilization. UTI reported better-than-expected results for its most recent quarter, with growth in both its transportation and skilled trade segment and its healthcare business.
Air Transport Services Group provides medium widebody freighter aircraft leasing, air-cargo transportation and support services.
During the third quarter, the company entered into an agreement to be acquired by a private equity firm at an attractive premium to its market valuation. The all-cash deal is expected to close within the next six months.
The leading detractors in the quarter were CareDx, Inc (CDNA), Century Communities, Inc. (CCS), Tronox Holdings Plc (TROX), Zeta Global Holdings Corp. Class A (ZETA) and Beazer Homes USA, Inc (BZH).
CareDx provides diagnostic surveillance solutions for organ-transplant recipients, including testing products and services to match donors with recipients and monitor post-transplant care. Expectation-level testing volumes reported for the latest quarter disappointed investors hoping for better results.
Century Communities constructs entry-level homes in the US, primarily in the Sun Belt. Rising mortgage rates necessitated higher incentives to clear inventory, pressuring gross margins. With a solid track record of strong operational execution, Century appears well positioned to weather cyclical downdrafts in housing. As demand for affordable housing continues to outstrip supply, Century should be able to gain share in new and established communities.
Tronox produces titanium dioxide pigment to brighten and strengthen paints, coatings and other products. Higher interest rates during the quarter dampened the outlook for existing-home sales, a catalyst for paint demand, while anticipated weaker new-home sales also dampened restocking. Tronox is well positioned to weather the cyclical downturn in housing. Recent trade barriers in the EU and Brazil combined with potential tariffs on Chinese titanium dioxide could provide competitive pricing relief while industry consolidation may further ease pressure.
Zeta Global operates a multichannel data-driven cloud platform that utilizes artificial intelligence to provide consumer data to enterprise clients and provides marketing automation software worldwide. Financial results for the most recent quarter came in weaker than expected and also relied on a heavy mix of political and advocacy ads, which is not part of Zeta’s core focus. Recently surfaced questions about Zeta’s acquisition accounting and data-collection practices triggered our exit from the position.
Beazer Homes is one of the nation’s largest home builders, serving entry-level buyers primarily in the western and southeastern US. Shares traded down in the quarter on rising mortgage rates. Additionally, the company’s gross margins have been pressured by a mix shift toward more speculative construction and increased incentives to motivate sales. We remain constructive on the shares: secular prospects for homebuilders remain strong as the US housing market remains underbuilt, and Beazer is well positioned to grow earnings as they increase penetration.
We appreciate your confidence and thank you for your support.
Sincerely,
First Eagle Investments
* Performance for Class A shares without the effect of sales charges and assumes all distributions have been reinvested, and if a sales charge was included values would be lower. Footnotes
The performance data quoted herein represents past performance and does not guarantee future results. Market volatility can dramatically impact the fund’s short term performance. Current performance may be lower or higher than figures shown. The investment return and principal value will fluctuate so that an investor’s shares, when redeemed may be worth more or less than their original cost. Past performance data through the most recent month end is available at www.firsteagle.com or by calling 800-334-2143. “With load” performance for Class A Shares gives effect to the deduction of the maximum sales charge of 5.00%. Class I Shares require $1mm minimum investment, and are offered without sales charge. Class R6 is offered without sales charge. 1. The annual expense ratio is based on expenses incurred by the fund, as stated in the most recent prospectus. These are the actual fund operating expenses prior to the application of fee waivers and/or expense reimbursements. First Eagle Investment Management, LLC (the ‘‘Adviser’’) has contractually agreed to waive and/or reimburse certain fees and expenses of Classes A, I and R6 so that the total annual operating expenses (excluding interest, taxes, brokerage commissions, acquired fund fees and expenses, dividend and interest expenses relating to short sales, and extraordinary expenses, if any) (‘‘annual operating expenses’’) of each class are limited to 1.25%, 1.00% and 1.00% of average net assets, respectively. Each of these undertakings lasts until 28-Feb-2025 and may not be terminated during its term without the consent of the Board of Trustees. The Fund has agreed that each of Classes A, I and R6 will repay the Adviser for fees and expenses waived or reimbursed for the class provided that repayment does not cause annual operating expenses (after the repayment is taken into account) to exceed the lesser of: (1) 1.25%, 1.00% and 1.00% of the class’ average net assets, respectively; or (2) if applicable, the then-current expense limitations. Any such repayment must be made within three years after the year in which the Adviser incurred the expense. 2. Primary index. Investments are not FDIC insured or bank guaranteed and may lose value. Federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an uncollateralized basis. Risk Disclosures All investments involve the risk of loss of principal. Diversification does not guarantee investment returns and does not eliminate the risk of loss. There are risks associated with investing in foreign investments(including depositary receipts). Foreign investments, which can be denominated in foreign currencies, are susceptible to less politically, economically and socially stable environments, fluctuations in the value of foreign currency and exchange rates, and adverse changes to government regulations. The value and liquidity of portfolio holdings may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the United States or abroad. During periods of market volatility, the value of individual securities and other investments at times may decline significantly and rapidly. The securities of small and micro-size companies can be more volatile in price than those of larger companies and may be more difficult or expensive to trade. A principal risk of investing in value stocks is that the price of the security may not approach its anticipated value or may decline in value. “Value” investments, as a category, or entire industries or sectors associated with such investments, may lose favor with investors as compared to those that are more “growth” oriented. Strategies whose investments are concentrated in a specific industry or sector may be subject to a higher degree of risk than funds whose investments are diversified and may not be suitable for all investors. Russell 2000® Value Index(Gross/Total) measures the performance of the small cap value segment of the US equity universe. It includes those Russell 2000 companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium term (two-year) growth and lower sales per share historical growth (five-year). A total-return index tracks price changes and reinvestment of distribution income. Russell 2000® Index(Gross/Total) measures the performance of the small-cap segment of the US equity universe. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. A total-return index tracks price changes and reinvestment of distribution income. NYSE FANG+ Index is an equal-weighted equity benchmark designed to track the performance of 10 highly traded growth stocks of technology and tech-enabled companies in the technology, media & communications and consumer discretionary sectors S&P 500 Index(Gross/ Total) measures the performance of 500 of the top companies in the leading industries of the US economy and is widely recognized as a proxy for the US market as a whole. A total-return index tracks price changes and reinvestment of distribution income. Indices are unmanaged and do not incur management fees or other operating expenses. One cannot invest directly in an index. The holdings mentioned herein represent the following total assets of the First Eagle Small Cap Opportunity Fund as of 31-Dec-2024: TTM Technologies, Inc. 0.90%; Graham Corporation 0.75%; Remitly Global, Inc. 0.60%; Universal Technical Institute, Inc. 0.57%; Air Transport Services Group, Inc. 0.43%; CareDx, Inc 0.56%; Century Communities, Inc. 0.53%; Tronox Holdings Plc 0.48%; Zeta Global Holdings Corp. Class A 0.00%; Beazer Homes USA, Inc. 0.76%. The commentary represents the opinion of the Small Cap team as of the date noted. The opinions expressed are not necessarily those of the firm. These materials are provided for informational purposes only. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The views expressed herein may change at any time subsequent to the date of issue hereof. The information provided is not to be construed as a recommendation or an offer to buy, hold or sell or the solicitation of an offer to buy or sell any fund or security. The Fund’s portfolio is actively managed and holdings can change at any time. Current and future portfolio holdings are subject to risk. The opinions expressed are not necessarily those of the firm. These materials are provided for informational purposes only. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The views expressed herein may change at any time subsequent to the date of issue hereof. Third-party marks are the property of their respective owners. FEF Distributors, LLC (“FEFD”) (SIPC), a limited purpose broker-dealer, distributes certain First Eagle products. FEFD does not provide services to any investor but rather provides services to its First Eagle affiliates. As such, when FEFD presents a fund, strategy or other product to a prospective investor, FEFD and its representatives do not determine whether an investment in the fund, strategy or other product is in the best interests of, or is otherwise beneficial or suitable for, the investor. No statement by FEFD should be construed as a recommendation. Investors should exercise their own judgment and/or consult with a financial professional to determine whether it is advisable for the investor to invest in any First Eagle fund, strategy or product. Investors should consider investment objectives, risks, charges and expenses carefully before investing. The prospectus and summary prospectus contain this and other information about the Funds and may be viewed at www.firsteagle.com. You may also request printed copies by calling us at 800-747-2008. Please read our prospectus carefully before investing. First Eagle Funds are offered by FEF Distributors, LLC, a subsidiary of First Eagle Investment Management, LLC, which provides advisory services. ©2025 First Eagle Investment Management, LLC. All rights reserved. | ||||||||||||||||||||||||||||||||||||||||||||||||
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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