Q4 2022 Putnam Small Cap Growth Fund Q&A
- The fund underperformed its benchmark for the fourth quarter and 1-year periods, but outperformed for the 3-, 5-, and 10-year and life-of-fund periods ended December 31, 2022.
- For most of 2022, large-cap equities outperformed small caps, and value outperformed growth.
- We believe the market will refocus on micro drivers in 2023.
How were investing conditions in the fourth quarter and in 2022?
After the worst 9-month start on record for the Russell 2000 Index, small-cap growth stocks had a better fourth quarter. The index’s quarterly advance peaked on December 2, before a significant sell-off into year-end as the hawkish Federal Reserve increased investor concerns about a recession.
The year overall was challenging, characterized by macro-driven volatility, negative returns across most major asset classes, and broad-based underperformance for small-cap and growth stocks. Correlations between asset classes spiked, and 7 out of 8 major asset classes declined more than 10% for the year. Only energy and commodity assets had positive returns, while the bond market experienced its worst returns in more than eight decades.
Multiple measures of sentiment reached new or near-record bearish levels, encompassing consumers, businesses, and investors. The year was also notable for dispersion between sectors. The S&P 500 Index’s best sector, energy, was up over 50%, while the worst sector, communication services, was down over 40%. Within the Russell 2000 Growth Index, energy gained 42%, communication services declined 39%, and real estate fell 41%.
How was performance for small-cap growth versus other asset classes?
For most of 2022, large-cap equities outperformed small caps, and value outperformed growth. The fourth quarter of 2022 was the 7th quarter of the past 8 in which small-cap value outperformed small-cap growth. Also, it was the first 2-year stretch of value outperformance since 2005–2006.
How did the fund perform?
For the fourth quarter, the fund underperformed the benchmark, with the portfolio’s cash position as the main detractor as equity markets rose. Stock selection was positive in 5 of 10 sectors. Selection was strongest in consumer discretionary and health care, and weakest in technology. Looking at longer periods, the fund outperformed the benchmark for the 3-, 5-, and 10-year and life-of-fund periods ended December 31, 2022.
What is your outlook as we begin 2023?
As we begin a new year, investors are faced with several lingering risks. Abroad, the Russia-Ukraine War continues to create volatility in commodities. China’s reopening is causing a Covid–19 resurgence in the country, which could lead to further supply chain disruptions. And the most critical risk for equities may be persistent elevated inflation, as well as the rising interest rates that are meant to tame it. This brings the risk of margin erosion and demand destruction beyond traditional rate-sensitive sectors. Also, higher-for-longer interest rates will keep pressure on equity multiples and will be particularly challenging for businesses that rely on capital markets to grow.
Based on the known macroeconomic challenges, and barring any unanticipated risks yet to surface, we believe the market will refocus on micro drivers in 2023. As a result, the fundamentals of higher-quality companies are likely to prove more resilient than those of businesses with lower returns on invested capital and less dependable cash flows.
For informational purposes only. Not an investment recommendation.
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Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
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