VENADO INVESMENT ADVISORS
SMALL-MID CAP EQUITY STRATEGY
FOURTH QUARTER 2025 REVIEW
SMALL-MID CAP EQUITY STRATEGY
FOURTH QUARTER 2025 REVIEW
COMMENTARY
I will simply summarize 2025 as being one of the oddest years in my investment career. At a distance, it might have appeared similar to say 2020 where the market sold off in the first three months only to rally off the bottom. But that is where the similarities end.
The playbook broke in 2025. If one were to describe an environment whereby inflation was hovering at almost 3% and unemployment stood at cyclical lows, I would have predicted a rate increase by the Federal Reserve. Instead, they cut.
Within small cap stocks, both consumer staples and software both declined in value even during a rate cut induced rally. Typically, a powerful bounce of a bottom lifts all boats. A more defensive sector might not go up as much as the leaders, but it will still go up.
The Small-Mid Cap Equity Strategy certainly exemplified the oddities. The portfolio’s beta (a measure of volatility and correlation to the Russell 2500 Index) was a mere 0.35. I have never seen an equity strategy exhibit such characteristics as typically our portfolio has a beta between 0.7 and 0.8. Some of this was due to the portfolio positioning but some of it was also the nature of the market and the rally’s concentration in AI and extreme low-quality stocks.
Beyond the immediate, it raises bigger questions about how a quality portfolio should exist in the current era. Over the last 20 years, the small-mid universe has become increasingly higher risk as great companies either grow into large cap faster or go/stay private. Given this, does high quality provide the same performance characteristics now that it might have a decade or two ago?
This question might lead one to question our strategy or at least suggest we lack conviction. I encourage the opposite. This is a normal part of the evolutionary process associated with investing. There are certain characteristics that stand the test of time, but their implementation evolves as the world changes. This is growth mindset stuff here.
All that said, the macroeconomic/political environment lent itself to oddities. Perhaps it is as simple as that.
I will simply summarize 2025 as being one of the oddest years in my investment career. At a distance, it might have appeared similar to say 2020 where the market sold off in the first three months only to rally off the bottom. But that is where the similarities end.
The playbook broke in 2025. If one were to describe an environment whereby inflation was hovering at almost 3% and unemployment stood at cyclical lows, I would have predicted a rate increase by the Federal Reserve. Instead, they cut.
Within small cap stocks, both consumer staples and software both declined in value even during a rate cut induced rally. Typically, a powerful bounce of a bottom lifts all boats. A more defensive sector might not go up as much as the leaders, but it will still go up.
The Small-Mid Cap Equity Strategy certainly exemplified the oddities. The portfolio’s beta (a measure of volatility and correlation to the Russell 2500 Index) was a mere 0.35. I have never seen an equity strategy exhibit such characteristics as typically our portfolio has a beta between 0.7 and 0.8. Some of this was due to the portfolio positioning but some of it was also the nature of the market and the rally’s concentration in AI and extreme low-quality stocks.
Beyond the immediate, it raises bigger questions about how a quality portfolio should exist in the current era. Over the last 20 years, the small-mid universe has become increasingly higher risk as great companies either grow into large cap faster or go/stay private. Given this, does high quality provide the same performance characteristics now that it might have a decade or two ago?
This question might lead one to question our strategy or at least suggest we lack conviction. I encourage the opposite. This is a normal part of the evolutionary process associated with investing. There are certain characteristics that stand the test of time, but their implementation evolves as the world changes. This is growth mindset stuff here.
All that said, the macroeconomic/political environment lent itself to oddities. Perhaps it is as simple as that.
FOURTH QUARTER REVIEW AND OUTLOOK
The strategy underperformed the Russell 2500 benchmark following the bottom in April. This was largely due to a flight to low quality stocks, driven by rate cuts, and underperformance of software stocks and consumer staples.
The strategy underperformed the Russell 2500 benchmark following the bottom in April. This was largely due to a flight to low quality stocks, driven by rate cuts, and underperformance of software stocks and consumer staples.
The underperformance was most disappointing in that we actually lost money in an up market. That is a tough pill to swallow. It is notable that most of our peers experienced similar and often worse results, suggesting that this was more market driven than strategy specific. Frankly, I hesitate to share that because it sounds like an excuse. But it reinforces the idea of the market dynamics at play.
Staples, the one area experiencing the most difficulties due to tariffs and inflation as their ability to pass on higher costs has been limited. Software is facing existential questions due to the rise of AI. Investor sentiment has been shoot first and ask questions later. It didn’t help that software stocks were generally overvalued before the sentiment shift and also face declining revenue growth rates after a decade of wind behind their back.
Staples, the one area experiencing the most difficulties due to tariffs and inflation as their ability to pass on higher costs has been limited. Software is facing existential questions due to the rise of AI. Investor sentiment has been shoot first and ask questions later. It didn’t help that software stocks were generally overvalued before the sentiment shift and also face declining revenue growth rates after a decade of wind behind their back.
Sources: Koyfin, Russell. Based on a representative account. Weights in client portfolios may vary.
Our general view is that volatility will continue and that the recent rally was driven more by short-term stimulus than sustainable economic growth. While this may well continue into the new year, we don’t believe it is long-lasting enough to make it investable. As such our positioning is generally unchanged. One change we do expect to make during the year is to add international exposure to the portfolio. Guidelines allow for a maximum 30% allocation to international and while we do not expect to add that much, we will opportunistically do so. Our general view is that we can find companies of similar quality in similar industries but at more attractive valuations and less political volatility. Stay tuned.
TRANSACTIONS
There were no purchases or sales during the fourth quarter. While we reviewed several names and have more we were working on, we failed to generate meaningful conviction such that we added a new name to the portfolio.
We do not expect that to be the case in the first quarter of 2026. Several of our winners have become large positions in the portfolio and also command premium valuations. They are candidates for trimming. Meanwhile, we hold a few positions in stocks that are smaller than we prefer, requiring a decision to add or sell. Finally, we are now seeing some out of favor quality names that are finally trading at favorable valuations.
There were no purchases or sales during the fourth quarter. While we reviewed several names and have more we were working on, we failed to generate meaningful conviction such that we added a new name to the portfolio.
We do not expect that to be the case in the first quarter of 2026. Several of our winners have become large positions in the portfolio and also command premium valuations. They are candidates for trimming. Meanwhile, we hold a few positions in stocks that are smaller than we prefer, requiring a decision to add or sell. Finally, we are now seeing some out of favor quality names that are finally trading at favorable valuations.
FINAL THOUGHTS
As expected, 2025 was volatile. Between the fiscal and monetary stimulus on the positive and elections or tariffs on the negative, we expect more of the same. We will seek out more risk should we become more confident that the recent economic growth is sustainable, most likely evident through a broadening of income gains on the consumer side and a pick-up in capital expenditures.
Although our focus on quality will hurt us during risk on rallies as we saw in the second half of 2025, we believe it will outperform through the sine wave we expect going forward, assuming we do our job as stock pickers.
Regards,
Gregory Toppe, CFA
As expected, 2025 was volatile. Between the fiscal and monetary stimulus on the positive and elections or tariffs on the negative, we expect more of the same. We will seek out more risk should we become more confident that the recent economic growth is sustainable, most likely evident through a broadening of income gains on the consumer side and a pick-up in capital expenditures.
Although our focus on quality will hurt us during risk on rallies as we saw in the second half of 2025, we believe it will outperform through the sine wave we expect going forward, assuming we do our job as stock pickers.
Regards,
Gregory Toppe, CFA