Listen to Mike Marzolf, Lead Manager of the Mairs & Power Small Cap Fund, as he gives an update on the market, economy and impact to the Mairs & Power Small Cap Fund in 2023, as well as the 2024 outlook. This was recorded on January 24, 2024.

 
Executive Summary

For the year, the Mairs & Power Small Cap Fund was up 11% on an absolute basis but lagged S&P 600 by 5%. This relative underperformance also pulled down the Fund’s medium-term relative performance.

Favorable stock selection has historically driven Fund performance since its inception in 2011. During some periods, stock selection is a detractor to performance, and this was the case in 2023. But we believe that our process will lead to strong performance over the long term, through shifting market conditions and economic cycles. 

 
Sector Performance

The Fund’s underweight in Consumer Discretionary, the S&P 600’s best-performing sector in 2023 thanks largely to lower inflation and interest rates, led to some relative underperformance. In Technology, many holdings underperformed due to an ongoing inventory correction and reduced order rates. In Financials, pressures on balance sheets and margins due to sharply higher interest rates drove underperformance for several of Fund bank holdings.

On the positive side, availability of parts and labor allowed Industrial companies to build and ship products. In Healthcare, continued improvements in patient volumes drove strong performance during the year.

Improvements in supply chain, labor availability, and freight costs are leading to less uncertainty in the businesses we follow and hold. Those companies also have seen early signs of productivity gains from implementing AI. We believe those gains will lead to higher margins and productivity, especially in sectors where the Fund is overweighted, including Industrial, Healthcare, and Technology.

 

Positive Performers

Among the Fund’s top performers in 2023 was AZEK, a Chicago-based maker of synthetic decks, railings, and exteriors. It’s at the tail end of an inventory cycle, which has led to improved order rates. Lower interest rates also are helping demand.

Another bright spot was Michigan-based Altair Engineering, which develops simulation software for high-performance computing, data analytics, and the generative design of physical products. The company has enjoyed strong demand, and its adjacency to artificial intelligence has attracted customers and boosted margins.

The Fund also received strong performance from nVent Electric, a manufacturer of thermal management products and enclosures that has benefited from strong data center expansions, especially for AI servers.

 

Negative Performers                   

Among the Fund’s negative contributors in 2023 was Clearfield, a Minnesota-based supplier of passive optical networking gear for broadband connectivity. Clearfield was hit by a severe inventory cycle after a COVID-driven surge in demand, which caused orders to tail off. But it remains well positioned with labor-saving products, a strong balance sheet, and an attractive valuation.

Another laggard was Gentherm, a Michigan-based manufacturer of thermal management products, specifically targeting the automotive industry. It went through its own inventory destocking cycle, and it was also hurt by ebbing demand for electric vehicles.

Inspire Medical Systems, a Minnesota-based provider of implantable devices for patients with obstructive sleep apnea, experienced some weakness in the second half of 2023 around fears of disruption from GLP-1 weight-loss drugs such as Ozempic. But physician productivity, as measured by procedures per center per month, continues to improve for Inspire, and upward margin movement should help boost future earnings growth.

 
2024 Outlook

While earnings growth in 2023 for small caps was minimal, analysts are projecting double-digit earnings growth for this year. The prospects for lower inflation and lower interest rates are helping demand and margins, and this should lead to earnings growth in the future.

Small cap stocks, as measured by the S&P 600, are trading at a 31% discount to the S&P 500 and a 21% discount to their 10-year average. As a result, we’re finding opportunities to invest in small companies with durable competitive advantages at favorable valuations.

 

Top 10 Fund Holdings (subject to change)

Mairs & Power Small Cap Fund 

Expense ratio: 0.92%

The statements and opinions expressed are those of the speakers and are as of the date of this call. All information is historical and not indicative of future results and subject to change.  

Cash flow is the net amount of cash and cash equivalents being transferred in and out of a company.

S&P Small Cap 600 TR Index is an index of small-company stocks managed by Standard and Poor’s that covers a broad range of small cap stocks in the U.S. The index is weighted according to market capitalization and covers 3-4% of the total market for equities in the U.S. It tracks both the capital gains of a group of stocks over time and assumes that any cash distributions, such as dividends, are reinvested back in the index.

Russell 2000 TR Index is a small-cap stock market index of the smallest 2,000 stocks in the Russell 3000 Index.

Morningstar Small Blend Category, as defined by Morningstar are stocks in the bottom 10% of the capitalization of the U.S. equity market which are defined as small cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate.

All investments have risks. The Small Cap Fund is designed for long-term investors. Equity investments are subject to market fluctuations and the Fund’s share price can fall because of weakness in thebroad market, a particular industry, or specific holdings. Investments in small and midcap companies generally are more volatile. International investing risks include among others political, social or economic instability, difficulty in predicting international trade patterns, taxation and foreign trading practices, and greater fluctuations in price than United States corporations. The Small Cap Fund may invest in initial public offerings by small cap companies, which can involve greater risks than investments in companies which are already publicly traded.

The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Funds may be lower or higher than the performance
quoted. For the most recent month-end performance figures, visit the Funds’ website at www.mairsandpower.com, or call Shareholder Services at (800) 304-7404.The Funds’ investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus and summary prospectuses contain this and other important information about the Funds, and may be obtained by calling Shareholder Services at 800-304-7404, or by visiting www.mairsandpower.com. Read the prospectus and summary prospectuses carefully before investing.

Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be lower or higher than the performance quoted. Performance as of the most recent month end is available by calling 800-304-7404. Click Here for standardized performance.