In the third quarter, small-cap equities experienced a notable upswing, particularly driven by a "risk-on" market sentiment that favored higher-beta, lower-quality, and non-earning companies. Despite this positive market trend, the Virtus KAR Small-Cap Value Fund (Class I) faced challenges, registering a return of -1.11%. This performance significantly lagged the Russell 2000 Value Index, which posted a robust 12.60% gain. The primary factors contributing to this underperformance were strategic stock selection in the financial sector and a substantial overweighting in the industrial sector. The fund's concentrated portfolio and continued conviction in its sector positions remained unchanged, with no new acquisitions or divestitures during this period.
Detailed Investment Performance Analysis: Virtus KAR Small-Cap Value Fund in Q3 2025
The third quarter of 2025 saw a remarkable recovery in small-cap stocks, with the Russell 2000® Index surging by 12.39%—its strongest quarterly performance since 2021. This rally was largely fueled by a widespread "risk-on" sentiment across financial markets, leading to outperformance by equities with higher beta, lower quality, and those not yet generating earnings. Concurrently, technology companies, especially those involved in artificial intelligence (AI), continued to dominate financial news and provided a significant boost to the large-cap growth segment, as evidenced by the Russell 1000® Growth Index's 10.51% increase.
However, the Virtus KAR Small-Cap Value Fund, specifically its Class I shares, recorded a return of -1.11% during this buoyant quarter. This result sharply contrasted with the Russell 2000® Value Index, which advanced by 12.60%. The fund's underperformance can be primarily attributed to specific stock choices within the financials sector. Additionally, its overweight allocation to the industrials sector, combined with less favorable stock selections in that area, negatively impacted overall returns.
The fund's sector positioning also played a critical role. While underweights in real estate and utilities positively contributed to its relative performance, the substantial exposure to industrials increased the fund's susceptibility to sector-specific challenges, leading to underperformance. Despite these short-term fluctuations, the fund maintained a stable and concentrated portfolio, reflecting a firm belief in its existing sector and position strategies, with no significant changes in holdings during the quarter.
This quarter's market dynamics highlight the complexities of navigating diverse economic environments. While growth-oriented sectors and small-cap stocks benefited from renewed investor confidence, value-oriented funds like Virtus KAR Small-Cap Value Fund faced challenges. The fund's experience underscores the importance of rigorous stock selection and careful sector allocation, especially in a market where enthusiasm for specific trends can quickly shift investor preferences. Looking ahead, investors in such funds will be keen to see how management adjusts strategies to leverage future market opportunities and mitigate sector-specific risks, particularly given the ongoing influence of technology and shifting sentiment towards different market segments.