The third quarter of 2025 presented a complex landscape for equity markets, with small-cap equities experiencing a boost due to expectations of future interest rate reductions by the Federal Reserve. However, the Virtus KAR Small-Mid Cap Core Fund (Class I) recorded a return of merely 0.59%, which starkly contrasted with the Russell 2500\u2122 Index's robust 9.00% gain. This significant disparity in performance was primarily attributable to challenges in stock selection within the information technology and industrials sectors, which negatively impacted the fund's overall returns. Meanwhile, the broader market narrative was dominated by the strong performance of large-cap growth stocks, particularly those linked to artificial intelligence, reflecting an environment where lower-quality and non-earning companies often outperformed their more fundamentally sound counterparts.
During the third quarter, a notable trend in the financial markets was the resurgence of small-cap companies, largely fueled by widespread anticipation that the Federal Reserve would soon implement cuts to short-term interest rates. This expectation generally benefits smaller firms, as lower borrowing costs can significantly improve their growth prospects and profitability. Concurrently, the quarter witnessed an unusual market dynamic where companies with weaker financial fundamentals and those not generating profits experienced more substantial gains compared to their more established, higher-quality peers. This indicated a speculative fervor, possibly driven by the broader optimism surrounding potential economic stimulus and technological advancements.
In this volatile market environment, the Virtus KAR Small-Mid Cap Core Fund found its performance diverging sharply from the benchmark. Despite the general uplift in the small-cap sector, the fund's strategic investments in information technology and industrial companies did not yield the desired results. Poor stock picks in these two crucial sectors were identified as the primary drivers of the fund's underperformance relative to the Russell 2500\u2122 Index. This highlights the critical importance of meticulous analysis and selection in a market where sector-specific dynamics can heavily influence fund outcomes, even when the overall market sentiment is positive.
Looking at the portfolio adjustments made during the quarter, the fund strategically acquired shares in Trimble and UL Solutions. Trimble, a company known for its advanced positioning technologies, and UL Solutions, a global leader in applied safety science, represent investments aimed at leveraging opportunities in innovative technology and essential safety services. These additions reflect a forward-looking strategy to enhance the portfolio with companies that possess strong underlying business models and potential for long-term growth, despite the immediate challenges faced by the fund's overall performance. The fund manager's decision to integrate these new holdings suggests a re-evaluation of sector exposures and a pivot towards areas expected to deliver future value.
The market's enthusiasm for large-cap growth stocks, particularly those within the artificial intelligence domain, created a significant challenge for funds focused on smaller and mid-sized companies. The Russell 1000\u00ae Growth Index, heavily weighted with these dominant players, advanced by 10.51%, illustrating the concentrated nature of market gains. This environment meant that funds not heavily invested in these leading sectors or individual stocks found it difficult to keep pace, irrespective of the performance of their specific niche. The disparity underscores a period of market bifurcation, where a select group of companies disproportionately drove overall market returns.
The third quarter of 2025 marked a period of both opportunity and challenge for the Virtus KAR Small-Mid Cap Core Fund. While the prospect of Federal Reserve interest rate cuts boosted small-cap stocks, the fund's specific investment choices in technology and industrials proved detrimental. Despite new strategic investments in companies like Trimble and UL Solutions, the fund significantly trailed its benchmark, reflecting the concentrated gains in large-cap growth and AI-related sectors.