Navigating Small-Cap Value in a Shifting Fed Landscape: Lessons from AMG GW&K's Q1 2025 Performance

The AMG GW&K Small Cap Value Fund (Class N) faced headwinds in Q1 2025, posting a return of -8.45%, narrowly trailing its Russell 2000® Value Index benchmark (-7.74%). While underperforming in the short term, the fund's -2.82% decline over the past 12 months outpaced its benchmark's -3.12% slide, underscoring its resilience in a volatile market. This performance sets the stage for a critical question: How can investors leverage sector rotation opportunities in undervalued small-caps as the Federal Reserve navigates inflationary pressures and policy shifts?

The Fed's Crossroads: Inflation, Rates, and Small-Cap Dynamics

The Federal Reserve's cautious stance—pausing rate hikes but signaling vigilance against inflation—has created a precarious environment for small-cap equities. Value-oriented funds like the AMG GW&K Small Cap Value, which focuses on companies with market caps under $5 billion, face a dual challenge: balancing exposure to sectors vulnerable to rising costs while capitalizing on undervalued opportunities. The Fed's policy uncertainty has amplified volatility, favoring investors who can identify sectors with structural growth or defensive characteristics.

Historical analysis reveals that small-cap Value stocks, such as those in the fund's portfolio, often outperformed Growth peers during Fed decision periods. In Q1 2025, for instance, Value-oriented benchmarks outpaced Growth styles by 338 basis points, a trend reflecting the fund's strategic focus on resilient sectors during periods of policy uncertainty. While the fund underperformed its benchmark in Q1 2025, this short-term dip aligns with broader market dynamics—underscoring the importance of long-term holding discipline when timing Fed cycles.

Sector Rotation: Where Value Lies Amid the Shift

While the AMG fund's Q1 performance lacked luster, broader market data reveals pockets of opportunity. Analysis of sector dynamics from the KCM Small Cap Growth Composite (a growth-oriented peer fund) highlights key divergences:
- Outperformers: Consumer Discretionary and Financials. Consumer Discretionary benefited from a housing-related manufacturer with strong margin improvements, while Financials rebounded on disciplined balance sheets and organic revenue growth.
- Underperformers: Technology and Healthcare. Tech faced tariff-related disruptions in semiconductors, while Healthcare struggled with ERP system integration delays and margin pressures.

Though these data points stem from a growth fund, they illuminate sector trends critical to value investors. For the AMG GW&K fund, a rotation into Financials or Consumer Discretionary—sectors demonstrating resilience—could enhance returns. Meanwhile, Technology's slump may signal an entry point for long-term investors, provided companies address supply chain or regulatory hurdles.

Undervalued Sectors: A Strategic Play

The Fed's focus on inflation has skewed market sentiment toward defensive and income-generating assets. Small-cap value sectors like:
- Financials: Benefit from rising rates and robust organic growth, as seen in the KCM data.
- Consumer Discretionary: Positioned to capitalize on affordability trends (e.g., factory-built housing), which remain unmet in a tight housing market.
- Energy Infrastructure: Though not explicitly mentioned in the fund's holdings, AMG's parent company's lithium investments highlight a strategic shift toward critical materials—a sector with secular growth potential.

Investment Strategy: Timing the Rotation

Investors should consider three steps to align with the AMG fund's strategy while capitalizing on sector shifts:
1. Rebalance toward Financials and Consumer Discretionary: These sectors offer near-term upside amid stable fundamentals.
2. Monitor Tech and Healthcare: Use dips to accumulate undervalued names with clear path-to-value clarity, such as semiconductor firms addressing AI bottlenecks.
3. Leverage the Fund's ESG Integration: The fund's focus on ESG principles in some strategies aligns with long-term sustainability trends, particularly in energy and materials.

Conclusion: Patience and Precision in a Volatile Landscape

The AMG GW&K Small Cap Value Fund's Q1 stumble reflects broader market turbulence, but its 12-month outperformance signals underlying strength. As the Fed's policy path becomes clearer, sector rotation—targeting resilient value plays—will be key. Investors should pair the fund's disciplined small-cap focus with a tactical tilt toward Financials and Consumer Discretionary, while keeping an eye on cyclical opportunities in Tech. In a Fed-driven market, patience and sector-specific precision will define success.

In sum, the AMG GW&K Small Cap Value Fund remains a viable vehicle for value investors, provided they actively manage sector exposures to navigate the Fed's evolving landscape.