Summary

Although it is very early days, the fund’s first full quarter since its December 2025 launch was a difficult one. Frustratingly, the underperformance was overwhelmingly driven by sector exposure, not stock selection. Owning software, healthcare technology and media, while being materially underweight energy, mining and tech hardware, created a structural headwind of approximately 600 basis points in a period defined by AI-driven indiscriminate selling and a sharp rotation into old-economy cyclicals.

The companies we own have, in the main, reported strong results and improving fundamentals. We believe the portfolio remains very attractive for the next five or more years, trading on 11.6x forward earnings with a greater than 10% free cash flow yield, strong double-digit sales and profit growth, and a weighted average CFROI above 20%. By comparison, the DMSCN benchmark trades on 14.6x forward earnings for 6–7% sales growth and an 8.6% ROE.

Figure 1 · Portfolio vs DMSCN Benchmark – Key Metrics (Q1 2026). Growth for GSC is organic with M&A growth on top.

Market Backdrop

The backdrop Goodhart outlined in its ‘Four Forces’ framework; ageing demographics, rising geopolitical competition, environmental cost internalisation, and technology assimilation continued to assert itself in Q1 2026. The macro tailwinds that underpinned three decades of strong equity market returns (falling rates, falling inflation, falling taxes, growing labour forces, and expanding globalisation) are structurally in reverse. We are not in a cyclical downturn; we are in a regime change.

Rates and Inflation

Interest rates remained elevated, with the annual median across the ECB, US, UK and Japan sitting well above the near-zero levels of 2010–2020. Inflation has not returned to target in any sustained sense. This matters for two reasons: it raises the cost of capital for long-duration growth assets (valuations increasingly matter; high multiples are a source of additional risk), and it means governments face structurally higher debt servicing costs. US interest payments as a percentage of tax receipts have risen sharply, constraining the fiscal firepower that helped prop up markets post-2008. The New York Fed’s March 2026 model estimates a 35.8% probability of recession over the next four quarters, while Goldman Sachs raised its recession odds to 25% specifically in response to the Iran energy shock. The message from forecasters is clear: we face a higher-for-longer rate environment layered on top of a new and acute supply-side inflation impulse. Given this uncertainty, there is a significant benefit to owning stocks that are economically resilient, have their destiny in their own hands and with pricing power (which is where we focus).

Valuations for broad equity markets remain stretched. The S&P 500 CAPE ratio is above 40x, index concentration is at multi-decade highs, and credit spreads are extremely tight. Against this backdrop, a portfolio of quality global smaller companies on 11.6x forward earnings represents an unusually asymmetric starting point.

Geopolitics, the Iran Conflict and Energy Markets

Much has changed since the letter we wrote in Q4 2025. What was then a framework of gradually shifting geopolitical risk has, in a matter of weeks, become an acute and historically significant energy shock.

On 28 February 2026, the United States and Israel launched coordinated strikes on Iran under Operation Epic Fury, killing Supreme Leader Ali Khamenei and targeting military and nuclear infrastructure. Iran’s response included missile and drone attacks on US bases across the Gulf and the effective closure of the Strait of Hormuz, through which approximately 20% of global seaborne oil flows. The IEA has described the resulting disruption as the ‘greatest global energy security challenge in history’. [The International Energy Agency described the disruption as the “greatest global energy security threat in history.” (Birol, quoted in Le Monde, 2026)]

Brent crude surged from around $74 per barrel at the start of Q1 to above $112 by late March, with WTI approaching $100. Goldman Sachs raised its 2026 US inflation forecast by 0.8 percentage points to 2.9% in response, and trimmed its GDP growth projection accordingly. The ECB postponed planned rate cuts and revised up its inflation forecast; UK CPI is expected to breach 5%. Oxford Economics models a scenario in which sustained disruption at $140/bbl pushes the eurozone, UK and Japan into contraction.

Figure 2 · Brent Crude Price Trajectory, Q1 2026 (USD per barrel)

We remain wary of commodity-linked businesses without genuine pricing power. Our focus continues to be on companies that can sustain margins regardless of input cost pressures. In the current environment, this focus has become more valuable, not less.

On metals, gold has benefited from reserve diversification away from US dollar assets and genuine inflation hedging demand. Industrial metals held up on structural demand from electrification and defence reshoring, themes consistent with the Four Forces. We observe these dynamics but have no direct exposure. Our indirect benefit comes through companies that serve these sectors without taking commodity risk themselves.

AI: The Market’s Most Important and Most Misread Variable

The quarter saw another violent rotation in AI-related sentiment. Software sold off indiscriminately as investors extrapolated replacement risk across every technology (and non-technology) business regardless of the nature of the underlying moat. We think this broad-brush approach is wrong, but, importantly, creates opportunity.

Our framework distinguishes between three types of company: those with wide moats that can capture AI efficiency gains (lowering costs without passing all savings to customers); those with proprietary data and deep domain knowledge that AI will amplify rather than replace; and mission-critical software where the cost of failure is so high that switching risk is minimal regardless of AI capability. The businesses we own fit into these categories and are now even cheaper. We have been adding to those where it makes sense. The market has not yet made this distinction. We believe it will.

Portfolio Performance

The principal driver of underperformance was sector allocation, which contributed a negative 600 basis points since inception. Stock selection was broadly supportive. The companies we own have, on the whole, reported solid results and in many cases beaten expectations materially. The frustration is that the fundamentals of many holdings improved during the period, yet share prices moved in the opposite direction. In our experience, this resolves itself over time.

What Worked and what didn’t work

Figure 3 · Attribution by Position – Since Inception (basis points)

What Worked

• Soitec - Bought close to trough valuation with a clear thesis around destocking cycle completion and AI-driven demand for advanced substrates. We continue to hold with strong conviction for the cycle into 2030.

• Rovi - The Spanish CDMO has capacity that competitors lack precisely when GLP-1 and injectable demand is accelerating. Guidance remains deeply conservative relative to what we believe the business can deliver.

• Calian - A strong earnings beat; revenues 15% ahead of expectations and which drove a significant re-rating once the market recognised the significant defence and space exposure that was already embedded in the portfolio.

  
  

What Didn’t Work

• Innoscripta - This German R&D tax credit software platform reported strong results and drove analyst upgrades. The stock nonetheless fell 35% as a recent IPO with limited trading history in a sector caught up in the AI panic. We added to the position. The moat here is driven by regulatory complexity. We are now paying <12x PE for a company growing 50% with a net cash balance sheet.

• Boku - The payments infrastructure business suffered from UK small-cap outflows and a handful of large sellers rather than any change in investment thesis. Two strong sets of results drove analyst upgrades post-launch. The position remains our second largest at approximately 5%.

• Vitalhub - ARR growth came in at 10% against a 14–15% run rate, partly lumpy government procurement timing, partly AI fears, partly tough comparatives. We remain holders. The moat (97% retention, mission-critical healthcare software, NRR above 100%) is intact.

  
  

Agile Investing in Practice

One of the most counterintuitive lessons from our experience managing smaller company portfolios is that activity is not the same as value creation. The data from analysing our own historical trading is humbling: over a multi-year period, a buy-and-hold approach on day-one positions would have produced a stronger outcome than the actual managed result.

This quarter tested that discipline. We did make several deliberate structural changes: rotating capital toward businesses with stronger balance sheets, with the most attractive risk-rewards and companies with higher certainty of outcome where valuations had become compelling. What we did not do and deliberately chose not to do was reduce exposure where the core thesis remained on track.

Looking Forward

The starting point for the portfolio going into Q2 2026 is, in our view, unusually attractive. We hold a collection of businesses trading on 11.6x forward earnings with a free cash flow yield above 10%, a weighted average CFROI of over 20%, and an attractive projected return profile driven primarily by 16% organic revenue growth and 9% margin expansion, with only modest re-rating assumed.

The macro environment we have described is challenging for broad indices, but it is precisely the kind of environment where stock selection in less-covered, higher-quality small and mid-cap companies has historically been most rewarded. Passive flows and index concentration have pushed capital into a narrow set of large-cap names at extreme valuations. The rolling 10-year small-cap premium relative to the S&P 500 is at its most negative in nearly a century. History does not repeat, but it does punish extremes and prior episodes of large-cap dominance at this scale have historically reversed, in some cases sharply. With the added benefit that history suggests that small cap materially outperforms over time (see chart below).

On AI: we are not trying to pick the best AI mousetrap. The landscape is changing too rapidly for that to be a sensible bet. Instead, we are focused on owning businesses that either benefit from AI efficiency gains, hold proprietary data and domain knowledge that AI amplifies, or operate in mission-critical niches where the cost of disruption is prohibitively high. We expect the market’s current blunt treatment of ‘all software (and even technology enabled cos) to be at risk’ to differentiate meaningfully over the next 12–24 months.

The fund is positioned with a beta of 0.86, a deliberately conservative balance sheet orientation, and a focus on companies where we have genuine conviction in the 3–5 year outcome. We are excited by what we own. Patient capital will, we believe, be well rewarded.