In the second quarter of 2026, the International Small Cap Equity Strategy demonstrated impressive performance, significantly outperforming its benchmark. This success was largely attributed to a combination of easing global tensions, a surge in artificial intelligence infrastructure spending, and resilient corporate earnings. The strategy's strategic stock selection and sector allocation played a pivotal role in its strong returns, particularly its emphasis on the technology sector.

The global equity markets experienced a robust rally throughout the second quarter, buoyed by several key factors. A significant development was the de-escalation of geopolitical tensions, notably a ceasefire agreement between the US and Iran in April, which alleviated considerable market uncertainty. This led to the resumption of shipping through the Strait of Hormuz and a subsequent decline in oil prices from their previous peak. This reduction in risk, coupled with sustained investment in AI infrastructure, propelled widespread gains across international markets. Initially, large-cap growth stocks and US tech giants led the charge, but the rally soon extended to small-cap and cyclical sectors as the quarter progressed. Semiconductor companies, especially those involved in memory production, stood out due to supply constraints, enhanced pricing power, and persistent demand fueled by AI infrastructure development.

As the quarter advanced, the macroeconomic landscape grew more intricate. Central banks maintained a cautious stance, and political shifts in major European economies introduced new uncertainties. In the United States, the Federal Reserve kept interest rates stable, signaling market expectations for a prolonged period of higher rates. Additionally, the impending expiration of the Trump administration's 10% global tariff in late July, with hints of further tariffs, suggested that trade policy would remain a significant source of market volatility. These combined factors led to a sharp appreciation of risk assets, even as equity valuations became stretched and monetary policies tightened. This environment underscored the critical importance of sustainable earnings growth as a distinguishing factor for evaluating the resilience of equities in the latter half of the year.

The strategy's outperformance was evident across various metrics. For the second quarter, it delivered a gross return of 15.23% (14.97% net), compared to the MSCI ACWI ex-US Small Cap Index's 9.62%. Year-to-date, the strategy returned 15.28% gross (14.78% net) versus the benchmark's 9.10%. Both stock selection and sector allocation made substantial contributions, adding 326 basis points and 289 basis points, respectively. The overweight position in Technology was a primary driver of the positive allocation effect, contributing 106 basis points, while underweight positions in Real Estate and Healthcare added 60 and 45 basis points, respectively. Key contributors to this strong performance included Taiwan Union Technology, Technoprobe, and ASPEED Technology, collectively adding 444 basis points. Conversely, NexGen Energy, Nippon Avionics, and IHI Corporation were detractors, collectively reducing performance by 68 basis points. Geographic allocations also contributed positively, with underweights in China and South Korea and an overweight in Ireland adding 62 basis points.

The strategy's success was significantly propelled by evolving supply chain dynamics within the semiconductor industry and the continuous expansion of global AI infrastructure. Taiwan Union Technology, a prominent manufacturer of copper-clad laminates vital for AI servers, saw strong demand, tight supply, and substantial margin growth. The company's ongoing capacity expansion is expected to further bolster its market position. Technoprobe, an Italian producer of probe cards for testing advanced logic devices like CPUs and AI GPUs, benefited from both AI-driven demand and increasing testing complexity, trends deemed sustainable in the long term. ASPEED Technology, a Taiwanese designer of baseboard management controller chips for AI and traditional servers, capitalized on growing AI server demand and successfully addressed its glass substrate supply challenges, enabling it to gain additional market share.

Despite the overall strong performance, some holdings faced industry-specific challenges. NexGen Energy, a Canadian uranium developer, progressed with its mining project but saw its share price closely tied to uranium prices, which remained stagnant or declined during the quarter. Nippon Avionics, a key contractor for Japan's Defense Agency, benefited from an expanding defense budget but encountered production capacity limitations and labor shortages. IHI Corporation, a Japanese industrial conglomerate, continued its structural reform, divesting from lower-growth businesses to reinvest in higher-growth aerospace, defense, and energy sectors. However, concerns about a potential jet fuel shortage impacting its profitable commercial aerospace segment, stemming from the Middle East conflict, weighed on its stock, though this scenario ultimately did not materialize. Despite their underperformance in the quarter, these stocks remain part of the portfolio, as their long-term investment cases are still strong, and their valuations have become more attractive.

During the quarter, the portfolio underwent active management with new positions initiated in Asta Energy Solutions, Morinaga Milk Industry, Tokyo Tatemono, TBS Holdings, and Bird Construction. Conversely, positions in Sojitz Corporation, Rakuten Bank, Nippon Television Holdings, and Munters Group were exited. Looking ahead, the focus remains on bottom-up stock selection, targeting companies that are undergoing sustainable positive fundamental shifts. The objective is to identify firms whose improving earnings power, returns, or competitive positioning are not yet fully reflected in market valuations, ensuring continued growth and capital preservation in an uncertain economic climate.