Hood River’s Big Quarter: Beating AI at Its Own Game in Small Caps | Buyside Digest
InsightArticleOctober 28, 20256 min read
Hood River’s Big Quarter: Beating AI at Its Own Game in Small Caps
By Genevievecjackson@gmail.com
The Fund That Actually Beat the AI Bubble
While megacaps argued over who invented artificial intelligence, Hood River Capital’s New Opportunities Fund quietly delivered a +19.97% gain in Q3 2025, trouncing the Russell 2500 Growth Index’s +10.73% by more than 900 basis points.
Year-to-date, the fund’s up +25.9%, or roughly 1,600 bps ahead of the benchmark. Since inception last August, they’re up +55.0% net versus the index’s +20.8%.
This isn’t some passive SMID-cap ETF accidentally catching a wave — it’s old-fashioned stock picking, the kind of thing people forgot existed somewhere between the SPAC boom and ChatGPT 7.
The letter’s tone is refreshingly unglamorous: “We’re not chasing the theme; we’re finding who’s actually making money from it.”
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Q3 2025
+19.97%
+10.73%
+924
AI infrastructure tailwind
YTD 2025
+25.89%
+9.95%
+1,594
Quality beats junk
1-Year
+35.79%
+12.62%
+2,317
Outperformance compounds
Since Inception (Aug 2024)**
+55.02%
+20.77%
+3,425
Consistent execution
Source: Hood River Capital Management, Bloomberg. Net of fees.
Liberation Day for Small Caps
The managers — Brian Smoluch and David Swank — describe the third quarter as a turning point for small and mid-caps, calling it “Liberation Day.”
After years of being ignored, small caps finally broke free of their macro chains, fueled by a combination of falling tariffs, rate-cut optimism, and an AI-driven industrial renaissance.
Yes, you read that right — AI has made small caps cool again.
But Hood River’s not just buying anything with “neural” in the name. They’re zeroing in on companies powering the AI supply chain — semiconductors, energy infrastructure, drone systems, and industrial capacity — the tangible picks and shovels of the digital gold rush.
According to Bridgewater, nearly half of U.S. GDP growth in H1 2025 came from tech capital expenditures, a stat the letter quotes with equal parts awe and opportunism.
“AI infrastructure is not just about chips,” they write. “It’s about the power grid, the cooling systems, the logistics, and the maintenance networks that make those chips usable.”
In other words: buy the guys selling servers and electricity, not the ones selling hype.
When Small Caps Go Supersonic
Hood River’s success this quarter came down to good, old-fashioned stock selection — adding 848 basis points of outperformance from individual names alone.
Top sector contributors:
Information Technology: +970 bps contribution (semiconductors, software, hardware suppliers)
Communication Services: +59 bps
Consumer Discretionary: +34 bps
They gave up a bit in Financials (–62 bps), Industrials (–55 bps), and Energy (–47 bps) — mostly because they’ve been allergic to leverage-heavy “zombie” names that briefly rallied when everyone forgot how interest rates work.
But those givebacks barely dented the quarter.
“We continue to see fundamental execution rewarded,” they write. “Earnings power and cash flow generation — not just multiple expansion — are driving results.”
Imagine that.
The AI Hype, Minus the Hopium
Hood River’s commentary could double as a masterclass in managing a theme without being consumed by it.
They acknowledge that AI remains the dominant force in markets — driving both valuations and FOMO — but they’re quick to note that the real beneficiaries are the enablers, not the marketers.
They’ve reduced their “AI tilt” since the start of the year. No sector in the portfolio is more than ±4% away from benchmark weighting. Roughly half of their 26.5% IT allocation is tied directly to AI infrastructure capex from hyperscalers. The rest? Boringly profitable small tech and industrial names growing earnings the old-fashioned way.
That’s not an accident. It’s deliberate positioning for sustainability over spectacle.
When asked about the frothier corners of the market, they point to valuation math, not vibes:
“While the S&P 500 trades at ~23× 2026 earnings, small and mid-caps trade at similar multiples despite historically commanding a premium.”
Translation: small caps are cheap again — and they’ve actually got earnings.
The Power (Grid) Trade
If there’s one recurring subtext here, it’s that AI’s biggest constraint isn’t talent or data — it’s electricity.
Hood River’s portfolio is filled with power infrastructure names that quietly benefit from AI’s insatiable energy demand. The theme’s simple: if GPUs are the new oil, then the grid is the new pipeline.
From industrials building substation tech to semiconductors enabling energy efficiency, the fund is leaning into the overlooked backbone of the AI revolution — the analog side of digital growth.
They even nod to drone technology as a sleeper trend: rising military budgets and commercial logistics are merging into one of the most investable tailwinds for the next decade.
It’s the kind of industrial renaissance you can only get when governments panic about falling behind in AI.
A Return to Active Sanity
The letter makes a subtle but powerful point: in a world of over-indexed everything, active management in small and mid-caps actually matters again.
Passive flows still dominate large caps, but the SMID universe — full of inefficiencies, undercoverage, and mispricings — is where stock picking’s edge reemerges.
The managers argue that valuations remain “compelling,” with multiple ways to win:
Structural growth from secular themes (AI, drones, energy transition)
Even after a 25% YTD run, they see broad opportunity heading into 2026.
“Our companies have adapted well to the current tariff environment,” they note. “With impacts spread across supply chains, pricing, and margins, the environment remains manageable.”
Translation: while everyone else panics about politics, they’re counting cash flows.
The Psychology of a +20% Quarter
For all the impressive stats, what stands out in this letter is the tone. It’s analytical but calm — confident without the chest-thumping.
The writers clearly know the difference between luck and process.
This wasn’t some high-beta, “YOLO into small caps” quarter. It was the logical result of sticking to a bottom-up, fundamentals-first process during one of the most macro-obsessed years in recent memory.
As they put it, “Steady execution drove results even as Q1 was overshadowed by noise.”
That’s how you know you’re reading real investors, not financial influencers.
Looking Ahead
Heading into 2026, Hood River expects fundamentals to stay in the driver’s seat. Rate cuts may help, but they’re not the core thesis. The managers are betting on earnings durability and idiosyncratic growth in small and mid-cap companies that don’t need the Fed to justify their valuations.
They’re also staying balanced — no sector over- or underweight by more than 4%. It’s active, not hyperactive.
The takeaway is simple but rare: if you do the work, diversification doesn’t have to mean dilution.
The Final Word
Hood River’s Q3 letter reads like a quiet victory lap for disciplined investing. It’s refreshing in a year when everyone else is making trillion-dollar forecasts about machine consciousness.
Their message? Stick to the fundamentals. Own companies that make things. Sell hype, buy execution.
The AI era may be loud, but the winners will still whisper in free cash flow.
