ABNB - ClearBridge Aggressive Growth Strategy Q1 2023 Portfolio Manager Commentary

2023-04-22 00:30:00 ET

Summary

• ClearBridge is a leading global asset manager committed to active management. Research-based stock selection guides our investment approach, with our strategies reflecting the highest-conviction ideas of our portfolio managers.
• Our goal is to outperform the market over a full three-to-five-year cycle that includes both risk-on environments and episodes of distress. During such turbulent periods, we feel that good companies get better and emerge stronger both competitively and financially.
• Despite standout results for several disruptors, not owning mega cap growth stocks that gained the most in March’s flight-to-safety caused the Strategy to underperform for the quarter.
• We solidified our allocation to durable compounders with strong growth and profit margins and low financial leverage with the purchase of Accenture. These types of companies serve as the base of a portfolio balanced across our pyramid of growth.

By Evan Bauman & Aram Green

Market Overview

A rotation into mega cap equities in the first quarter obscured broader market weakness as a banking crisis and further monetary tightening by the Federal Reserve weighed on stocks down the market cap scale. The S&P 500 Index ( SP500 ) rose 7.50% while the small cap Russell 2000 Index gained 2.74% as investors gravitated to larger companies deemed more resilient as the removal of liquidity accelerated. The benchmark Russell 3000 Growth Index advanced 13.85%, reversing the leadership trend of the last year and outperforming the Russell 3000 Value Index by nearly 1,300 basis points.

Reminiscent of the FAANG period of market leadership in recent years, performance was concentrated in a handful of the largest growth stocks in the benchmark. For example, Apple ( AAPL ), Microsoft ( MSFT ) and Nvidia ( NVDA ) were responsible for close to half its total return (6.47%). Despite the Russell 3000 Growth Index losing nearly 29% in 2022 and underperforming its value counterpart by 2,100 bps, the benchmark remains extremely concentrated (Apple and Microsoft alone account for 22.4% of the index). Meanwhile, a tighter financing environment created by the Fed’s aggressive rate hike campaign and worsened by the March failure of Silicon Valley Bank and Signature Bank ( SBNY ), hurt small cap companies the most (Exhibit 1) while health care stocks also trailed due to higher funding costs.

Exhibit 1: Mega Caps Dominated First Quarter Performance

This setup was a headwind for the ClearBridge Aggressive Growth Strategy, which seeks to deliver performance by primarily targeting growth companies in the $10 billion to $100 billion market cap range. Not owning mega cap growth stocks that gained the most in March’s flight-to-safety accounted for about half of the performance shortfall in the quarter. The rest resulted from profit taking in UnitedHealth Group ( UNH ), a strong performer in 2022 that was also hurt by slightly disappointing initial reimbursement rates in its Medicare Advantage business, our health care overweight and negative stock selection among certain of our media and industrials holdings.

While the Strategy underperformed for the quarter, a handful of disruptors aggressively taking share in their respective markets participated well in the growth rally. Marketing automation software maker HubSpot ( HUBS ) surged after beating quarterly cash flow estimates due to effective cost management and its ability to generate more revenue per customer by cross selling additional functionality. Shares of information security provider CrowdStrike ( CRWD ) also rebounded on improved execution and success expanding its product suite into adjacent security markets. Alternative lodging platform Airbnb ( ABNB ), meanwhile, benefited from a continued consumer spending shift to services with travel demand holding up despite rising average daily rates across the industry.

Coming off a period of outperformance in 2022, the portfolio remains balanced across our pyramid of growth. The contributions of higher-growth disruptors and improving growth companies are complemented by a foundation of durable compounders. As noted last quarter and reinforced by the banking crisis this past month, we are clearly in a more volatile economic environment where visibility remains low. This type of backdrop places a premium on the types of industry leaders with strong growth and profit margins and low financial leverage that we seek. Additionally, it increases the imperative to invest alongside quality, experienced management teams, well suited to navigate any near-term macro headwinds while continuing to invest in opportunities for long-term growth. Such characteristics should enable these companies to not only outperform in a choppier environment, but also gain share and emerge in a better position post correction.

Portfolio Positioning

We added to our durable compounders in the first quarter with the purchase of Accenture in the information technology ((IT)) sector. Accenture ( ACN ) is a leading global professional services company that helps clients build their digital infrastructure and optimize their operations. With a diversified product set and client base, we see the company as a unique way to gain broad-based exposure to secular growth drivers such as rising cloud migration and digital transformation, as well as new, innovative technology deployments like cyber security, block chain, AI and machine learning. While IT spending is sensitive to the macro environment, the stock has historically been resilient through market cycles due to its durable earnings and cash flow, strong balance sheet and attractive returns on capital.

While we apply a multiyear time horizon for our investments, we are cognizant that factors can change for both the better, or worse. Accordingly, when these factors cause the risk/reward to skew more negatively it is imperative we take the necessary portfolio action to protect client capital.

Outlook

After outperforming through a volatile year marked by historic monetary tightening and greater investor attention to growth company fundamentals and valuations, the Strategy trailed in the mega-cap-led, risk-on environment present through most of the first quarter. We believe the first bank run since the Global Financial Crisis has worsened the feeling of consternation and fear in equity markets we referenced in past letters. However, as long-term investors with the mentality of business owners, we can take advantage of these periods. As we have shared in the past, our goal is to outperform the market over a full three-to-five-year cycle that includes both risk-on environments and episodes of distress. During such turbulent periods, we feel that good companies get better and emerge stronger both competitively and financially.

We continue to derisk a robust pipeline of investment ideas, waiting for volatility to work in our favor to both create attractive entry points into new growth names and opportunity to further scale newly initiated positions. To make room for stocks offering more compelling risk/reward profiles, we have also been taking action to adjust the existing portfolio. This has included lowering our exposure to cyclical growth holdings such as disk drive maker Seagate Technology and reducing companies such as content and distribution provider Comcast where we see increasing risks in the current environment.

Portfolio Highlights

The ClearBridge Aggressive Growth Strategy underperformed its Russell 3000 Growth Index benchmark in the first quarter. On an absolute basis, the Strategy had gains in six of the eight sectors in which it was invested (out of 11 sectors total). The primary contributors were in the IT and communication services sectors while the industrials and health care sectors were detractors.

Relative to the benchmark, overall stock selection and sector allocation detracted from performance. In particular, stock selection in the IT, communication services and industrials sectors, an overweight to the health care sector and an underweight to the consumer discretionary sector weighed on results. On the positive side, an overweight to communication services, an underweight to consumer staples and financials and a lack of exposure to the energy sector contributed to performance.

On an individual stock basis, positions in HubSpot, Broadcom ( AVGO ), TE Connectivity ( TEL ), CrowdStrike and Vertex Pharmaceuticals ( VRTX ) were the leading contributors to absolute returns during the period. The primary detractors were UnitedHealth Group, Liberty Media SiriusXM ( LSXMK ), L3Harris Technologies ( LHX ), Wolfspeed ( WOLF ) and Johnson Controls ( JCI ).

In addition to the Accenture purchase, we initiated a position in LYFT in the industrials sector.

Evan Bauman, Managing Director, Portfolio Manager Aram Green, Managing Director, Portfolio Manager

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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