WOLF - ClearBridge Aggressive Growth Strategy Q2 2023 Portfolio Manager Commentary

2023-07-16 05:45:00 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.
• While the Strategy has limited mega cap exposure, a recent headwind to relative performance, we own several companies that stand to benefit from the explosive growth in generative AI.
• The Strategy maintains a low correlation to market cap weighted indexes and passive strategies and, as market participation expands, we own a number of underappreciated names we believe are well-positioned for strong performance over time.
• We took advantage of narrow market breadth to increase exposure to the consumer discretionary sector with two new additions and consolidate our media exposure.

By Evan Bauman & Aram Green

Improving Balance with Consumer Exposure

Market Overview

Mega cap stocks remained in favor in the second quarter, with enthusiasm over generative AI extending their gains in a historically narrow market. The S&P 500 ( SP500 , SPX ) Index rose 8.74% while the small cap Russell 2000 advanced 5.21% as investors took cooling inflation to mean the Federal Reserve’s tightening cycle is nearing its conclusion. The benchmark Russell 3000 Growth Index maintained its positive momentum, advancing 12.47% and outperforming the Russell 3000 Value Index (+4.03%). Growth is ahead of value by 2,300 basis points year-to-date.

2023 has so far marked a return to the leadership of the largest growth stocks in the market, a handful of companies in the information technology ((IT)), consumer discretionary and communication services sectors. Year-to-date, the “Magnificent Seven,” as coined by CNBC’s Jim Cramer (Apple, Microsoft, Amazon.com , Google, Nvidia, Tesla and Meta Platforms), have accounted for 69.4% of the total return of the Russell 3000 Growth Index (Exhibit 1).

While the ClearBridge Aggressive Growth Strategy has limited mega cap exposure, which has been a recent headwind to relative performance, we own several companies that stand to benefit from the explosive growth in generative AI. These holdings play key roles in building out the necessary infrastructure and helping customers leverage capabilities enabled by this emerging technology.

Exhibit 1: Mega Cap Performance Illustrates Concentrated Market

Semiconductor and software solutions provider Broadcom, for example, is an important supplier of networking chips that power ethernet switches and routers for connectivity between AI servers. The company sees quarterly revenue from this part of their business exceeding $1 billion in their fiscal third quarter, on a trajectory toward doubling over the course of the year. Accenture ( ACN ), a business and IT services consultant, will be instrumental in helping enterprises reinvent and modernize their IT architecture for AI. The company recently announced a $3 billion investment, which includes doubling their data and AI workforce to 80,000 to address this growing opportunity. Snowflake ( SNOW ), a cloud-based data platform company, is positioned well to help enterprises better leverage their own data to get the most out of AI models. Though it is still early days in terms of adoption, Snowflake saw workloads for data science, machine learning, and AI use cases grow more than 90% year-over-year in its most recent quarter. Likewise, we see other portfolio companies likes HubSpot ( HUBS ), a marketing automation software provider, already integrating AI technology into their core products to drive increased value to their customers.

Portfolio Positioning

Top heavy leadership has overshadowed weakness across much of the equity market. We took advantage of the narrow breadth in the second quarter to increase our exposure to the consumer discretionary sector with two purchases that further enhance portfolio diversification and should help support consistent performance through a full cycle.

[[TJX]] is the leading off-price apparel and home furnishings retailer known for its TJ Maxx, Marshalls and HomeGoods brands, with 4,800 global locations. We see TJX as a differentiated retailer offering shoppers a combination of value and convenience with continued share gain opportunity against large addressable U.S. markets for apparel and home decor. We also see room for TJX to modestly expand margins on the back of sales leverage and as freight, shrink and wage pressures ease. While TJX is not immune to macro risks, we see the company as relatively well-positioned even in the event of an economic deterioration as benefits from better inventory availability and consumer trade-down accrue.

Starbucks ( SBUX ) is the leading provider of specialty coffee beverages, operating close to 19,000 global stores primarily in North America, China and Japan and 37,000 licensed partner locations. We view Starbucks as a quality compounder with strong free cash flow, operating in a segment and in dayparts that are very much routine-based and habitual, balancing the business’s exposure to discretionary spending. Additionally, Starbucks is still in the early stages of its reinvention plan to help accelerate revenue growth over the next several years on the back of better same store sales and unit growth. Coupled with the benefits of margin expansion, we believe the company can drive double-digit EPS growth at scale.

We also consolidated our bets in media by exiting AMC Networks ( AMCX ), a name where we have a less optimistic outlooks for growth, and adding to existing holding Liberty Media Formula One, which along with World Wrestling Entertainment ( WWE ) should both benefit from structural growth in media rights, sponsorship and event-related revenue.

The addition of Pinterest ( PINS ), a social media platform for visual discovery which allows users to find ideas and inspiration, also acts to diversify our traditional media exposure. We believe the company is poised to take share in the large and growing market for online advertising. Under the direction of new CEO Bill Ready, we see levers for improved user engagement and monetization. While relatively new to the company, we are encouraged by Ready’s track record in prior company roles as well as early signs of progress from his efforts. Pinterest is profitable on a non-GAAP basis today, but we also see opportunities for meaningful margin expansion as revenue scales.

The sale of rideshare provider [[LYFT]], similar to our moves in communication services, prunes a smaller position to consolidate the portfolio in our highest conviction ideas. We initially purchased Lyft in May 2021 when rideshare volumes were still depressed due to COVID-19. While Lyft was a clear #2 behind [[UBER]] in domestic rideshare, we believed it was a cleaner way to play the U.S. recovery due to the focused nature of its business. However, poor execution and the uneven nature of the U.S. recovery, with West Coast markets where Lyft has historically had greater exposure lagging due to a lack of return to office work, further weakened its market position. In March, Lyft announced co-founder Logan Green would step down as CEO with David Risher, a former Amazon ( AMZN ) executive, taking his place. While Risher has laid out ambitions to drive Lyft’s market share higher, we believe doing so will require more than a few quarters fix. Furthermore, while the company has looked for areas to right size their cost base, we see necessary investments in price, service levels and product differentiation to drive this turnaround further pushing out the path to improved profitability.

Outlook

We are encouraged by improving market breadth as the second quarter ended, with small caps outperforming large caps and value closing the gap with growth . As market participation expands, the Strategy owns several underappreciated names that we believe are well-positioned for strong performance over time. Our high active share approach continues to result in a portfolio with a low correlation to cap-weighted indexes and passive strategies.

For example, we own different flavors of tech and continue to evaluate new opportunities in software, industrials and the consumer space to augment our existing health care and communication services overweights, building out a white board of ideas while scaling up newer positions amidst volatility. While it is still early days to understand the full reach of generative AI, we own a number of companies that should benefit as businesses look to modernize their infrastructure and find ways to better exploit this technology. We believe our focus on identifying innovative companies with management teams investing for future growth positions the portfolio well for the long term as technology cycles like AI emerge.

Portfolio Highlights

The ClearBridge Aggressive Growth Strategy underperformed its benchmark in the second quarter. On an absolute basis, the Strategy posted gains across four of the eight sectors in which it was invested (out of 11 sectors total). The primary contributor to performance was the IT sector. The chief detractor was the consumer discretionary sector.

Relative to the benchmark, overall stock selection detracted from performance. In particular, stock selection in the IT, communication services and consumer discretionary sectors and an overweight to health care had negative impacts on results. Conversely, an overweight to communication services and underweights to consumer staples and industrials contributed to performance.

On an individual stock basis, the leading absolute contributors were positions in Broadcom ( AVGO ), HubSpot, Vertex Pharmaceuticals ( VRTX ), Comcast ( CMCSA ) and Johnson Controls ( JCI ). The primary detractors were Wolfspeed ( WOLF ), [[ETSY]], AbbVie ( ABBV ), Insulet ( PODD ) and Cohen & Steers ( CNS ).

In addition to the transactions mentioned above, we added a position in Madison Square Garden Entertainment ( MSGE ) in the communication services sector and closed a position in Guardant Health ( GH ) in the health care 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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