TSYHF - ClearBridge Global Growth Strategy Q1 2023 Portfolio Manager Commentary

2023-04-22 00:15:00 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.
• A crisis-driven rotation out of banks and more cyclically-exposed value stocks, as well as the potential for a pause or even reversal in central bank tightening, lifted IT and similar growth companies during the quarter.
• The growth rebound, coupled with an underweight to financials and solid contributions from U.S. mega cap technology holdings, led to Strategy outperformance.
• We increased the portfolio’s secular growth exposure with the addition of new positions in the IT, consumer discretionary, industrials, consumer staples and communication services sectors and are constructive on our positioning should regional economies weaken.

By Elisa Mazen, Michael Testorf, & Pawel Wroblewski

Market Overview

Global equities exhibited resilience in the first quarter, looking past potential bank contagion and stubborn inflation to extend gains. The benchmark MSCI All Country World Index advanced 7.31%, the S&P 500 Index added 7.50%, the developed market MSCI EAFE Index rose 8.47% for the quarter while the MSCI Emerging Markets Index added 3.96%.

After trailing for much of 2022, non-U.S. growth stocks earned a reprieve with the MSCI All Country World Growth Index gaining 13.78% for the quarter, outperforming the MSCI All Country World Value Index (+1.24%). This was driven by a rotation out of banks and more cyclically-exposed value sectors such as energy, into information technology ((IT)) and similar growth companies deemed more insulated from potential risks to the financial system and potentially benefiting from a pause, or even reversal, in central bank tightening.

On a sector basis, the best performers in the quarter were IT (+22.20%), communication services (+17.32%) and consumer discretionary (+14.70%), three areas where the Strategy is well represented. Laggards included energy (-3.10%), health care (-1.71%), financials (-0.68%) and utilities (-0.68%). The consumer staples (+3.19%), materials (+5.31%) and industrials (+6.44) sectors also underperformed the MSCI ACWI.

Exhibit 1: MSCI Growth vs. Value Performance

More pronounced growth exposure enabled the ClearBridge Global Growth Strategy to outperform by over 300 bps in the quarter. We attribute recent results to the Strategy being less tilted towards financials than the index, ending the first quarter with a financials underweight of approximately 680 bps, as well as strong performance in North America, a region where the Strategy’s holdings outperformed those in the benchmark by over 400 bps.

The Banking Crisis

The Strategy has historically been underweight financials, and we had been in the process of reducing our exposure prior to the market dislocations caused by the closure of Silicon Valley Bank (SIVB) and Signature Bank ( SBNY ) in the U.S. and the forced sale of Credit Suisse ( CS ) to UBS . As we neared our price targets in our lone bank holding, French-based global bank BNP Paribas ( BNPQF ), we began to trim the position. By the end of the quarter, we had exited BNP. The decision was equal parts risk reduction and profit taking after the strong upward performance of the stock over the year leading up to the bank crisis.

We have no exposure to Credit Suisse, whose investment bank has been in restructuring mode for years. Out of three businesses at Credit Suisse, we believe two are sound (their domestic bank and wealth management business) while the investment division has proven weak. In addition, the company’s management turmoil, operational missteps and deposit outflows had been persistent headwinds for many years. The current crisis has likely just accelerated an inevitable restructuring/breakup. While we believe the forced takeover is not a perfect solution, it is the best that could be completed in a short period of time to allow the contagion risks from Credit Suisse to subside.

The most significant part of our financial exposure is in stock exchanges, including Intercontinental Exchange ( ICE ), Deutsche Boerse ( DBOEY ) and Hong Kong Exchanges & Clearing ( HKXCF ), and data provider S&P Global ( SPGI ). These stocks should see little impact from the SIVB closure and Credit Suisse takeover. Higher volatility, common in times of bank sector stress, is a positive for many aspects of their operations. We also hold Hong Kong-based insurer AIA Group ( AAGIY ), which was mostly insulated from the banking crisis.

Beyond financials, relative performance was driven by our countercyclical health care holdings, higher beta IT holdings and defensive consumer staples names. This performance illustrates the diversification we seek in the portfolio by spreading our growth ownership across three buckets of growth companies: secular, structural and emerging. The first two buckets drove performance through a turbulent 2022 while our higher risk, higher growth holdings made a meaningful contribution in the first quarter, led by U.S. mega caps Tesla ( TSLA ), Alphabet ( GOOG , GOOGL ) and Amazon.com ( AMZN ). Graphics chipmaker Nvidia ( NVDA ), which we consider a structural grower given the cyclical semiconductor industry, was the Strategy’s top performer as it is well-positioned to expand its leadership in developing chips for AI applications. Within health care, secular growers Straumann ( SAUHF ) and Stryker ( SYK ) in the medical device industry led performance.

Portfolio Positioning

Ongoing volatility has provided an attractive environment for us as active managers to reposition and upgrade the portfolio as prices allow. We were busy in the first quarter, initiating 13 new positions while exiting 12 others. Our activity included increasing exposure to emerging markets with purchases in China and Mexico.

The largest addition during the quarter was secular grower SAP in the IT sector. We believe the German software maker is well-positioned as we are at the early innings of a mega enterprise resource planning ((ERP)) upgrade cycle to the cloud, which will last multiple years and return the company to sustainable, double-digit growth. SAP should benefit from more recurring revenues from cloud-based subscriptions as well as a broad range of solutions across the enterprise including human resources, customer relationship and spend management.

Compelling valuations and increasing optimism about China’s reopening motivated the repurchase of Tencent ( TCEHY ), a Chinese Internet and social media conglomerate, and Alibaba ( BABA ), a Chinese e-commerce leader, whose shares had fallen sharply since we sold it in 2021. Tencent’s earnings estimates suffered due to a weak Chinese economy shut down by COVID restrictions and many clients curtailing spending due to increased government regulation, which negatively impacted Tencent game approvals. We now believe estimates have bottomed and should start moving higher as the economy reopens, with advertising spending coming back on Tencent’s social media and other media assets and corporations restarting spending on cloud services. In addition, regulators are likely to restart approval of new Tencent games within the limits on kids play time. Alibaba was crippled by regulatory crackdowns that limited its growth plans, including the IPO of its Ant Group. During the quarter, the company announced plans to divide itself into six separate companies, a decision that drew positive approval from markets and could serve as a template for future growth of similar privately-owned technology companies in China.

The luxury market within the consumer discretionary sector has traditionally been a solid growth area for the portfolio and we added a new holding in Kering ( PPRUF ) which, like longtime holding LVMHF , is a French owner of luxury brands headlined by Gucci and Saint Laurent. Within luxury, scaled players like Kering and LVMH enjoy significant advantages over smaller companies that might only have single brands – players with scale possess the best real estate, creative/merchandising/management talent and control over distribution.

Outlook

As we come out of a mild winter, Europe and the United Kingdom have withstood energy shortages but continue to battle stubbornly high inflation. Yields have risen to competitive levels as the ECB and Bank of England have followed the U.S. Fed in tightening financial conditions. While we are watching inflation prints and earnings reports carefully, we continue to favor the region as it is home to many high-quality businesses that meet the characteristics we look for in secular and structural growth companies. We are also very selectively returning to emerging growth companies, repurchasing a small position in Canadian e-commerce enabler Shopify ( SHOP ), as valuations have reset after the pandemic boom in 2020 and 2021 and growth selloff last year, as well as U.S. biopharmaceutical Vertex Pharmaceuticals ( VRTX ) which is the market leader in the treatment of cystic fibrosis.

In the U.S., we continue to orient the Strategy for a base case of recession where growth companies able to maintain revenue and earnings visibility should thrive. We believe the portfolio balance we have achieved through active positioning moves and a consistent commitment to risk management should be supportive of performance both in difficult market periods as well as strong rallies like the one to start the year.

Asian economies are normalizing from the pandemic but the region remains unsettled. The Bank of Japan has a new governor, so we will monitor his comments to determine the direction of monetary policy and whether Japan will remove its very easy stance. Sudden moves towards higher rates in Japan could impede a very slow recovery from the COVID lockdowns last year. China’s recovery post their zero-COVID lockdowns has been slow. Several of President Xi’s key lieutenants in China have a technology background, which offers us some optimism after the very negative attitude toward technology leaders last year. Global politics remain challenging for non-Chinese investors to re-engage as they have previously. Our positioning in China is moderate and concentrated in stocks that should advance off very low levels of last year, regardless of global politics.

The past few years have been challenging to long-term investors as style cycles have vacillated meaningfully. Global growth stocks were very out of favor post the Russian invasion of Ukraine in February 2022, while global value stocks reached record highs against growth stocks. Today, money supply around the world is tightening meaningfully from historically high levels, interest rates are moving up and the cost of capital is increasing. We have been watching these moves and are constructive on our current positioning. We maintain high-conviction exposure in growth companies which not only generate abundant free cash flow but who also have healthy cash balances and low debt levels. We have been trimming and selling more cyclically-oriented positions. Over the next few quarters, we will see if the impact on economies from higher rates introduced over a year ago begins to take hold. Should weakness emerge in global markets, the Strategy has a sound foundation to withstand it. Regardless of the timing of a recession, growth stocks have historically demonstrated resilience through an economic contraction.

Portfolio Highlights

During the first quarter, the ClearBridge Global Growth Strategy outperformed its MSCI ACWI benchmark. On an absolute basis, the Strategy saw gains across the nine sectors in which it was invested (out of 11 total) with the IT and consumer discretionary sectors as the leading contributors.

On a relative basis, overall stock selection and sector allocation contributed to performance. In particular, stock selection in the health care, consumer staples and IT sectors, an underweight to financials and a lack of exposure to energy drove results. Conversely, overweights to health care and consumer staples and an underweight to communication services detracted from performance.

On a regional basis, stock selection in North America, Europe Ex U.K. and Japan and an overweight to Europe Ex U.K. contributed to performance while stock selection in Asia Ex Japan detracted. On an individual stock basis, the largest contributors to absolute returns in the quarter included Nvidia, Apple and Microsoft in the IT sector, Tesla in the consumer discretionary sector and Coty in the consumer staples sector. The greatest detractors from absolute returns included positions in UnitedHealth Group in the health care sector, Computershare in the industrials sector, Raymond James Financial in the financials sector, TravelSky Technology in the consumer discretionary sector and NextEra Energy in the utilities sector.

In addition to the transactions mentioned above, we initiated positions in Netflix ( NFLX ) in the communication services sector, Safran ( SAFRF ) in the industrials sector, Grupo Bimbo ( GRBMF ) in the consumer staples sector, TravelSky Technology ( TSYHY ) in the consumer discretionary sector, Arista Networks ( ANET ) and Amphenol ( APH ) in the IT sector and Karuna Therapeutics ( KRTX ) in the health care sector. We also closed additional positions in Air Liquide ( AIQUF ) and CRH in the materials sector, TE Connectivity ( TEL ) and Dassault Systemes ( DASTY ) in the IT sector, Avantor ( AVTR ), ICON, EssilorLuxottica ( ESLOF ) and Ansell ( ANSLF ) in the health care sector, United Rentals ( URI ) in the industrials sector, Dr. Martens ( DOCMF ) in the consumer discretionary sector and Aflac ( AFL ) in the financials sector.

Elisa Mazen, Managing Director, Head of Global Growth, Portfolio Manager

Michael Testorf, CFA, Managing Director, Portfolio Manager

Pawel Wroblewski, CFA, Managing Director, Portfolio Manager

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