EMO - ClearBridge Global Growth Strategy Q4 2023 Portfolio Manager Commentary

2024-01-21 09:00:00 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.
• Global growth equities outperformed as market breadth improved amid signs of softening inflation in the U.S. and Europe and monetary tightening reaching its peak.
• The Strategy outperformed its benchmark, led by our U.S. large cap technology related holdings as well as strong stock selection in Canada, Japan and selective emerging markets.
• We were active in the quarter, initiating 13 positions while closing out eight names to manage risk and better position the portfolio for what we expect to be a more conducive environment for growth stocks in 2024.

By Elisa Mazen, Michael Testorf, CFA, & Pawel Wroblewski, CFA

Strength in U.S. Growth Stocks Drives Outperformance

Market Overview

Global equities rebounded in the fourth quarter, sparked by moderating inflation and plunging bond yields in the U.S. and Europe. The benchmark MSCI All Country World Index ( ACWI ) advanced 11.03% for the quarter.

In an indicator of improved market breadth, the MSCI ACWI Small Cap Index rose 11.98%. This followed the first three quarters of the year when small and mid cap stocks in the U.S. and Europe underperformed. While narrow leadership in international markets has not merited the same attention as the dominance of the Magnificent Seven in the U.S., outperformance in the benchmark has generally been limited to large cap companies, many with a technology bias, as well as regions like Japan benefiting from accommodative monetary policy.

A more palatable yield environment supported growth stocks, enabling the MSCI ACWI Growth Index to climb 12.74% for the quarter and outperform the MSCI ACWI Value Index by 358 basis points. Growth’s resurgence expanded its leadership for the year, with ACWI Growth finishing 33.22% higher to outperform ACWI Value (+11.81%) by over 2,100 bps (Exhibit 1).

Exhibit 1: MSCI Growth vs. Value Performance

U.S. equities, which account for the largest allocation in the Strategy and the benchmark, rallied on signs of cooling inflation and a slowing labor market that not only reversed a two-year climb in yields but also increased the likelihood that the Federal Reserve had completed its tightening cycle. The market is pricing in the first rate cut in the first half of 2024. With the 10-year Treasury ( US10Y ) yield declining 70 bps, growth remained in favor with the Russell 1000 Growth Index outperforming the Russell 1000 Value Index by 467 bps. For the year, the growth index climbed 42.68%, outperforming value by over 3,100 bps, second only to 2020 as the largest performance differential in investment styles since both indexes launched in 1987.

The ClearBridge Global Growth Strategy outperformed the benchmark for the quarter, led by strong stock selection in the U.S. Performance was also supported by contributions in the traditional growth sectors of communication services and information technology ('IT') and the higher beta segments of health care. Microsoft ( MSFT ) continued to be supported by strong execution and a leadership position in the implementation of generative artificial intelligence ('AI') while Amazon ( AMZN ) benefited from strong margin expansion across segments, most notably its core e-commerce business.

Further, we believe conditions conducive to growth outperformance will be more prevalent in the year ahead, from factors such as a more benign rate environment and more challenging overall macro backdrop, with economies already slowing through 2023. Room for continued fiscal stimulus measures, which has benefited a broader group of stocks, is also more constrained than previously. We continue to maintain a diversified portfolio across sectors and regions, focusing on our valuation approach to growth and risk management, a setup that should keep us well-positioned to participate in a potential growth resurgence as financial conditions loosen.

Despite these risks, our holdings in Europe and the U.K. found their footing in the fourth quarter. Irish building materials supplier CRH , which has demonstrated strong value creation through M&A and optimization of its portfolio assets over the last several quarters, rose strongly on positive sentiment after its investor day highlighted the company’s accelerating growth in the U.S.

Another welcome change has been the recognition of generative artificial intelligence ('AI') opportunities for companies outside the U.S. Semiconductor equipment maker ASML , which we consider an enabler of AI, as well as enterprise software maker SAP and IT consultant Accenture ( ACN ), which we see as facilitators of AI adoption in new product lines and/or enhanced business models, rose strongly in the quarter.

These gains, and the tailwinds of a period of growth outperformance, were partially offset by weakness among the Strategy’s consumer staples holdings, which underperformed the overall market.

Portfolio Positioning

We were active in the quarter, initiating 13 positions while closing out eight others. Among the largest additions were U.S. stocks META Platforms, Visa ( V ) and Target ( TGT ). Meta, the operator of Instagram and Facebook and one of the largest digital advertising platforms, has multiple tailwinds going into 2024 with the overall business positioned to grow high teens or better through 2025. Engagement and click-through rates started to go up steadily from the first quarter of 2023 due to recent investments. Click to messaging, meanwhile, is a huge untapped opportunity while we believe Reels is better suited for performance ads than rival TikTok. Visa, which operates the world’s largest transaction processing network for credit and debit cards, remains on track to continue to generate low double-digit revenue growth. Its New Flows and Value Added Services revenues are growing faster as a result of improved sales and new product development. Meanwhile, core business growth should benefit from still recovering cross-border volumes and from continued penetration of tap to pay, particularly in the U.S.

In addition to these two secular growers, we added structural growth exposure with the repurchase of general merchandise retailer Target. Target provides early cycle consumer exposure but with support from cash flow and a dividend yield. The retailer reset earnings in August by lowering its full-year outlook to account for weak sales and one-time cost issues, leaving the shares trading at a historically wide discount to peers. We see Target as a self-help turnaround story, with better than expected margin and inventory control leading to improved comparisons. We believe an end is in sight to the pressure on retailers due to stimulus rolling off, inflation, and the shift from goods to services.

Our biggest addition outside the U.S. was the opportunistic purchase of Hoya ( HOCPY ), a high-quality manufacturer of technology products and health care instruments based in Japan. Hoya maintains high rates of innovation and a strong focus on attractive market niches such as optical products critical for the manufacturing of semiconductors. We believe the market underestimates the durability of earnings growth of this franchise. Also in Japan, we added SMC ( SMCAY ), a secular grower in the industrials sector well-positioned for continued share gains in the growing markets of manufacturing automation for semiconductors, rechargeable batteries and others. New purchase Hexagon ( HXGBF ), in the IT sector, is a Swedish designer of a broad range of technology and scientific applications including industrial control and automation, design and cyber security solutions.

Our largest sales were Tesla ( TSLA ), Hong Kong Exchanges & Clearing ( HKXCF ) and Procter & Gamble ( PG ). Tesla was sold as the shares neared our price target and we moved into a new auto name in Ferrari ( RACE ) with a niche luxury offering, higher overall margins and a significant portion of cars pre-sold for several years out. We view Ferrari as a unique asset in the auto world. Hong Kong Exchanges & Clearing has been hurt by lower transaction volumes for cash and derivatives the last several quarters because the Hong Kong and mainland China markets have been out of favor. New stock exchange listings have also been very low and have not contributed to turnover and fees, weighing on the stock and leading to our exit. Procter & Gamble was sold on a relatively full valuation at a premium to the sector and at a modest upside in order to move into new holdings with more potential.

As part of our fundamental research on new and existing holdings, we engage our portfolio companies regularly on ESG issues germane to their business model and profitability. During the quarter, ClearBridge led an annual engagement on behalf of the Access to Medicines Index (“ATMI”) with new addition Novo Nordisk ( NVO ). Novo provides insulin to 46,000 children in low- and middle-income countries (LMIC), making progress toward the company’s goal of 100,000 by 2030. The company needs both deeper penetration in existing countries and to add new ones to achieve its goal. In recognition of current conflicts and humanitarian challenges, Novo has also made outright donations of insulins to Ukraine and to NGOs helping the people of Gaza.

Novo would like to run its LMIC access programs as a viable and sustainable business, not solely a donation program, providing an incentive to the company and to the employees involved in its LMIC efforts. Notably, despite supply shortages of its blockbuster GLP-1 therapeutics due to production backlogs, the company explicitly prioritizes maintaining current insulin production “because of its moral obligation to do so.”

Outlook

One of the greatest headwinds to growth stock performance over the last two years, tightening liquidity due to higher yields, could abate as the new year unfolds. The Fed, ECB and BoE are expected to commence rate cuts as early as the first half of 2024 as inflation continues to normalize toward central banks’ target range and labor costs moderate. Consumers also appear well-positioned to weather a mild economic downturn, which could lead to a pickup in demand. Areas including consumer staples, health care and other long-duration growth sectors outside the U.S. did not work in 2023. In watching for a broadening of international market leadership, we are hopeful that an extended decline in rates can start to benefit these laggard areas of growth.

However, equity performance improvement will also be dependent on earnings, which are expected to remain soft outside the U.S. through the first half of 2024 due to tough comparisons. Europe continues to face other challenges such as the fiscal spending required to continue to the secular transition to electric vehicles. Canada, which represents a meaningful allocation in the Strategy, is also flirting with contraction as its economy is more resource dependent than the services-driven U.S. Successfully navigating this environment will require vigilance of consumer behavior, policy moves and focusing our research on self-funding, cash generative businesses that can outperform through a macro transition.

We are paying particular attention to Japan, which remains an outlier among global equity markets in several ways. Among developed markets, Japan is the only one which has not raised policy rates. Inflation has been muted but is approaching the level where the Bank of Japan is likely to abandon its negative interest rate regime. Given cash rich balance sheets on the corporate side and 50% of Japanese consumer assets in cash, even a small rate rise should be beneficial.

We have discussed in past commentaries the multiple programs underway to improve profitability and encourage more equity ownership. There are several small measures coalescing and combining with the push from the government to improve capital returns to shareholders. Share buybacks are growing tremendously in Japan and are becoming a meaningful component of stock performance.

Portfolio Highlights

During the fourth quarter, the ClearBridge Global Growth Strategy outperformed its MSCI ACWI benchmark. On an absolute basis, the Strategy experienced gains across the nine sectors in which it was invested (out of 11 total) with the IT and health care sectors the primary contributors.

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

On a regional basis, stock selection in the U.S. was the main driver of performance while selection in Canada, emerging markets and Japan were also additive. Stock selection in Asia Ex Japan detracted from returns.

On an individual stock basis, the largest contributors to absolute returns in the quarter included Microsoft, Amazon.com ( AMZN ), Apple ( AAPL ), Karuna Therapeutics ( KRTX ) and Netflix ( NFLX ). The greatest detractors from absolute returns included positions in Hong Kong Exchanges & Clearing, argenx ( ARGX ), Tesla, Daiichi Sankyo ( DSKYF ) and Alibaba ( BABA ).

In addition to the transaction mentioned above, we initiated positions in Inditex in the consumer discretionary sector, Chubb ( CB ) and Marsh & McLennan ( MMC ) in the financials sector -- an area we have been long underweight in the U.S. -- Pinterest ( PINS ) in the communication services sector and Monolithic Power Systems ( MPWR ) in the IT sector. We also exited Deere ( DE ) in the industrials sector, Kroger ( KR ) in the consumer staples sector, Tencent ( TCEHY ) in the communication services sector as well as Alibaba and Kering ( PPRUF ) in the consumer discretionary 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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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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