STVN - ClearBridge Mid Cap Growth Strategy Q4 2023 Portfolio Manager Commentary

2024-01-20 10:45:00 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.
• A drastic shift in investor sentiment toward an economic soft landing and a dovish pivot from the Fed helped propel growth stocks to outperform value.
• The Strategy outperformed its benchmark, as strong contributions from our consumer discretionary and financials holdings overcame headwinds in health care.
• We believe a portfolio of high-quality companies with strong balance sheets and the ability to self-fund will help us to successfully navigate whatever challenges the new year brings.

By Brian Angerame, Jeffrey Bailin, CFA, Aram Green, Matthew Lilling, CFA

Growth Stocks Rise on Rate Cut Prospects

Market Overview

Equity markets generated strong returns in the fourth quarter, bolstered by declining bond yields and a resurgence of optimism that the U.S. economy could indeed achieve a soft landing. This helped to further broaden market participation among mid cap stocks, with the Russell Midcap Index returning 12.82% compared to the 11.96% return of the Russell 1000 Index. Growth stocks outperformed their value counterparts, with the Russell Midcap Growth Index returning 14.55% versus the Russell Midcap Value Index, which returned 12.11%.

Despite weaker performance early in the quarter thanks to rising bond yields, stubborn inflation and concerns over hostilities in the Middle East, markets came roaring back in November and December to close near all-time highs. The prospect of interest rate cuts as early as the first half of 2024 helped to spur a rally in more interest-rate sensitive and lower-quality stocks.

Within the Russell Midcap Growth Index, the leading performers were the interest-rate sensitive utilities (+23.89%), information technology (IT, +20.54%) and real estate sectors (+20.38%), while the consumer discretionary (+17.89%) and materials (+14.65%) sectors also outperformed the broader index. The health care (+13.61%), communication services (+13.15%), industrials (+12.91%), financials (+11.83%) and consumer staples (+5.52%) sectors also generated positive returns for the period. Energy (-2.45%) was the sole detractor.

"Despite weaker performance early in the quarter, markets came roaring back to close near all-time highs."

The Strategy’s consumer discretionary holdings benefited from optimism over an economic soft landing that eased concerns about future consumer spending. Top individual performer Chipotle Mexican Grill ( CMG ) rebounded from lackluster results in the third quarter due to concerns over the timing and level of price increases. However, strong third quarter earnings and continued execution on its long-term growth plans help to mitigate these headwinds. Online travel company Expedia ( EXPE ) was another top contributor. Entering the quarter, fears of a recession cast doubt on consumer travel. However, the completed integration of Expedia’s multiple brands under the same technology and marketing infrastructure helped bolster the company’s ability to capture additional market share. We believe that further integration synergies and management’s focus on internal improvement will continue to drive long-term results.

Stock selection in the financials sector also boosted performance. KKR , Tradeweb Markets ( TW ) and MSCI saw their share prices increase on the belief that anticipated Fed rate cuts would bolster activity in financial markets. For example, KKR, a leading private equity and real estate investment firm specializing in direct and fund of fund investments, faced a challenging environment in 2023 due to rising interest rates and other headwinds to raising new funds. However, we believe KKR’s strong performance and franchise will enable it to continue to grow its stream of recurring management fees and its capital markets business is likely to re-accelerate in 2024.

Stock selection in the health care sector was the primary detractor from relative performance, exacerbated by a rally that lifted many lower-quality, speculative biotechnology stocks we did not hold in the portfolio. For example, Stevanato ( STVN ), which designs and engineers containment solutions and drug delivery systems, saw its share price pull back as some of the exuberance regarding positively exposed GLP-1 stocks subsided. Argenx ( ARGX ) develops various therapies for the treatment of autoimmune diseases. Despite lackluster phase 3 trial data for two of their drugs due to trial design issues, we remain optimistic about the Dutch company’s long-term prospects and capitalized on a decline in the share price to add to the position. Given argenx’s strong balance sheet, and potential to expand their platform to treat dozens of similar autoimmune conditions, we like the biotechnology company’s long-term prospects.

Portfolio Positioning

We utilized the fourth quarter as a period of reflection and evaluation, eliminating positions where we felt our thesis was weakening while adding to new and existing holdings we felt were excellently positioned for years to come. Ultimately, this resulted in us initiating four new positions and exiting two.

We established a position in monday.com ( MNDY ) in the IT sector, which provides software efficiency work management tools through its cloud-based operating system. After an extended stretch of revenue deceleration in the software industry, we believe conditions are stabilizing, and monday.com is exceptionally well-positioned to capitalize on an industry re-acceleration, especially as it expands from a single product into a platform offering.

We also added a new position in West Pharmaceutical Services ( WST ), in the health care sector, which designs, manufactures and sells containment and delivery systems for injectable drugs and health care products. The company commands a substantial market share for stopper caps for intravenously ('IV') administered drugs, biologics and gene therapies, which are regulated by FDA mandates, and which we believe give it very strong competitive dynamics within the industry and a wide moat around its core businesses. As the outlook and proliferation of IV-administered drugs and therapies continues to grow, driven by the blockbuster market for GLP-1 diabetes and obesity treatments, we believe the company’s attractive cash flows and impressive margins can sustain its growth trajectory.

We exited our position in Splunk ( SPLK ), in the IT sector, a maker of data monitoring, analysis and security software applications for enterprises. The company announced it had agreed to be acquired by Cisco Systems ( CSCO ) during the third quarter at an attractive premium. As we determined there would not be a better offer for the company, we elected to exit the position.

Outlook

Having spent the fourth quarter reflecting on our performance over the last year, we approach 2024 confidently and believe we are well-positioned for the new year. Although we think optimism surrounding the soft-landing narrative and the prospect of rate cuts has helped embolden the market, the fourth quarter also proved how quickly and decisively sentiment and outlooks can change. As a result, we continue to carefully evaluate the risk/reward potential of each of our portfolio holdings and the volatility each contributes to the portfolio. We firmly believe our process of building a portfolio of high-quality companies with strong balance sheets and compelling long-term growth prospects will help us to successfully navigate whatever challenges the new year brings.

Portfolio Highlights

The ClearBridge Mid Cap Growth Strategy outperformed its Russell Midcap Growth Index during the fourth quarter. On an absolute basis, the Strategy had gains across nine of the 10 sectors in which it was invested during the quarter (out of 11 sectors total). The main contributors were the IT and consumer discretionary sectors, while the energy sector was the sole detractor.

On a relative basis, overall stock selection and sector allocation effects contributed to performance. Specifically, stock selection in the consumer discretionary, financials and consumer staples sectors as well as an overweight relative to the IT sector benefited performance. Conversely, stock selection in the health care, IT and real estate sectors weighed on performance.

On an individual stock basis, the biggest contributors to absolute returns in the quarter were Chipotle Mexican Grill, Palo Alto Networks ( PANW ), Monolithic Power Systems ( MPWR ), IDEXX Laboratories ( IDXX ) and Expedia. The largest detractors from absolute returns were Aptiv ( APTV ), Paylocity ( PCTY ), Stevanato, argenx and Sarepta Therapeutics ( SRPT ).

In addition to the transactions listed above, we initiated new positions in Guidewire Software ( GWRE ) in the IT sector and Sarepta Therapeutics in the health care sector. We exited a position in Enphase Energy ( ENPH ) in the IT sector.

Brian Angerame, Portfolio Manager

Jeffrey Bailin, CFA, Director, Portfolio Manager

Aram Green, Managing Director, Portfolio Manager

Matthew Lilling, CFA, 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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