ZD - Meridian Growth Fund Q2 2023 Investment Commentary

2023-08-14 01:30:00 ET

Summary

• Meridian Growth Fund seeks long-term growth of capital by investing primarily in equity securities of small to mid-capitalization growth companies.
• With inflation gradually easing and the U.S. economy holding firm, stocks generally advanced during the second quarter.
• The Meridian Growth Fund returned 3.61% (net) during the quarter ended June 30, 2023.

With inflation gradually easing and the U.S. economy holding firm, stocks generally advanced during the second quarter. Conditions prompted U.S. Federal Reserve ("Fed") officials to pause their aggressive rate-hike campaign in June and forecast that the U.S. would avoid a recession in 2023. Fed Chair Jerome Powell did assert, however, that markets should expect further rate increases in the coming months, perhaps as many as two more by year-end. Running counter to stock investors' general optimism, bond investors drove short- and long-duration yields higher, further sharpening the already inverted U.S. Treasury yield curve.

Fueled by a surge in artificial intelligence-related technology stocks, double-digit gains in large cap growth stocks led the market higher, according to the Russell family of indices. Among small cap and mid cap stocks, growth stocks outperformed value stocks.

Fund Performance

The Meridian Growth Fund (the "Fund") returned 3.61% (net) during the quarter ended June 30, 2023, underperforming its benchmark, the Russell 2500 Growth Index, which returned 6.42%.

Our investment process prioritizes the management of risk over the opportunity for return. We look to build an enduring Fund that can mitigate capital losses during turbulent bear market environments and, secondarily, participate on the upside during strong market environments. Muted market volatility - the index declined more than 2% just once during the quarter - limited the impact of our philosophy during the period.

Otherwise, unique market dynamics presented a mixed return landscape. For example, both high- and low-momentum stocks outperformed, although modestly better returns in high-momentum stocks created a headwind for our Fund, in which our valuation discipline emphasizes more lower-momentum stocks. In addition, advances among companies without earnings also weighed on performance. From a sector perspective, stock selection was positive in the communication services and industrials sectors. Conversely, holdings in the healthcare sector detracted from relative returns.

The Fund's performance data represents past performance and does not guarantee future results. Current performance may be lower or higher than the performance data shown. The investment return and principal value of an investment will fluctuate so that you may have a gain or loss upon sale. You can obtain performance data current to the most recent month-end at www.arrowmarkpartners.com/meridian

Top 10 Holdings (% Of Portfolio)

Bottom Three Detractors

Three individual detractors from the Fund's relative performance during the period included Ziff Davis, Inc. , Certara, Inc. ( CERT ) , and Sensata Technologies Holding PLC.

Ziff Davis, Inc. is a leading internet and software services company operating through two segments: business cloud services and digital media. The cloud services business provides niche products to small- and mid-sized businesses and enjoys a high percentage of recurring revenues, low churn, and high margins. Ziff Davis's digital media business generates revenue through subscriptions and advertising on websites it owns, including wellness site Everyday Health. Ziff Davis's advertising business model is unique in that it is almost entirely performance-based, as opposed to other sites that rely heavily on banner advertisements. Furthermore, while companies that rely on tracking users' online behaviors to target advertising must navigate stricter privacy rules and regulations, Ziff Davis does not use tracking technology, so it has no exposure to the headwinds presented by the tougher rules. During the quarter, the stock traded off due largely to extended weakness in advertising spending, especially in the technology industry. We also believe that some investors may be growing impatient with Ziff Davis's patient approach on the acquisition front. We, however, believe there's limited remaining downside in the advertising cycle, and we're comfortable with management's disciplined approach to seeking higher returns on its acquisitions during a period of uncertainty. We therefore added to our exposure as the stock declined during the period.

Certara, Inc . develops technology to streamline drug development through biosimulations that model how investigational compounds interact at varied dosing levels with organs and other drugs. Although the technology is still relatively new, a large majority of the most recent 100 drugs that received Food and Drug Administration approval tapped a Certara solution at some point in the process. The company continues to grow and increase its penetration with new and existing clients. It has also largely been insulated from the industry spending slowdown that clipped the revenues of clinical research organizations. Late in the quarter, however, the company cautiously acknowledged that it was experiencing longer sales cycles amid funding pressures within the biotechnology industry and heightened discipline in research and development spending among large pharmaceutical companies. Although management didn't discuss potential impacts on Certara's outlook, such conditions can be a recipe for slower revenue growth in the near term, so the stock sold off. Although we continue to believe in the long-term prospects of the company, we slightly trimmed our exposure to the stock.

Sensata Technologies Holding PLC develops and manufactures sensors and electronic components for the automotive, aerospace, and industrial sectors. We believe the company is well run and is responsible for much of the sophisticated technology behind current megatrends such as electrification, autonomous driving systems, clean and efficient appliances, and smart devices. After years of expanding via acquisitions, Sensata is committed to focusing almost exclusively on organic growth, which we believe will help lead to healthy margin expansion, improved returns on invested capital, and declining leverage. The stock fell during the quarter as the company was unable to outgrow its end markets. However, on a trailing 12 months basis, Sensata outgrew the markets it serves by more than 600 basis points, suggesting that timing issues might have depressed growth in the current quarter. Despite the setback, we believe the company remains on track for its full-year market out-growth goals. Additionally, the company paid down a portion of its outstanding debt during the quarter, reflecting management's commitment to reducing leverage. As we believe the company's fundamentals remain sound and the stock's valuation very reasonable, we added to our position.

Top Three Contributors

Three individual contributors to the Fund's relative performance during the quarter included ACV Auctions, Inc. , STERIS plc , and CarGurus, Inc.

ACV Auctions, Inc. operates a digital wholesale auction marketplace to facilitate business-to-business used car sales between sellers and dealers. It has disrupted the traditional physical used-car auction marketplace by attracting thousands of dealers to its online platform. ACV's competitive advantage is its sizeable team of inspectors and the technology tools supporting this team. The depth and accuracy of ACV's inspection reports provide buyers the confidence to bid aggressively, knowing that they are unlikely to contend with negative post-purchase surprises. Sellers are drawn to ACV due to its lower auction fees and large buyer base. Strong quarterly results, featuring better-than-expected revenue growth and sharply improving margins, propelled the stock higher during the period. Just as critically, ACV continued to capture a significant amount of market share, posting positive unit volume growth amid the broader industry's decline. Separately, the company presented projections through 2026, which targeted considerable gains in revenue and EBITDA. We slightly reduced our holdings in the company during the quarter due to a less favorable risk-reward profile.

STERIS PLC specializes in sterilization and surgical products for the healthcare industry. Our original investment was motivated by the company's consistent growth and profit profile given its leading market positions for mission-critical healthcare services. The stock advanced during the quarter on the back of strong results featuring accelerating organic growth rates and improved performance in its equipment business, which had been hindered by supply chain challenges, especially for semiconductor chips. Sales volumes in STERIS's core sterilization technology business continued to rise, and with capacity constrained industrywide, overall pricing dynamics remain healthy, which contributed to management's increased full-year earnings guidance. During the period, we took advantage of the share price appreciation to trim our position.

CarGurus, Inc . is at the forefront of the online automobile sales industry, operating a web-based retail marketplace and holding a 50% stake in an online auction wholesaler. The marketplace business is unique in that it presents buyers with an unbiased list of available vehicles ranked on their value - a combination of the price and quality of the vehicle. Meanwhile, Caroline

Meanwhile, dealers are drawn to CarGurus.com's attractive pricing and extensive suite of ancillary services. The stock reacted positively to better-than-expected results and guidance driven by a stable marketplace business and improving profitability in the online auction business. Looking ahead, we believe the platform's benefits to dealers will broaden available vehicle inventories, especially as competition for buyers keeps growing. Also, we believe a push into a fully online car buying experience will dramatically expand CarGurus' market footprint while improving monetization. Separately, the digital wholesale business, which suffered setbacks during a period of hypergrowth, appears to have stabilized, and we believe it's back on track to return to profitability soon. We maintained our position during the quarter.

Outlook

At quarter-end, the economic softness expected in the wake of the Fed's aggressive actions over the previous 16 months had failed to materialize. The employment picture and broader economic conditions remained relatively healthy. Inflation gauges, while still above targeted levels, have continued to moderate, which has led to increased confidence in a soft landing. Despite this backdrop, overall core inflation remains high, with the Fed signaling more rate increases will be necessary to achieve their goals, potentially leading to further market volatility. We remain poised to take advantage of any market weakness and multiple contractions by adding to existing positions and building positions in new names when valuations decline to attractive levels, although we remain cognizant of the risks inherent in such a challenging environment. We remain focused on companies that have resilient business models and the ability to execute in a higher rate environment.

Thank you for your continued partnership with ArrowMark.

Fund Total Performance (As Of 6/30/2023)

The Fund's performance data represents past performance and does not guarantee future results. Current performance may be lower or higher than the performance data shown. The investment return and principal value of an investment will fluctuate so that you may have a gain or loss upon sale. You can obtain performance data current to the most recent month-end at Meridian Funds .

¹ Listed holdings are presented to illustrate examples of the securities the Fund has bought and do not represent all of the Fund's holdings or future investments. Information about the Fund's holdings should not be considered investment advice. There is no guarantee that the Fund will continue to hold any one particular security or stay invested in any one particular sector. Holdings are subject to change at any time and are as of the date shown above.

² The Fund's Index, the Russell 2500™ Growth Index, measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2500 Index companies with higher price-to-value ratios and higher forecasted growth values. One cannot invest directly into an index.

³ Closed to new investors.

⁴ Performance is annualized.

⁵ Since inception returns are calculated using the Fund's Legacy class inception date of 8/1/84.

A Class: Prior to 7/1/15, the A Class was named Advisor Class. The historical performance shown for periods prior to inception on 11/15/13 was calculated using historical Legacy class performance as adjusted for estimated class-specific expenses, for distribution, shareholder servicing and sub-transfer agency fees, without consideration to any expense limitation or waivers. The annual gross expense ratio is 1.17% as of 12/30/22. The net expense ratio is 1.17% as of 12/30/22. If the class had been offered prior to 11/15/13, the actual performance and expenses may have differed from the amounts shown. Performance shown for class A shares with load includes the Fund's maximum sales charge of 5.75%. C Class: The historical performance shown for periods prior to inception on 7/1/15 was calculated using historical Legacy class performance as adjusted for estimated class-specific expenses, for distribution, shareholder servicing and sub-transfer agency fees, without consideration to any expense limitation or waivers. The annual gross expense ratio is 1.87% as of 12/30/22. The net expense ratio is 1.87% as of 12/30/22. If the class had been offered prior to 7/1/15, the actual performance and expenses may have differed from the amounts shown. Investor Class: The historical performance shown for periods prior to inception on 11/15/13 was calculated using historical Legacy class performance as adjusted for estimated class-specific expenses for shareholder servicing and sub-transfer agency fees without consideration to any expense limitation or waivers. The annual gross expense ratio is 0.92% as of 12/30/22. The annual net expense ratio is 0.92% as of 12/30/22. Legacy Class: The annual gross expense ratio is 0.85% as of 12/30/22. The annual net expense ratio is 0.85% as of 12/30/22. Legacy class shares of the Fund are no longer available for purchase by new investors, except under certain limited circumstances which are described in the Statement of Additional Information.

Investors should consider the investment objective and policies, risk considerations, charges and ongoing expenses of an investment carefully before investing. The prospectus contains this and other information relevant to an investment in the fund. Please read the prospectus carefully before you invest or send money. To obtain a prospectus, please contact your investment representative or access the website at arrowmarkpartners.com/meridian .

Principal Investment Risks

There are risks involved with any investment. The principal risks associated with an investment in the Fund, which could adversely affect its net asset value, yield and return, are set forth below. Please see the section "Further Information About Principal Risks" in the Prospectus for a more detailed discussion of these risks and other factors you should carefully consider before deciding to invest in the Fund. An investment in the Fund may lose money and is not a deposit of a bank or insured or guaranteed by the Federal Deposit Insurance Corporation or any other governmental agency. Investment Strategy Risk: The Investment Adviser uses the Fund's principal investment strategies and other investment strategies to seek to achieve the Fund's investment objective of long-term growth of capital. There is no assurance that the Investment Adviser's investment strategies or securities selection method will achieve that investment objective. Equity Securities Risk: Equity securities fluctuate in price and value in response to many factors including historical and prospective earnings of the issuer and its financial condition, the value of its assets, general economic conditions, interest rates, investors' perceptions and market liquidity. Market Risk: The value of the Fund's investments will fluctuate in response to the activities of individual companies and general stock market and economic conditions. As a result, the value of your investment in the Fund may be more or less than your purchase price. Growth Securities Risk: Because growth securities typically trade at a higher multiple of earnings than other types of securities, the market values of growth securities may be more sensitive to changes in current or expected earnings than the market values of other types of securities. In addition, growth securities, at times, may not perform as well as value securities or the stock market in general, and may be out of favor with investors for varying periods of time. Small Company Risk: Generally, the smaller the capitalization of a company, the greater the risk associated with an investment in the company. The stock prices of small capitalization and newer companies tend to fluctuate more than those of larger capitalized and/or more established companies and generally have a smaller market for their shares than do large capitalization companies. Foreign Securities Risk: Investments in foreign securities may be subject to more risks than those associated with U.S. investments, including currency fluctuations, political and economic instability and differences in accounting, auditing and financial reporting standards. Foreign securities may be less liquid than domestic securities so that the Fund may, at times, be unable to sell foreign securities at desirable times or prices. In addition, emerging market securities involve greater risk and more volatility than those of companies in more developed markets. Significant levels of foreign taxes are also a risk related to foreign investments. Glossary : Earnings Per Share: A company's profit divided by its number of common shares outstanding. EBITDA: Earnings before interest, taxes, depreciation & amortization. Free Cash Flow: A measure of a company's financial performance, calculated as operating cash flow minus capital expenditures. Price-to-earnings: A valuation ratio of current share price compared to its per-share operating earnings over the previous four quarters. Return On Invested Capital (ROIC) : A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. Basis Point: A common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001, and is used to denote the percentage change in a financial instrument. Russell 2500™ Value Index: An index that measures the performance of the small to mid-cap value segment of the US equity universe. It includes those Russell 2500™ companies that are considered more value oriented relative to the overall market as defined by Russell's leading style methodology. One cannot invest directly into an index.

ALPS Distributors, Inc., a member FINRA, is the distributor of the Meridian Mutual Funds, advised by ArrowMark Colorado Holdings, LLC. ALPS, Meridian and ArrowMark are unaffiliated. The statements and opinions expressed in this commentary are as of the date of the commentary. All information is historical and not indicative of future results and is subject to change. ALPS Distributors, Inc. is affiliated with SS&C and DST Systems.

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