ClearBridge Global Growth Strategy Q3 2023 Portfolio Manager Commentary

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

Staying Opportunistic As Fee Cycle Matures

Market Overview

World equities suffered losses within the third quarter, with rising bond yields resulting in a large divergence amongst progress and worth funding kinds. The benchmark MSCI All Nation World Index declined 3.40% for the quarter, whereas the U.S. S&P 500 Index (SP500, SPX) fell 3.27%, the developed market MSCI EAFE Index retreated 4.11% and the MSCI Rising Markets Index fell 2.93%.

Over a three-month interval paying homage to 2022, which marked the brunt of worldwide financial tightening, worth shares outperformed progress by over 300 foundation factors (bps), with the MSCI ACWI Worth Index down 1.76% in comparison with a 4.89% loss for the MSCI ACWI Development Index. Worth dominance was most pronounced exterior the U.S., the place the MSCI EAFE Worth Index outperformed its progress counterpart by over 900 bps.

Exhibit 1: MSCI Development vs. Worth Efficiency

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The U.S. 10-year Treasury yield climbed 74 bps throughout the quarter, reaching its highest degree in 16 years (Exhibit 2). Surging yields have resulted from resilient financial knowledge and a rebound in inflation that brought on the Fed to push out any hopes of a charge minimize within the close to future. Whereas the central financial institution could also be nearing or on the finish of its tightening cycle, we imagine the lagging impacts of 525 bps of rate of interest hikes within the final 18 months will probably be felt on company and client steadiness sheets nicely into the long run.

We had been stunned by the resilience of the U.S. economic system — one thing we don’t try and predict. It has had an outsize affect on our model, which, mixed with our broader allocation amongst sectors and progress groupings, traditionally has been helpful to efficiency. The breadth of the market has narrowed fairly meaningfully together with worth dominance, most notably exterior the U.S., which has additionally hindered relative efficiency. Importantly, we don’t suppose these circumstances will final.

Exhibit 2: Rising Yields Once more Pressuring Development Shares

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Towards this backdrop, the ClearBridge World Development Technique underperformed the benchmark for the quarter, held again by our dedication to progress throughout a price rally. Whereas disenchanted by latest efficiency and conscious {that a} handful of shares haven’t labored as we anticipated, we stay assured within the composition of the portfolio and imagine it’s well-positioned to ship alpha because the headwinds of restricted world liquidity start to dissipate.

Weak point for the quarter was centered within the financials sector, notably in Asia. AIA Group (OTCPK:AAGIY), a Hong Kong-based life insurer catering to mainland China shoppers, was impacted by very poor sentiment towards China. We have now seen very sturdy outflows from Chinese language equities because the financial restoration post-COVID has been weaker than anticipated. Nonetheless, we imagine markets in Asia provide an excellent long-term progress alternative and we proceed to love AIA as a high-quality progress franchise. New addition HDFC Financial institution (HDB), a number one banking and monetary companies supplier in India, in addition to U.S. index and monetary knowledge supplier S&P World (SPGI), additionally harm outcomes.

The latest efficiency of our client holdings has additionally been disappointing as weak demand in China has made them act much less defensively than we might have anticipated. This was true of French luxurious items maker OTCPK:LVMHF, U.S.-based cosmetics and perfume makers Estee Lauder (EL) and COTY, in addition to British spirits maker Diageo (DEO), which has been harm by weaker-than-expected world alcohol consumption popping out of COVID-19. In the meantime, Haleon (HLN), the U.Ok. well being care and client merchandise firm spun out of GlaxoSmithKline (GSK) and Pfizer (PFE), has been held again by the share overhang of its former dad and mom and higher-than-average debt ranges from its IPO. The corporate is exhibiting progress in decreasing debt, with asset gross sales being contemplated that might additional enhance its steadiness sheet.

Regionally, our inventory choice within the U.S., by far the biggest allocation within the benchmark and the Technique, was additionally detrimental. Right here we had been once more harm by our progress orientation with mega cap progress names Apple (AAPL) and Microsoft (MSFT), that dominated efficiency within the first half of the 12 months, giving again beneficial properties. This weak spot was partially offset by power in Alphabet (GOOG,GOOGL) and constructive, albeit extra restrained beneficial properties from AI chipmaker Nvidia (NVDA). As progress traders, we proceed to search out enticing alternatives within the data know-how (IT) sector, the place our obese negatively impacted efficiency throughout the quarter.

The brilliant spot within the quarter was our well being care publicity, particularly inside biopharmaceuticals. U.S. drug maker Eli Lilly (LLY) rallied on extra constructive information surrounding GLP-1 remedies for diabetes and weight problems which have additionally confirmed efficient in treating cardiovascular circumstances. Dutch biotechnology firm Argenx (ARGX) rose on a profitable launch for its myasthenia gravis drug, which it’s rolling out globally. Argenx is concentrating on the identical molecule to deal with different uncommon illnesses, with key readouts by 12 months finish or early subsequent 12 months. U.S. managed care supplier UnitedHealth Group (UNH) rebounded within the quarter as the corporate beat expectations and raised full-year steerage, offering proof that it could efficiently navigate the latest uptick in utilization amongst its Medicare sufferers. U.S. pharmaceutical AbbVie (ABBV) was additionally up strongly as traders have seemed previous issues a few patent expiration for its blockbuster Humira and pricing uncertainty for 2 of its newer remedies.

Portfolio Positioning

Reasonably than reverse course to maintain up with what we view as fleeting management for deep worth shares, we stay dedicated to a disciplined valuation method to portfolio building that delivers diversification by investing throughout three varieties or buckets of progress firms (secular, structural and rising). We remained lively within the third quarter, establishing seven new positions whereas eliminating eight others, with our positioning strikes underscoring this dedication to sourcing enticing progress franchises throughout world markets.

Our largest addition was Intuit (INTU), a U.S. supplier of software program for small enterprise accounting and tax preparation beneath the QuickBooks and TurboTax manufacturers in addition to private finance (Credit score Karma) and advertising and marketing companies (Mailchimp). We see a transparent path to upside earnings revisions as the corporate expands new merchandise that enhance its whole addressable market and drive common income per consumer progress. We imagine Intuit’s a number of progress initiatives, mixed with its market-leading core choices, underpin its sturdy double-digit earnings progress profile.

We added to our secular progress bucket with the acquisition of RELX, a U.Ok.-based data companies conglomerate with sturdy market positions throughout threat and analytics, scientific and medical publishing in addition to authorized and enterprise data. Over the subsequent a number of years, we anticipate earnings to return to its historic excessive single-digit progress given a rising mixture of the quicker rising threat enterprise, growth of AI and analytics options in sure verticals and restoration of the COVID-19 impacted exhibitions enterprise.

The acquisition of HDFC Financial institution, whose muted efficiency this 12 months supplied a gorgeous entry level, will increase our restricted publicity to rising markets. Throughout the interval, HDFC Financial institution accomplished its merger with India’s Housing Improvement Finance Company, giving the mixed entity a number of benefits. The latter is understood for its sturdy mortgage origination enterprise, however was brief on deposits and needed to self-finance on relative costly phrases. HDFC Financial institution, which continues to draw substantial deposits, will provide the mixed entity a less expensive type of financing for mortgage origination. The corporate may also be capable of leverage a bigger shopper base for cross-selling merchandise.

ESG can be a spotlight of the Technique, with ClearBridge’s integration of ESG issues into the basic analysis course of guiding us to best-in-class ESG leaders in addition to firms dedicated to enhancing their ESG profile. New buy TREX falls into the previous class and is enjoying a major position in limiting the degradation of pure assets, a rising point of interest for sustainability traders as biodiversity turns into a precedence alongside local weather change.

Trex has redefined the decking trade with a enterprise mannequin that addresses two key drivers of biodiversity loss, deforestation and air pollution, by substituting high-impact merchandise. As an alternative of counting on virgin wooden, Trex makes composite decking for residential and business clients utilizing 95% recycled wooden fibers and plastic waste. In 2022, Trex recycled 337 million kilos of waste polyethylene, a plastic generally used for plastic baggage and bottles, because it produced its high-end decking. Wooden decks stopped utilizing arsenic remedies in 2004, which has shortened their life span, dramatically growing the variety of decks that should be changed. Trex’s merchandise assist fill this want in a manner that preserves forests, reduces a significant supply of air pollution in oceans, and lowers clients’ whole prices of possession, since Trex’s decks have for much longer lifespans relative to pure lumber decks.

As valuations of rising markets shares have severely corrected, we now have been selectively revisiting them. This was the case with the repurchase of Latin American e-commerce platform MercadoLibre (MELI). Like many work-from-home and COVID-19 beneficiaries, the corporate’s share worth has declined since our exit in late 2020. MercadoLibre has continued to ship good outcomes, with revenues rising and margins improved because the enterprise scaled and expanded into new worthwhile companies. Its ecosystem is getting stronger with e-commerce supported by fintech, logistics and new companies reminiscent of streaming subscriptions much like Amazon Prime that generate extra advertising and marketing revenues.

Cognizant of the dangers that stay throughout world markets, we now have been tactically managing our publicity to probably the most economically delicate names within the portfolio. This motivated the third-quarter gross sales of Japanese semiconductor gear maker Tokyo Electron (OTCPK:TOELF) and European industrials names Safran (OTCPK:SAFRF) and Sandvik (OTCPK:SDVKF).

Outlook

Thus far in 2023, our structural holdings haven’t moved meaningfully, which has harm our potential to maintain up when worth leads. A few of our structural names, reminiscent of Olympus (OTCPK:OCPNF) and Daiichi Sankyo (OTCPK:DSKYF), are time-based, that means the catalysts we purchased them for have but to materialize. Kering Group (OTCPK:PPRUF), a luxurious items firm with a brand new designer who confirmed fairly nicely at Milan’s Vogue Week, failed to maneuver as the complete luxurious house was in promote down mode. We additionally imagine our strategic choice to achieve client discretionary publicity via luxurious items quite than the top-performing auto trade will result in higher long-term returns as the posh retailers we personal have higher margins and money and decrease working leverage than different shares within the client discretionary house in addition to quite a few levers to drag in financial downturns.

The selloff in non-U.S. progress shares is giving us an opportunity to guage fairly a number of new funding alternatives. Multiples in progress have come down meaningfully in areas like renewables, client staples, durables reminiscent of luxurious items and even supplies. Most of the future alternatives are in our portfolio right this moment and we now have been growing positions in areas that we predict have been overdone to the draw back.

The general financial surroundings each within the U.S. and abroad is difficult, however most of the extra prices of final 12 months are coming down, save, at the very least for the second, vitality. Our focus stays on firms with dominant market positions which have sturdy money era, good steadiness sheets and enticing valuations, and these traits ought to finally come to the forefront of traders’ mindsets. We have now been invested in lots of names which have accomplished fairly nicely, reminiscent of Lilly, Nvidia, SAP, Alphabet and Amazon. Fee decreases, an indication of financial weak spot, will drastically profit our client staples holdings, which didn’t carry out nicely this quarter. We have now seen these durations earlier than and really feel assured they are going to be good shares despite the fact that they’re testing traders’ persistence.

Portfolio Highlights

Throughout the third quarter, the ClearBridge World Development Technique underperformed its MSCI ACWI benchmark. On an absolute foundation, the Technique noticed losses throughout the 9 sectors by which it was invested (out of 11 whole) with the IT and client staples sectors the first detractors.

On a relative foundation, total inventory choice and sector allocation detracted from efficiency. Specifically, inventory choice within the financials, client staples, utilities and communication companies sectors, an absence of publicity to vitality and an obese to IT weighed on outcomes. On the constructive facet, inventory choice within the well being care and industrials sectors contributed to efficiency.

On a regional foundation, inventory choice in North America, Europe Ex U.Ok. and Japan harm efficiency.

On a person inventory foundation, the biggest contributors to absolute returns within the quarter included Eli Lilly, Argenx and UnitedHealth Group within the well being care sector, Alphabet within the communication companies sector and Marriott Worldwide (MAR) within the client discretionary sector. The best detractors from absolute returns included positions in Apple and Microsoft within the IT sector, Estee Lauder within the client staples sector, LVMH within the client discretionary sector and NextEra Power (NEE) within the utilities sector.

Along with the transactions talked about above, we initiated positions in UBER and Waste Connections WCN within the industrials sector. We additionally exited a place in Straumann (OTCPK:SAUHF) within the well being care sector, Sensient Applied sciences (SXT) within the supplies sector, Arista Networks (ANET) within the IT sector, Marriott Worldwide within the client discretionary sector and Iberdrola (OTCPK:IBDSF) within the utilities 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 Notice: The abstract bullets for this text had been chosen by Looking for Alpha editors.

Editor’s Notice: This text discusses a number of securities that don’t commerce on a significant U.S. trade. Please pay attention to the dangers related to these shares.