ClearBridge Strategies and Fiduciary Management: Q2 2024 Market Insights and Investment Outlooks

ClearBridge Appreciation ESG Strategy Q2 2024 Commentary

The soft landing rally that gained traction in November 2023 continued through 2024's second quarter, driven by virtually ideal disinflation data and continued fervor around AI. The S&P 500 Index (SP500,SPX) has now advanced in six of the past seven quarters (including seven of the past eight months). The second quarter's 4.3% advance left the S&P 500 up 15.3% year to date and an eye-popping 34% off the November 2023 low. Market performance narrowed from the broad base of the early stages of the current rally. Information technology ('IT') and communication services shares rose 13.8% and 9.4%, contributing 115%, or more than all, of the S&P 500's return. Apple (AAPL) and Nvidia (NVDA) alone accounted for 76% of the benchmark's return in the quarter. Narrow markets, especially after a large rise, have historically been risky markets. This has us on alert for a correction should the AI frenzy cool. "Although we believe investors underestimate the risk of a U.S. recession, we do not foresee a severe or protracted downturn." On the flip side, six of the 11 GICS sectors declined in absolute terms in the quarter, including the shares of materials, industrials, energy and financials stocks, which are key barometers of economic activity. Materials, the worst-performing sector, declined 4.5%, underperforming the benchmark by 878 bps, the sector's worst relative performance quarter in nearly nine years. Industrials, the second-worst-performing sector, underperformed the S&P 500 by 717 bps, its worst showing since the first quarter of 2020. Financial, energy, health care and real estate shares underperformed the benchmark by more than 500 bps. We also follow measures of liquidity to assess the environment for risky assets. Although we have been concerned that sustained high interest rates and the withdrawal of liquidity from a shrinking Fed balance sheet would tighten financial conditions, the impact of this dynamic has yet to impact key measures of liquidity: corporate credit spreads still look benign; bank deposits are expanding for the first time since 2022; and capital markets activity showed robust debt issuance. Clearly, we underestimated the degree to which enormous fiscal spend would help offset tightening monetary conditions. Although we are concerned a quantitative tightening liquidity drain is a matter of when and not if, we expect the Fed to ensure ample liquidity exists through the presidential election. We are at a key inflection point for the economy and investors, in our view. After hovering near expansion territory, the ISM Manufacturing Index has slipped back into contractionary territory. Leading indicators of consumer expectations have deteriorated. More specifically, transport volumes are anemic with railroad car loads flattish and trucking and logistics mired in contraction. Higher delinquency rates on credit cards and mortgages indicate that consumer credit has started to deteriorate. Housing starts and new home sales, which had held up surprisingly well given sticky mortgage rates, are finally showing signs of fatigue. Finally, the employment picture bears watching as late spring job openings declined while the unemployment and underemployment rates ticked higher. Although we believe investors underestimate the risk of a U.S. recession, we do not foresee a severe or protracted downturn. We would likely use a growth scare as opportunity to methodically add incremental risk to the portfolio. This is not all bad for investors. An economic slowdown combined with continued disinflationary data would compel the Fed to begin an interest rate cutting campaign, bolstering the chances of a Fed engineered soft landing. We are at the last mile to determine whether disinflation will reach the Fed's 2% target, which we view largely as a wage question, since services inflation remains sticky. Today, wage growth at 4.7% remains too high to reach the last mile target, but the trend is favorable, having declined consistently over the past year. Most economists circle 3.5% wage growth as the level that would support a 2% core PCE (3.5% wage growth + 1.5% productivity = 2% core inflation). To us, wage growth will be the key moving forward to determine whether the Fed can cut rates before the economy loses too much momentum to accomplish a soft landing (Exhibit 1). We remain in wait-and-see mode on this topic. History has shown tackling the last mile has proved challenging, with elevated risk that easing too soon could spur a renewed bout of inflationary pressures. Exhibit 1: Wage Growth Pointing in Right Direction to Reduce Core Inflation In sum, near-immaculate inflation data has further cemented the soft landing narrative as consensus, while animal spirits are betting that AI will revolutionize the global economy. We believe this dynamic has heightened the risk to the investment landscape should there be any stall in the disinflationary trend or disappointment in AI-driven capex. Our focus is, first, can corporate America monetize its investment in AI enough to justify capital spending levels that support the valuations of AI-related stocks? And second, will a weaker jobs market and the deflationary force of technological advancement deliver disinflation supportive of Fed rate cuts this fall? "We would likely use a growth scare as opportunity to methodically add incremental risk to the portfolio." Longer term, we worry about the sustainability of government debt and the increasing burden of higher interest rates on the budget deficit. At some point the U.S. will need to increase taxes or cut spending to prevent debt costs from spiraling out of control. Neither will happen in an election year, but the next Congress faces stark choices. By no means is the U.S. dollar's status as reserve currency our birthright. While we are optimistic about the long-term benefits generative AI will have on workplace productivity, aggressive assumptions need to be made to justify current valuations for the direct hardware vendors. Software stocks have lagged this year, creating opportunities in companies that can successfully monetize generative AI. We admire the business models of the largest technology companies, but we are mindful of their regulatory risks and also the concentration risk they create for our portfolio. We are positive on much of the health care sector as market expectations for medical device and life science/tool companies have come in markedly, while we find the non-cyclical nature and modest valuation of pharmaceutical companies appealing. We are positive on select cyclicals such as rails where expectations are low and sustained economic growth would create upside. We believe stable financial conditions and the potential for rate cuts and a steeper yield curve will benefit select financial companies such as banks. We do not expect the top-heavy market of the second quarter to continue and believe a diversified portfolio with investments focused on durable growth at attractive valuations is best positioned in this transitioning interest rate regime. Although we remain constructive on the medium-term outlook, we believe narrow market performance and the upcoming presidential election pose risks to today's placid environment. We believe investors should anchor return expectations closer to longer-term trends (high-single digits annually) versus the current ebullient backdrop. There is value in many non-AI corners of the market, especially should the Fed ease financial conditions. We are long-term investors focused on the risk-adjusted returns a diversified portfolio can deliver through a market cycle. Rather than trying to bet on near-term earnings trends, we believe it is better to look out two to three years and make investment decisions based upon our assessment of a company's longer-term, sustainable growth rate relative to what is implied in today's share price. The ClearBridge Appreciation Strategy ESG modestly underperformed the benchmark S&P 500 Index in the second quarter. On an absolute basis, the Strategy had positive contributions from six of 11 sectors. The IT sector was the main positive contributor to performance, while the financials sector was the main detractor. In relative terms, stock selection contributed positively while sector allocation detracted. Specifically, stock selection in the consumer staples, consumer discretionary, IT and energy sectors contributed the most, while stock selection in the communication services, financials and materials sectors detracted, along with an IT underweight and overweights to the materials and financials sectors. On an individual stock basis, the biggest contributors to absolute performance during the quarter were Nvidia, Apple, Costco (COST), Microsoft (MSFT) and Alphabet (GOOG,GOOGL). The biggest detractors were Walt Disney (DIS), Travelers (TRV), U.S. Bancorp (USB), Visa (V) and PPG Industries (PPG). During the quarter, we initiated a new position in ConocoPhillips (COP) in the energy sector and closed positions in Intel (INTC) in the IT sector and Hartford Financial Services (HIG) in the financials sector. Portfolio holding Pioneer Natural Resources was acquired by Exxon Mobil (XOM) in the energy sector, whose shares we did not retain. The Ellen MacArthur Foundation lists three basic principles of the circular economy: eliminating waste and pollution, circulating products and materials, and regenerating nature. These principles align with some key parts of ClearBridge's fundamental ESG framework, notably factors such as resource efficiency, recycling, product life cycle management, renewable generation and land usage, which we engage on as part of ongoing company research. By reducing energy use, stress on the environment and pollution, the circular economy is also linked to mitigating climate change and conserving biodiversity. Many ClearBridge holdings thus contribute to the circular economy as they either execute on best practices or make improvements in these areas. We have often highlighted TREX as exemplary of the circular economy. Trex is the market share leader of wood-alternative composite decking. Trex's low-maintenance and high-quality decking products are composed of 95% recycled wood fibers and plastic, making use of waste that would otherwise end up in landfills. Trex has continued to innovate and advance plastic recycling processes. Recently, as the demand for "clean streams" of plastic waste has increased in different parts of the economy, Trex has upgraded technology to be able to accept "dirtier" streams of plastic waste into the manufacturing process. This allowed Trex to begin using additional quantities of waste plastic that would otherwise never be recycled, without compromising product quality standards. Trex products are more durable and have a longer life than traditional wood decking, therefore reducing overall raw material usage and end-product manufacturing. Finally, the quality and durability of the product saves consumers money through less frequent replacements and lower maintenance and upkeep costs. While companies like Trex are making clear gains on plastic recycling, a circular economy that solves for plastics use remains a challenge. Regulatory bodies are stepping up requirements, such as the EU's new rules to reduce, reuse and recycle packaging, provisionally agreed upon in March 2024. Under the new rules, plastic packaging must also include minimum recycled content. Helping companies meet these new rules will be ClearBridge holding Eastman Chemical (EMN), which makes a range of advanced materials, chemicals and fibers for everyday purposes, among them plastics for food packaging. In a recent engagement with Eastman Chemical we discussed two different chemical recycling technologies it has developed: polyester renewal technology ('PRT') and carbon renewal technology ('CRT'). PRT recycles polyester-based materials such as soda bottles, carpet fibers and even clothing, breaking down their basic molecules until they are indistinguishable from materials made from virgin or nonrecycled content. CRT operates in a similar way but can take a broader range of plastic types and replaces the use of coal as a feedstock to make fibers. Combining these two technologies gives Eastman a competitive advantage in molecular recycling, as it can take most types of waste plastics (Exhibit 2). Ironically, securing feedstock (i.e., waste plastic) has been a bottleneck to scaling molecular recycling as competitor technologies not using Eastman's dual technologies often require the waste plastic to be separated purely according to grade, which waste and recycling companies do not readily offer. Eastman's dual technology approach allows it to accept most plastic grades, making it less reliant on waste companies' sorting. Eastman's first recycling plant is now operational in Tennessee, which will supply its internal Advanced Materials lines while also proving out the technology. The company is already working toward a second plant in Texas that will have Pepsi (PEP) as its anchor customer. In the second plant, not only will Eastman help Pepsi meet its recycled content goals, but it is also expected to receive long-term, take-or-pay volume commitments, for doing so. This should greatly improve earnings visibility, and in turn, potentially valuation. Exhibit 2: Eastman Chemical's Molecular Recycling Methods As the case of Eastman Chemical suggests, plastic is central to sustainable food. Accordingly, companies in the food industry can advance the circular economy through practices such as recycling, reducing or improving the sustainability of packaging and reducing landfill waste. Canadian grocer Loblaw (OTCPK:LBLCF) can make an impact with all three of these practices. In a recent engagement with Loblaw, we discussed its goal of making 100% of its control brand and in-store plastic packaging recyclable or reusable by 2025. This would put it in compliance with the Golden Design Rules ('GDR'), a set of rules established by the Consumer Goods Forum, made up of leading international retail and consumer goods companies, to benchmark packaging design, emphasizing the reduction of materials and the removal of problematic elements. Noteworthy steps along the way have involved changes to Loblaw's protein packaging, which used to come in polystyrene foam trays; the vast majority now are packaged in clear recycled PET trays, which are accepted in all the municipalities in which the store operates and allow for greater detectability in the recycling stream. The shift to PET trays for mushrooms led to 39.9 million trays entering the recycling stream in 2023. Removing the plastic window from 10 kg potato bags allowed 23 million bags to be more easily recycled in 2023. In addition, extending expiry dates for its PC Money Account and PC Mastercard physical cards should prevent more than 10,000 kgs of plastic waste in the next 12 years. Loblaw's advances in these areas also speak to its power to use its size to change the industry, as it communicated its GDR standards to hundreds of control brands and national brand vendors, effectively dictating a new national industry standard for plastic packaging. While navigating recycling standards and practices that vary from municipality to municipality, to improve recycling rates overall Loblaw supports extending producer responsibility, a system that give brand owners responsibility of both the cost and performance of recycling systems, incentivizing them to increase the recyclability of their packaging while empowering them with control over the recycling systems themselves. Food waste is an avoidable crisis that has both environmental and societal costs, and linking food as an organic resource in a circular economy can reduce land use and better support growing populations. Loblaw has set a goal to send zero food to landfill by 2030, a goal supportive of Sustainable Development Goal 12: Responsible Consumption and Production, in particular target 12.3, to halve global food waste by 2030. The company is currently ramping up data collection on food waste but achieved over 78,000 metric tons of diverted food waste in 2023, with most going to composting, animal feed and redistribution of food surplus to food charities. LKQ is also focused on recycling heavy materials. LKQ is the largest wholesale distributor of alternative parts for the auto aftermarket in North America and Europe. It provides "like kind and quality" ('LKQ') auto parts as lower-cost alternatives to those provided by auto OEMs. It is the largest wholesale distributor of collision parts (used to repair vehicle exteriors) in the U.S. and Canada and the largest distributor of mechanical parts (used to repair internal components) in Europe. LKQ also runs its own salvage and recycling operations. As the world's largest recycler of cars at end-of-life, recovering 90%+ of the materials from scrap cars for reuse or recycling, LKQ supports resource efficiency and responsible consumption as an investable theme. In a recent engagement with LKQ we had an extensive discussion about how it has become increasingly efficient over time at inventorying and selling more parts from its salvage vehicles, which reduces the amount of parts going for scrap and increases LKQ's margins, as it earns higher revenues from same fixed cost of goods. One powerful aspect of the circular economy is how, although with differing dynamics and levels of challenges, every sector may contribute. ClearBridge will continue to share key company advances and engagements on the topic as our holdings innovate to operate more efficiently and enable a more resilient economic system, with fewer emissions and less waste and risks. Scott Glasser, Chief Investment Officer, Portfolio Manager Michael Kagan, Managing Director, Portfolio Manager Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

ClearBridge Large Cap Growth ESG Strategy Q2 2024 Commentary

Equity leadership narrowed considerably in the second quarter, with mega cap growth stocks reasserting their influence and obscuring weakness across most of the market. The S&P 500 Index (SP500,SPX) rose 4.28% for the period, while the NASDAQ Composite (COMP:IND) advanced 8.26%. By comparison, the small cap Russell 2000 Index (RTY) was down 3.28% for the quarter. Boosted by Nvidia (NVDA) and a handful of other semiconductor stocks riding the momentum of generative AI demand, the benchmark Russell 1000 Growth Index jumped 8.34%, outperforming the Russell 1000 Value Index by 1,050 basis points. The second quarter marked the fourth time since 2020 that quarterly style dispersion exceeded 1,000 bps in favor of growth. The Magnificent Seven contributed 8.31% of the Russell 1000 Growth's gain, led by Nvidia and Apple (AAPL), meaning that seven mega caps were responsible for nearly 100% of index performance. This also increased the weighting of the group from 48% to 55% of the benchmark (compared to the ClearBridge Large Cap Growth ESG Strategy's roughly 39% weighting). Three stocks - Microsoft (MSFT), Apple and Nvidia - now maintain greater than 10% positions in the benchmark (Exhibit 1). The market's focus on AI beneficiaries further accentuated concentration risk and created near-term headwinds for diversified portfolios like ours. The Strategy underperformed the benchmark due to a combination of our mega cap allocation and stock selection. Specifically, we were hurt by underweights to Apple and Alphabet (GOOG,GOOGL), both of which outperformed the benchmark. We took advantage of recent price weakness to repurchase Alphabet in April, giving the Strategy exposure to all seven mega cap companies. Stock selection in software and consumer staples weighed on relative performance. In software, Salesforce and Workday were among a cohort of enterprise software stocks impacted by weakening software spending, partially resulting from AI-related diversions of IT budgets. Within staples, weakening spending among lower-income consumers weighed on energy drink maker Monster (MNST) and mass market retailer Target (TGT) while a pressured recovery in China continued to impact cosmetics and skin care company Estee Lauder (EL). While the Strategy continues to have a significant position in Nvidia, with the stock's strong price appreciation during the quarter offsetting position management trims, we are underweight semiconductors versus the benchmark. That exposure worked against us in a sentiment-driven period for chipmakers tied to AI. However, we added to our semiconductor positioning during the quarter with the purchase of Taiwan Semiconductor (TSM). TSM, an out-of-benchmark name, is the world's fabrication production provider of choice. The criticality and sophistication of the company's manufacturing footprint powers all of the leading edge fabless global semiconductor companies, including Apple, Nvidia, Qualcomm (QCOM), AMD and Broadcom (AVGO). While AI has driven upside in data centers, PCs and handsets are at cycle lows, positioning half of the company's business for a recovery. A new position in Accenture (ACN) helped reduce the Strategy's IT underweight while also providing high-quality exposure to the generative AI buildout. Accenture is a durable business well-positioned to benefit from continued growth in overall technology spending, including migration to the cloud and the ramp of enterprise AI adoption. While AI spending thus far has been largely concentrated at the infrastructure layer, we believe that service providers like Accenture will be critical to helping enterprise users implement and integrate AI into their workflows. The Strategy exited a position in Intel (INTC), a semiconductor manufacturer that has not been among the AI beneficiaries in the industry. While Intel has made progress in building a U.S.-based foundry business, the timing of key product launches and profit margin improvement have been pushed out. The business also faces challenges in the current spending environment with AI architecture investments crowding out traditional CPU server spend. "We have learned to not allow short-term investor sentiment undermine our long-term theses for the companies we own." Other moves during the quarter included sales of United Parcel Service (UPS) and Nike (NKE). We believe our margin expansion thesis for UPS has played out, with growth now more revenue-led with macro and competitive risks increasing. This exit consolidates our positioning in the industrials sector. Nike has become overly reliant on key platforms, like Jordan, for revenue growth while innovation in areas like running has lagged. Nike could face continued revenue and profit pressure as it invests to re-invigorate innovation and re-position the business back toward wholesale outlets. As such, we are seeking out better ways to participate in the global consumer recovery in companies where earnings estimates have already reset. AI-related momentum was a key driver of performance in the second quarter, lifting the enablers in technology as well as holdings like renewable power producer NextEra (NEE) that supply the increasing energy needs of data centers. Parts of the market lacking an AI connection, like our medical device holdings, underperformed despite no change to fundamentals. We have managed through several similar momentum periods over our tenure and have delivered long-term results for shareholders by staying true to an approach that emphasizes diversification across three buckets of growth companies (select, stable and cyclical) and seeks to take advantage of attractive entry points into quality growth businesses. We have also learned to not allow short-term investor sentiment to undermine our long-term theses for the companies we choose to own. Adobe (ADBE), for example, proved in raising guidance that the marketing and design solutions it offers are critical enough to customers to overcome perceived competition from generative AI. As growth investors, we will always have technology stocks as a core part of our portfolio, and we acknowledge that our 800 bps underweight to the sector has been a headwind in mega-cap-driven momentum periods. We have been carefully finding ways to close that gap with our recent IT purchases. Overall, we feel comfortable with our portfolio construction as the economy continues to slow. Retail sales, consumer confidence, loan growth and transport volumes are all down and the latest reading from the leading economic indicators shows signs of weakening. While higher-income consumers continue to spend, the lower end is seeing spikes in credit card delinquencies as accumulated savings from COVID have run out and the delayed impacts of Fed tightening are finally being felt. While frequency and timing remain uncertain, we see eventual rate cuts from the Fed acting as a stabilizer for the economy. We believe our portfolio companies remain well positioned to generate consistent organic growth through economic cycles. The ClearBridge Large Cap Growth ESG Strategy underperformed its Russell 1000 Growth Index benchmark in the second quarter. On an absolute basis, the Strategy delivered gains across five of the 10 sectors in which it was invested (out of 11 sectors total). The primary contributor to performance was the IT sector while the consumer staples and industrials sectors were the main detractors. Relative to the benchmark, overall stock selection and sector allocation detracted from performance. In particular, stock selection in the consumer staples, IT and communication services sectors, overweights to industrials and financials and an underweight to IT hurt results. On the positive side, stock selection in the consumer discretionary and health care sectors and an underweight to consumer discretionary contributed to performance. On an individual stock basis, the leading absolute contributors to performance were Nvidia, Apple, Amazon.com (AMZN), Microsoft and Palo Alto Networks (PANW). The primary detractors were Estee Lauder, Salesforce (CRM), Workday (WDAY), Target and Grainger (GWW). The Ellen MacArthur Foundation lists three basic principles of the circular economy: eliminating waste and pollution, circulating products and materials, and regenerating nature. These principles align with some key parts of ClearBridge's fundamental ESG framework, notably factors such as resource efficiency, recycling, product life cycle management, renewable generation and land usage, which we engage on as part of ongoing company research. By reducing energy use, stress on the environment and pollution, the circular economy is also linked to mitigating climate change and conserving biodiversity. "Food waste is an avoidable crisis that has both environmental and societal costs." Many ClearBridge holdings thus contribute to the circular economy as they either execute on best practices or make improvements in these areas. We have often highlighted Trex (TREX) as exemplary of the circular economy. Trex is the market share leader of wood-alternative composite decking. Trex's low-maintenance and high-quality decking products are composed of 95% recycled wood fibers and plastic, making use of waste that would otherwise end up in landfills. Trex has continued to innovate and advance plastic recycling processes. Recently, as the demand for "clean streams" of plastic waste has increased in different parts of the economy, Trex has upgraded technology to be able to accept "dirtier" streams of plastic waste into the manufacturing process. This allowed Trex to begin using additional quantities of waste plastic that would otherwise never be recycled, without compromising product quality standards. Trex products are more durable and have a longer life than traditional wood decking, therefore reducing overall raw material usage and end-product manufacturing. Finally, the quality and durability of the product saves consumers money through less frequent replacements and lower maintenance and upkeep costs. While companies like Trex are making clear gains on plastic recycling, a circular economy that solves for plastics use remains a challenge. Regulatory bodies are stepping up requirements, such as the EU's new rules to reduce, reuse and recycle packaging, provisionally agreed upon in March 2024. Under the new rules, plastic packaging must also include minimum recycled content. Helping companies meet these new rules will be ClearBridge holding Eastman Chemical (EMN), which makes a range of advanced materials, chemicals and fibers for everyday purposes, among them plastics for food packaging. In a recent engagement with Eastman Chemical we discussed two different chemical recycling technologies it has developed: polyester renewal technology ('PRT') and carbon renewal technology ('CRT'). PRT recycles polyester-based materials such as soda bottles, carpet fibers and even clothing, breaking down their basic molecules until they are indistinguishable from materials made from virgin or nonrecycled content. CRT operates in a similar way but can take a broader range of plastic types and replaces the use of coal as a feedstock to make fibers. Combining these two technologies gives Eastman a competitive advantage in molecular recycling, as it can take most types of waste plastics (Exhibit 4). Ironically, securing feedstock (i.e., waste plastic) has been a bottleneck to scaling molecular recycling as competitor technologies not using Eastman's dual technologies often require the waste plastic to be separated purely according to grade, which waste and recycling companies do not readily offer. Eastman's dual technology approach allows it to accept most plastic grades, making it less reliant on waste companies' sorting. Eastman's first recycling plant is now operational in Tennessee, which will supply its internal Advanced Materials lines while also proving out the technology. The company is already working toward a second plant in Texas that will have Pepsi (PEP) as its anchor customer. In the second plant, not only will Eastman help Pepsi meet its recycled content goals, but it is also expected to receive long-term, take-or-pay volume commitments, for doing so. This should greatly improve earnings visibility, and in turn, potentially valuation. Exhibit 4: Eastman Chemical's Molecular Recycling Methods As the case of Eastman Chemical suggests, plastic is central to sustainable food. Accordingly, companies in the food industry can advance the circular economy through practices such as recycling, reducing or improving the sustainability of packaging and reducing landfill waste. Canadian grocer Loblaw (OTCPK:LBLCF) can make an impact with all three of these practices. In a recent engagement with Loblaw, we discussed its goal of making 100% of its control brand and in-store plastic packaging recyclable or reusable by 2025. This would put it in compliance with the Golden Design Rules (GDR), a set of rules established by the Consumer Goods Forum, made up of leading international retail and consumer goods companies, to benchmark packaging design, emphasizing the reduction of materials and the removal of problematic elements. Noteworthy steps along the way have involved changes to Loblaw's protein packaging, which used to come in polystyrene foam trays; the vast majority now are packaged in clear recycled PET trays, which are accepted in all the municipalities in which the store operates and allow for greater detectability in the recycling stream. The shift to PET trays for mushrooms led to 39.9 million trays entering the recycling stream in 2023. Removing the plastic window from 10 kg potato bags allowed 23 million bags to be more easily recycled in 2023. In addition, extending expiry dates for its PC Money Account and PC Mastercard physical cards should prevent more than 10,000 kgs of plastic waste in the next 12 years. "Producer responsibility incentivizes brand owners to increase the recyclability of their packaging while empowering them with control over the recycling systems." Loblaw's advances in these areas also speak to its power to use its size to change the industry, as it communicated its GDR standards to hundreds of control brands and national brand vendors, effectively dictating a new national industry standard for plastic packaging. While navigating recycling standards and practices that vary from municipality to municipality, to improve recycling rates overall Loblaw supports extending producer responsibility, a system that give brand owners responsibility of both the cost and performance of recycling systems, incentivizing them to increase the recyclability of their packaging while empowering them with control over the recycling systems themselves. Food waste is an avoidable crisis that has both environmental and societal costs, and linking food as an organic resource in a circular economy can reduce land use and better support growing populations. Loblaw has set a goal to send zero food to landfill by 2030, a goal supportive of Sustainable Development Goal 12: Responsible Consumption and Production, in particular target 12.3, to halve global food waste by 2030. The company is currently ramping up data collection on food waste but achieved over 78,000 metric tons of diverted food waste in 2023, with most going to composting, animal feed and redistribution of food surplus to food charities. LKQ (LKQ) is also focused on recycling heavy materials. LKQ is the largest wholesale distributor of alternative parts for the auto aftermarket in North America and Europe. It provides "like kind and quality" ('LKQ') auto parts as lower-cost alternatives to those provided by auto OEMs. It is the largest wholesale distributor of collision parts (used to repair vehicle exteriors) in the U.S. and Canada and the largest distributor of mechanical parts (used to repair internal components) in Europe. LKQ also runs its own salvage and recycling operations. As the world's largest recycler of cars at end-of-life, recovering 90%+ of the materials from scrap cars for reuse or recycling, LKQ supports resource efficiency and responsible consumption as an investable theme. In a recent engagement with LKQ we had an extensive discussion about how it has become increasingly efficient over time at inventorying and selling more parts from its salvage vehicles, which reduces the amount of parts going for scrap and increases LKQ's margins, as it earns higher revenues from same fixed cost of goods. One powerful aspect of the circular economy is how, although with differing dynamics and levels of challenges, every sector may contribute. ClearBridge will continue to share key company advances and engagements on the topic as our holdings innovate to operate more efficiently and enable a more resilient economic system, with fewer emissions and less waste. Peter Bourbeau, Managing Director, Portfolio Manager Margaret Vitrano, Managing Director, Portfolio Manager Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

ClearBridge Small Cap Growth Strategy Q2 2024 Commentary

We continue to deliver strong new idea generation with six new investments in the quarter across four sectors that build on the momentum of the last four quarters. We are encouraged by a positive hit rate and solid overall contributions from these newer names. By Jeffrey Bailin, CFA & Aram Green Uncertainty, Volatility Fuel Still-Narrow Small Growth Market Market Overview In many ways, the second quarter of 2024 has been a continuation of the narrow, thematic-driven market backdrop. While the benchmark Russell 2000 Growth Index was only down 2.9% in the quarter, underlying volatility was greater with a maximum drawdown of nearly 9% through late April. Meanwhile, small cap stocks continue to screen at significant relative value relative to their large cap brethren given one of the longest periods of relative underperformance. Research from Jefferies suggests that the year-to-date difference between the S&P 500 Index (SP500, SPX) and the Russell 2000 Index (RTY) represents the largest period of underperformance to start a year in the last 51 years, a divergence that would look even worse ex-Super Micro Computer (SMCI). The year-to-date performance of the Russell 2000 Growth Index continues to be even narrower than the Russell 1000 Growth Index, with SMCI driving 44% of the gains in the index. SMCI and MicroStrategy (MSTR) combined have driven nearly 60% of the performance compared to Nvidia (NVDA) and Microsoft (MSFT) collectively driving 43% of the Russell 1000 Growth gain. A mere eight stocks have supported the entirety of the Russell 2000 Growth benchmark performance compared to 40 stocks driving the Russell 1000 Growth. Our internal analysis of the underlying benchmark highlights that through May, the trailing 12-month percentage of benchmark stocks underperforming is at the second-highest level in the last seven years (exceeded only by 2020). At the macro level, after a variety of datapoints in the first quarter supportive of Federal Reserve rate cuts in the back half of the year, contradictory signals on various inflation datapoints have led to a pushout in the timing and magnitude of rate cuts expected in 2024. Rates ended the quarter up modestly, but it was a wild ride for the U.S. 10-year Treasury with yields going from 4.2% to 4.7% before ending the quarter at 4.39%. "Over the last handful of quarters there has been a growing performance dichotomy between semiconductors and technology hardware versus software." Simultaneously, while broader stock market performance has been solid year to date, we have observed a variety of contradictory signals around the health of the economy. Outside of a small group of perceived winners from secular trends (i.e., AI, reshoring/electrification and GLP-1s), it is less clear regarding the magnitude of disruption to businesses in areas like software, consumer discretionary and food/beverages/alcohol, to name a few. Moreover, we can identify multiple areas of concern within broad swaths of the economy, with a non-exhaustive list including consumer goods spending, non-residential and housing related investment, aerospace OEM production, transports, software budgets and large pharma R&D/S&M spending. Historically we have had an overweight to the software sector given the potential to disrupt large legacy markets, with visible recurring growth and strong unit economics. Simultaneously we have found a variety of successful long-term investments in the semiconductor and hardware space but have been mindful of potential cyclicality. Over the last handful of quarters there has been a growing dichotomy in performance between semiconductors/technology hardware and software, as software growth and valuations have seen meaningful negative revisions. Year to date, within the Russell 2000 Growth Index, software and services are up +2% versus semiconductors up 8% and technology hardware and equipment (including SMCI) up 40% (Exhibit 1). Over the long term, we continue to see a lot of opportunity in software. However, we acknowledge that in the near term, the AI overhang is a challenge, both in terms of potential loss of seats per contract, as well as budgetary/mindshare diversion to AI hardware/development versus other software priorities. In the early enthusiasm around the potential of generative AI (Gen AI), the stock market beneficiaries have largely been those supporting the infrastructure to power the necessary advanced computing requirements. As the cycle matures, businesses with more durable recurring revenue models ultimately should outperform. This was seen in the early days of the dot-com buildout as data center and fiber investments took years to realize returns while the most profitable businesses proved to be the ones that built services and applications on that infrastructure, such as Salesforce (CRM), Oracle (ORCL), Amazon (AMZN) and Google (GOOG,GOOGL). Exhibit 1: Wide Performance Divergence in Small Cap Technology Various software investments held in the Strategy, such as Varonis (VRNS), Intapp (INTA) or WIX, have intriguing AI drivers to their business that can become more meaningful as enterprise customers adopt Gen AI at the application level. Additionally, we have had a handful of hardware and semiconductor investments that have benefited like Monolithic Power (MPWR) or recent addition Fabrinet (FN), but in these types of businesses we look for additional drivers such as underearning segments (i.e., Fabrinet's telecommunication business, which could cyclically improve) or long-term tailwinds (i.e., Monolithic Power's secular growth in industrial and automotive), underpinned by strong profitability and clean balance sheets. Against this backdrop, the ClearBridge Small Cap Growth Strategy underperformed its benchmark in the second quarter. With strong performance from a handful of new additions, the pace of relative underperformance improved slightly versus the first quarter; however, we remain disappointed by recent results. We are encouraged by solid contribution to overall performance from the majority of the 25 new ideas added over the last four quarters, despite these representing only a modest portion of the Strategy's assets. As has historically been the case in our Strategy, with the majority of risk allocated to stock selection coupled with very high active share, we have seen idiosyncratic issues impact stocks at a given time that can be a drag to performance. Uniquely over the last several quarters, we have observed increased volatility to the downside for businesses reporting even slight disappointments. Anecdotally, looking at our underperforming stocks in the quarter, we saw numerous instances of slight decelerations in growth or management changes leading to significant underperformance. We believe this can be partially attributed to a decline in active management assets relative to passive, and within active management a shift to shorter-term-focused investment strategies. Consequently, stocks with the slightest hint of volatility, decelerating trends or controversy are punished severely while the narrow group of clean names, usually exposed to one of the market's preferred mega-theme narratives, see already elevated levels of relative strength go even higher. Several of our worst-performing stocks in the quarter, such as TREX and H&E Equipment Services (HEES), were some of our best contributors in the first quarter and in 2023 but had significant moves in the last three months behind only modestly disappointing results. At an industry level, industrials and health care were the worst-performing sectors, although we continue to find an array of high-quality business models within each sector. Among most of our challenged holdings, we continue to see significant long-term potential with the magnitude of the stock reactions not matching the change in fundamentals in our opinion. Portfolio Positioning We continued to deliver strong new idea generation, building on the momentum over the last four quarters and in anticipation of the just completed annual Russell index rebalance. In the second quarter we initiated six new investments: Global-e Online (GLBE), Construction Partners (ROAD), Expro Group Holdings (XPRO), Blueprint Medicines (BPMC), Fabrinet, and Vaxcyte (PCVX). Global-e Online, in the IT sector, is a provider of cross-border e-commerce solutions for DTC merchants that enable customers to navigate the complexities of selling in more than 200+ global markets. The company has partnerships with major players like Shopify and has a unique combination of robust organic growth and healthy expanding margins. Construction Partners, in the industrials sector, is a vertically integrated construction and maintenance company that focuses on public highways, bridges, airports and non-residential applications in the Southeast. Through a combination of organic and inorganic opportunities, as well as exposure to fast-growing public end markets, the company offers one of the highest EBITDA growth profiles within the construction industry. Expro Group Holdings, in the energy sector, is an oilfield services company that is differentiated by high exposure to international and offshore markets where upstream spending continues to grow. Competing in consolidated markets with attractive pricing dynamics, multiyear contracts and an outlook for accelerating topline growth, Expro Group should be able to realize margin expansion over the intermediate term with improving free cash flow generation and shareholder returns. Blueprint Medicines, in the health care sector, is a biopharmaceutical company focused on conditions related to allergy/immunology, as well as oncology/hematology. The company has an approved and marketed product early in its launch in a rare disease market with blockbuster potential, as well as opportunities to leverage its expertise in other indications related to allergies/respiratory/immunological conditions. We see a reasonable near-term path for Blueprint to inflect to profitability as its main product ramps, along with early optionality on its broader pipeline. Vaxcyte, in the health care sector, is a biopharmaceutical company focused on novel vaccine technology in major bacterial disease vaccine markets. The company has a differentiated vaccine platform with the potential to have the broadest spectrum coverage vaccine for adults and infants, which could support a dominant future position in a market worth over $8 billion annually. Fabrinet, in the IT sector, is the leading contract manufacturer of optical components that go into data center networking and telecom equipment. Fabrinet has materially outgrown the industry as outsourcing has increased due to low manufacturing yields and volatile cycles in the optical market. New AI server architectures that involve connecting large amounts of servers together into "clusters" has driven further significant growth in Fabrinet's data center networking, where the company is a leading contract manufacturer for Nvidia. During the quarter, there were announcements of proposed acquisitions of two portfolio holdings. ChampionX (CHX), an oilfield services provider announced its sale to Schlumberger (SLB), accepting an all-stock offer. Model N, a vertical software company serving the health care industry, was acquired by a private equity buyer. In addition to exiting Model N upon the closure of its acquisition, we exited ICON due to its larger market capitalization, as well as Definitive Healthcare (DH), Pacira Biosciences (PCRX), Oddity Tech (ODD), and Arcadium Lithium (ALTM) due to fundamental considerations. Outlook The ClearBridge Small Cap Growth Strategy remains committed to identifying idiosyncratic companies with growth opportunities and attractive returns irrespective of the macro backdrop. The guiding principles that have also informed our investment process and philosophy remain at the core of our process to exercise "judgment and patience" to ensure that we have 1) the right balance of opportunity and risk in the Strategy and 2) appropriately capitalized investments with substantial intermediate to long-term growth opportunities. Thus far in 2024 we have seen continued extreme volatility and contradictory signals around the health of the underlying economy. The market and investors are coming to terms with a world that is fundamentally different post-COVID with difficulties assessing in 2022 and 2023 what would be permanent changes versus typical normalization following an unprecedented shutdown and incentive-fueled restart of the global economy. With wild swings in interest rates, inflationary pressures, inventory levels, consumer habits and crime, and amid multiple wars, geopolitical uncertainty and a partisan U.S. presidential election, it is increasingly important to lean into high-quality businesses with large, idiosyncratic growth opportunities. Given greater levels of unknowns relative to prior investment regimes, coupled with a skinny market powered by the themes of AI, bitcoin and GLP-1s, we intend to carefully balance risk and opportunity within the Strategy's holdings. As always, with the annual Russell index rebalancing we have completed some repositioning work to appropriately manage sector, factor and market capitalization exposure. We believe the Strategy has an appropriately balanced spectrum of growth businesses, and with the unprecedented concentration at the top of the benchmark index rebalancing out at the end of the second quarter, we anticipate fewer distortions in underlying benchmark performance. Portfolio Highlights The ClearBridge Small Cap Growth Strategy underperformed its benchmark in the second quarter. On an absolute basis, the Strategy posted gains across four of the nine sectors in which it was invested (out of 11 sectors total). We would note that of the nine sectors in which we were invested within the benchmark Russell 2000 Growth index, only two posted gains on an absolute basis in the quarter: consumer staples and communication services. The primary contributors to Strategy performance were in financials and consumer staples while the main detractors included industrials and health care. Relative to the benchmark, overall stock selection detracted from performance while sector allocation was additive. In particular, stock selection in the industrials and health care sectors detracted from returns. On the positive side, an overweight to consumer staples and stock selection in the financials, consumer discretionary and materials sectors contributed to performance. On an individual stock basis, the leading contributors were positions in Insmed (INSM), Casey's General Stores (CASY), Wingstop (WING), Zeta Global Holdings (ZETA) and BJ's Wholesale Club (BJ). The primary detractors were portfolio holdings Trex, Sprout Social (SPT), H&E Equipment Services, Lattice Semiconductor (LSCC) and National Vision (EYE). Jeffrey Bailin, CFA, Director, Portfolio Manager Aram Green, Managing Director, Portfolio Manager Past performance is no guarantee of future results. Copyright © 2024 ClearBridge Investments. All opinions and data included in this commentary are as of the publication date and are subject to change. The opinions and views expressed herein are of the author and may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information. Performance source: Internal. Benchmark source: Russell Investments. Frank Russell Company ("Russell") is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and/or Russell ratings or underlying data and no party may rely on any Russell Indexes and/or Russell ratings and/or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell's express written consent. Russell does not promote, sponsor or endorse the content of this communication. Performance source: Internal. Benchmark source: Standard & Poor's. Click to enlarge Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. 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. We convey these ideas to investors on a frequent basis through investment commentaries and thought leadership and look forward to sharing the latest insights from our white papers, blog posts as well as videos and podcasts.

ClearBridge Mid Cap Strategy Q2 2024 Commentary

With greater uncertainty on economic and political fronts, and mounting concerns over market concentration, we believe the benefits of our philosophy of active management and diversification and our focus on strong corporate fundamentals will only become more evident. By Brian Angerame & Matthew Lilling, CFA Despite Retreat, Mid Caps Show Strong Potential - Market Overview The second quarter proved a challenging one for the mid cap market, as investors continued to narrow their focus on a small handful of AI, bitcoin and other "big picture" stocks, while economic deceleration and a higher-for-longer interest rate outlook weighed on the rest. The result was a broad retreat, with seven of the 11 Russell Midcap Index sectors posting negative returns and a -3.35% decline for the overall index. Against this challenging backdrop, growth stocks only slightly outperformed value stocks for the quarter, with the Russell Midcap Growth Index returning -3.21% versus the -3.40% return of the Russell Midcap Value Index. From a sector standpoint, utilities (+3.80%) generated the best performance in the benchmark, followed by communication services (+2.69%), information technology (IT, +1.17%) and real estate (+0.45%). Energy (-0.38%) and financials (-3.12%) also outperformed the broader benchmark. Conversely, the consumer staples (-9.06%), health care (-8.45%), materials (-8.06%), consumer discretionary (-5.98%) and industrials (-5.14%) sectors underperformed. After two years, the long-awaited economic soft landing has finally appeared, manifesting as a prolonged economic deceleration. Given the market highs and hurdles for corporate earnings coming off a strong first quarter, this deceleration challenged even the best-executing companies to continue a beat-and-raise cadence. This was further complicated by a growing prospect of higher-for-longer interest rates, which had widespread implications across sectors, including delayed business spending, a deteriorating outlook for industrials and non-residential construction and additional pressure on discretionary consumer spending. Add to that increased uncertainty surrounding the upcoming U.S. election and its implications on tax rates, tariffs, the economy and inflation, and it is no wonder that companies are espousing a more conservative outlook to the disappointment of investors. However, it is not all doom and gloom for mid caps, and we are seeing plenty of reasons to feel optimistic. First, we believe many sectors that felt the pain of destocking trends in 2023, such as life science R&D, specialty chemicals and software, are seeing these headwinds dissipate. This should leave them exceptionally well positioned to beat weaker year-over-year comps in the second half of 2024. Additionally, the IPO and capital markets have begun to rebound, albeit slowly, providing new investment opportunities and idea generation. In fact, this quarter saw our first IPO participation since the capital markets fervor of 2021 with data security provider Rubrik (RBRK). Finally, elevated market concentration has resulted in a wide field of oversold mid cap stocks, many exhibiting strong revenue growth rates, which we believe can compound through this short-term weakness to become bigger and better companies on the other side. Stock selection in the IT sector was the leading detractor from relative performance, with our high-quality software holdings hurt by constrained client spending and a focus on how to maximize the benefits of AI integration. For example, shares of software-as-a-service development company Freshworks fell due to a weaker spending environment for small and medium-size businesses as customers continue to push out spending amid economic uncertainty. An obtuse explanation by management about the impact from AI on the company also pressured the stock. Rather than a threat, we believe that the ongoing development and rollout of AI will create a tailwind for this already strong company and, after speaking with management, we continue to believe that Freshworks's customer service and related sales offerings are optimally positioned to gain market share once customers' purse-strings open. Stock selection in industrials also weighed on performance, as macro uncertainty and higher-for-longer interest rates has led to weaker industrial and construction activity. This included Regal Rexnord (RRX), a leader in manufacturing specialty electrical components and systems, including industrial powertrain solutions, power transmission components, electric motors and air moving products. Likewise, Atkore (ATKR), which manufactures electrical, mechanical and safety products like conduits, cables and mechanical pipes, saw revenue slide as declining input costs were passed through to customers - a not unnatural occurrence in this type of market. However, in both cases, we believe that these companies are oversold, and remain fundamentally strong businesses with excellent cash flow yields. We anticipate many of these macro headwinds will dissipate in the second half of 2024 and into 2025 and allow these companies to continue to build on their strong idiosyncratic drivers. Relative performance was lifted by positive stock selection in the consumer staples sector, primarily from Casey's General Stores (CASY). An operator of gas stations and convenience stores, Casey's is now reaping the rewards of its aggressive reinvestment in its stores over the past decade, building its private label brand and broadening its product offerings. This has not only helped boost improve same-store sales but also encouraged repeat traffic, allowing the company to buck broader industry trends toward contraction in gas volumes and margins. Finally, the company's strategy of choosing locations in smaller and more remote markets has afforded it stronger pricing power. As a result, the company continues to execute strongly, and we believe it will continue to be a long-term compounder for the portfolio. Financials, and particularly, our insurance holdings, continued to build on their strong first-quarter performance. In addition to benefiting from a hardening insurance market as demand outpaces supply, companies like Arch Capital (ACGL) have been able to take advantage of the shift in investor perception from imminent rate cuts to a higher-for-longer environment to realize higher reinvestment returns on their assets. We believe that this supportive macro environment, combined with capital discipline, inflation in excess of the rising costs of litigation and solid underwriting have helped Arch Capital and Hartford Financial Services (HIG) increase their returns on equity. Portfolio Positioning We initiated a new position in online pet retailer Chewy in the consumer discretionary sector. We believe the company has exited a period of tough comparables achieved during COVID-19 and that the decline in pet products spending has begun to stabilize. The company's initiatives in warehouse automation, pharmaceutical services and private label products are strong catalysts, and Chewy has built a loyal base through peerless customer service to improve its margins as customer growth inflects positively. Rubrik, meanwhile, is a next-generation data storage, backup and recovery provider showing strong, double-digit subscription revenue growth. We believe its cloud-based offerings have resonated with its Fortune 500 customer base, positioning it well to continue to take share from legacy data backup providers. The introduction of new AI data security products could offer an additional revenue source to Rubrik's business. We trimmed several holdings during the period, including cloud-based compliance and regulatory software company Workiva. Although we believe Workiva remains a product leader in back-office software, we believe that more selective customers will lean toward investments in the broader enterprise software solutions. As a result, we used the proceeds from our trimming to initiate a new position in Dynatrace, which operates an application observability platform for multicloud environments. Outlook While we believe certain sectors, such as those that suffered from destocking headwinds in 2023, will see improvement in the second half of the year, most expectations for better results and the economic boon from rate cuts have been pushed out into 2025. With greater uncertainty on both the economic and political fronts, and mounting concerns over market concentration in such few stocks, we believe the benefits of our philosophy of active management and diversification and our focus on strong corporate fundamentals will become more evident going forward. Portfolio Highlights The ClearBridge Mid Cap Strategy underperformed its Russell Midcap Index during the second quarter. On an absolute basis, the Strategy had losses in nine of the 11 sectors in which it was invested during the quarter. The lone contributors were the communication services and financials sectors, while the industrials and IT sectors detracted the most. On a relative basis, overall stock selection and sector allocation effects detracted from performance. Specifically, stock selection in the IT, industrials, real estate and consumer discretionary sectors and an overweight to the consumer staples sector weighed on performance. Conversely, stock selection in the consumer staples, financials, materials and communication services sectors benefited performance. On an individual stock basis, the biggest contributors to absolute returns in the quarter were Casey's General Stores, Pinterest, Clean Harbors, Arch Capital and AppLovin. The largest detractors from absolute returns were Regal Rexnord, Atkore, WillScot Mobile Mini, Avantor and CoStar. In addition to the transactions listed above, we initiated a new position in Mohawk Industries in the consumer discretionary sector and exited a position in Endeavor, in the communication services sector, ahead of its buyout by private equity investor Silver Lake. Brian Angerame, Managing Director, Portfolio Manager Matthew Lilling, CFA, Managing Director, Portfolio Manager Past performance is no guarantee of future results. Copyright © 2024 ClearBridge Investments. All opinions and data included in this commentary are as of the publication date and are subject to change. The opinions and views expressed herein are of the author and may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information. Performance source: Internal. Benchmark source: Russell Investments. Frank Russell Company ("Russell") is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and/or Russell ratings or underlying data and no party may rely on any Russell Indexes and/or Russell ratings and/or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell's express written consent. Russell does not promote, sponsor or endorse the content of this communication. Click to enlarge Original Post 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. We convey these ideas to investors on a frequent basis through investment commentaries and thought leadership and look forward to sharing the latest insights from our white papers, blog posts as well as videos and podcasts.

Fiduciary Management Q2 2024 Investment Strategy Outlook

Other top-performing themes in the U.S. include Bitcoin sensitive equities, obesity drugs, and high-beta 12-month winners (i.e., momentum stocks), according to Goldman Sachs. Global stock markets were mixed in the second quarter, with U.S. Large Cap growth stocks continuing to march to their own beat, U.S. Small Cap stocks declining, and International stocks treading water. Economic growth in the U.S. has been resilient, while Europe and Japan have been softer. Inflation is stable, labor markets are easing (but still tight), and global trade is starting to rebound. Geopolitical risks remain high. Speculation is widespread with growth continuing to outperform value year-to-date across the board. Fortunately, one thing is always true about stock markets: trends don't last forever, and inflection points typically happen when investors least expect them. Our second quarter performance commentary is outlined below: In the second quarter, the FMI Small Cap Strategy declined by approximately 3.8% (gross) / 4.0% (net), compared with a 3.28% and 3.64% drop for the Russell 2000 Index ("Russell 2000") and Russell 2000 Value Index ("Russell 2000 Value"), respectively. Relative to the Russell 2000, FMI's top-performing sectors included Electronic Technology, Retail Trade, and Technology Services while Producer Manufacturing, Distribution Services, and Commercial Services each underperformed. Strong individual contributors included BJ's Wholesale Club Holdings Inc. (BJ), Skechers U.S.A. Inc. - Cl A (SKX), and Fabrinet Inc. (FN) as Fortune Brands Innovations Inc. (FBIN), Simpson Manufacturing Co. Inc. (SSD), and Henry Schein Inc. (HSIC) lagged the market. Small Cap stocks continue to fall behind their Large Cap counterparts thus far this year. In the second quarter, the FMI Large Cap Strategy lost approximately 0.2% (gross) / 0.3% (net), compared with a 4.28% gain and a 2.20% decline for the S&P 500 Index (S&P 500) and iShares Russell 1000 Value ETF[1], respectively. Growth outperformed value by over 10% in the period, driven in large part by just a select few Mega Cap technology stocks. Relative to the S&P 500, sector performance was driven by Health Technology, Consumer Services, and Consumer Non-Durables, while the strategy gave up ground in Electronic Technology, Retail Trade, and Distribution Services. Individual holdings Alphabet Inc. - Cl A (GOOG,GOOGL), Booking Holdings Inc. (BKNG), and Micron Technology Inc. (MU) outpaced the market, as CarMax Inc. (KMX), Masco Corp. (MAS), and Dollar Tree Inc. (DLTR) detracted. In the second quarter, the FMI All Cap Strategy dropped approximately 0.4% (gross) / 0.6% (net), compared with an increase of 3.12% for the iShares Russell 3000 ETF. Relative to the iShares Russell 3000 ETF, sectors that benefited performance included Consumer Non-Durables, Health Technology, and Consumer Services while Electronic Technology, Distribution Services, and Commercial Services were a draw from performance. BJ's Wholesale Club Holdings Inc., Koninklijke Philips N.V. ADR (PHG), and Skechers U.S.A. Inc. - Cl A were a boost to performance, while Robert Half Inc. (RHI), CarMax Inc., and Masco Corp. trailed the market. In the second quarter, the FMI International Strategies fell approximately 1.4% (gross) / 1.6% (net) on a currency hedged basis and 2.2% (gross) / 2.4% (net) currency unhedged, compared with the iShares Currency Hedged MSCI EAFE ETF, the iShares MSCI EAFE ETF, and the iShares MSCI EAFE Value ETF gain of 1.94%, loss of 0.19%, and gain of 0.32%, respectively. Relative to the iShares MSCI EAFE ETF, the International Strategies' Consumer Services, Consumer Non-Durables, and Health Technology sector exposures were a tailwind for performance, while Retail Trade, Distribution Services, and Transportation weighed on the results. Koninklijke Philips N.V., Unilever PLC (UL), and DBS Group Holdings Ltd. (OTCPK:DBSDF) performed well in the quarter, while B&M European Value Retail S.A. (OTCPK:BMRRY), Ferguson PLC (FERG), and Ryanair Holdings PLC ADR (RYAAY) failed to keep pace. USD strength was additive for the currency hedged portfolio. In the U.S., the Large Cap universe continues to be dominated by just a handful of anointed stocks. Today's concentration of the S&P 500 (SP500,SPX) is unprecedented. The top 10 stocks make up 37% of the iShares S&P 500 ETF (IVV). For comparison, at the peak of the 2000 tech bubble, the top 10 accounted for about 25% of the index. Performance of the S&P 500 this year has been similarly lopsided. Of the 15.29% year-to date return for the S&P 500, an astounding 30% has come from Nvidia (NVDA) alone, with 58% from Nvidia, Microsoft (MSFT), META Platforms, Amazon (AMZN), and Alphabet (GOOG,GOOGL). The S&P 500 Equal-Weighted Index trails the S&P 500 (market-capitalization weighted) by 10.21% this year, after losing by 12.42% last year, further illustrating the lack of breadth in the market. Historically, extremely narrow markets have been a harbinger of tougher stock markets to come. This time may be no different. We marvel at the unwavering euphoria encompassing Nvidia's stock. In under 30 trading days ending June 18, 2024, Nvidia added $1.1 trillion to its market cap. In the 6 months prior, it added over $2.0 trillion, larger than the entire market cap of Amazon! Nvidia briefly became the world's most highly valued company, worth as much as $3.3 trillion, exceeding the value of the entire UK, German, and Canadian stock markets, respectively. Nvidia is a key beneficiary of the generative artificial intelligence ('AI') craze, selling expensive AI chips into data centers, with over a 70% market share. Large cloud computing providers such as Microsoft, Amazon, and Google account for almost half of Nvidia's data center revenue. Over the long-term, Nvidia's rapid growth and high margins will attract increased competition, including from some of their biggest customers, which may weigh on future growth rates and returns. Expectations are high, as Wall Street currently projects Nvidia's sales to increase at nearly 7-fold over the five years from 2022 through 2027, with earnings per share growing 14-fold. At a valuation of 39 times sales and 69 times trailing earnings, the margin for error is narrow. While we certainly acknowledge the vast possibilities of generative AI, and we remain in observation mode, it appears that the hype is at a fever pitch. Sequoia Capital, one of Silicon Valley's biggest start-up investors, warns of an "AI bubble" and "speculative frenzies." On an annual run-rate basis, Sequoia estimates that there is over $180 billion of data center AI spend as of the first quarter of 2024, increasing to a whopping $300 billion by year-end. There is little AI revenue to show for all this spend, with OpenAI thought to have the lion's share of generative AI revenue today, at only $3.4 billion. Sequoia estimates $600 billion of revenue would be required annually to payback the projected spending levels. We have yet to see blockbuster products get launched (admittedly, it is still early days), but the buzz reminds us of driverless cars and the metaverse in recent years. Both have come up well short of very lofty expectations. Another thing to consider is that the cost to run generative AI queries is extremely high, as the power requirements are substantial. Eventually, this will get factored into revenue and profit models. If companies do not ultimately see adequate sales, productivity, earnings, and returns on capital from their investments, AI expenditures should slow. Only time can tell. Unfortunately, the speculative fervor is not confined to Nvidia, AI, and Mega Cap technology. Other top-performing themes in the U.S. include Bitcoin sensitive equities, obesity drugs, and high beta 12-month winners (i.e., momentum stocks), according to Goldman Sachs. On May 16, penny stocks also captured investor imaginations, as it was reported that 45% of the total market volume traded was in less than $1 stocks, which compares to a year-to-date average of ~12%. Additionally, meme stocks are back in vogue, with low-quality GameStop (GME) up 97% over the last three months on the heels of an endorsement from social media investment influencer "Roaring Kitty" (no, this is not a joke). GameStop currently has a market cap of $10.2 billion, yet lost money from 2019-23, with projected sales in 2024 at about half of where they were in 2017. Clearly business fundamentals are not driving the story. Complacent, risk-seeking behavior can also be found in the spread between the S&P 500 earnings yield (earnings/price) versus the 2-year Treasury bond yield (US2Y, risk-free yield). For the first time in over 20 years (since the 2000 tech bubble), the spread has turned negative, suggesting that investors are no longer requiring a sizeable risk premium (i.e., higher earnings yield) for investing in equities vs. risk-free bonds. The current reading of -0.8% is over two standard deviations below the long-term average spread of 3.9%. Lastly, with growth stocks sucking the air out of the room, it was not surprising to read that "Investors poured a net $8.7 billion into U.S. tech funds over the seven days through Tuesday [June 18, 2024] per data from EPFR, the largest weekly inflow on record. Growth-oriented mutual funds attracted upwards of $10 billion over the same stretch, likewise its most bountiful week since at least 2017," according to Almost Daily Grant's. When the good times are rolling, investors rarely contemplate whether the music will stop. Aggressive buying near the top is all but guaranteed. These recent fund flows remind us of three famous Warren Buffet quotes, all of which may prove valuable as the current cycle unfolds: Greed is running rampant as the herd rushes into today's popular trades. All roads appear to lead to technology and growth stocks ... until they don't. Eventually this cycle, too, shall pass. Our focus on quality has really paid off in recent years. A 15year period of interest rate suppression induced a massive wave of M&A, significantly shrinking the number of quality Small Cap companies. The Russell 2000 has been left with over 40% of its constituents losing money. As illustrated in the chart to the right, quality companies (high return on capital employed, or ROCE) in the Russell 2000 win over the longterm. While lower-quality stocks have outperformed from time to time (most notably in 1999, 2003, 2009, and 2020), the duration is typically short-lived. When looking for a combination of quality and liquidity, we estimate that only about 20% of the Russell 2000 both make money and are liquid, so buying quality in the current environment has become more challenging. As a result, FMI and many of our peers that also focus on quality, have been investing in modestly higher market capitalizations. By simply expanding the investable universe to the Russell 2500, for example, it roughly doubles the number of profitable, liquid companies. As illustrated above, during the current cycle, U.S. Small Cap stocks have underperformed their Large Cap counterparts for the longest stretch (158 months) and largest spread (-219.4%) on record. Some of this gap is warranted, as rising interest rates and wages have negatively impacted Small Cap companies more (a higher percentage of floating rate debt, shorter debt maturities, and more labor-intensive businesses). Additionally, the quality of the Small Cap universe has deteriorated in recent years, as mentioned above. Even with these stark realities, the current valuation spread is still very wide by historical standards. Profitable Small Cap companies now trade near the lowest level to profitable Large Cap companies in over 20 years. If history is any indication, there will be brighter days ahead for Small Cap. The Japanese stock market is off to a blistering start this year, with the Nikkei 225 up 19.30%, outpacing even the tech-driven S&P 500. This has been a meaningful headwind for our International Strategies' relative performance, given that we have a 16% underweight in Japanese stocks vs. MSCI EAFE. Gains in Japanese equities have been boosted by positive sentiment around improving corporate governance (which we view as modest and incremental in nature), the exit from a deflationary spiral, and profit tailwinds for exporters that are benefiting from a collapse of the Japanese yen (weakest vs. USD since 1986). We question whether the Japanese market has gotten a bit ahead of itself, as Japan now trades at a healthy premium to Europe. After its recent run, the Nikkei 225 (NKY:IND) trades at around 20 times next-twelve-months price-to-earnings versus the STOXX 600 at 14 times, despite having a significantly lower return profile. The return on equity ('ROE') for the Nikkei 225 stands at 8.3% versus the STOXX 600 at 11.7%, according to Bloomberg. It's also worth mentioning that over 50% of the Nikkei 225's revenue is generated in Japan, where they have an aging and shrinking population, extremely low average birth rates (1.2), the developed world's largest government debt load, and expectations for slower GDP growth than Europe in the coming years. Japan's GDP declined 2.9% in the first quarter of 2024, amid sluggish consumption. We question the level of enthusiasm for the Japanese equity market and have yet to see many compelling bottom-up fundamental opportunities. We will continue to actively research new candidates in Japan but remain prudent. As described above, the speculative backdrop across today's global markets is extreme, with growth beating value handily. Over short periods of time, stock markets can reward stocks, sectors, and even countries regardless of the underlying fundamentals. When a stock or theme has momentum, people are quick to jump on the bandwagon. As investors capitulate and all but give up on value, it makes us even more excited about the future. Value investing has a 100+ year track record of outperformance and we are confident it will be back on top before long. Listed below are a few portfolio investments where the long-term prospects are compelling: Henry Schein is the largest dental distributor in the world, holding a leading market share position in all of its main geographies, and is also a leader in medical distribution. Henry Schein provides value to both product manufacturers and its customers. Manufacturers benefit from cost effective access to a highly fragmented customer base, as well as sales and marketing support for products. Practitioner customers benefit from timely access to a broad range of products, a reduction in the number of vendors they need to deal with directly, inventory management services, and equipment servicing. Henry Schein also sells practice management software that is used by ~40% of dental practices in the U.S., which is a very sticky business. We expect continued strong long-term growth in spending on dental services, which will be driven by an aging population, along with a focus on preventive care and demand for cosmetic dentistry procedures. Schein's stock has been under pressure in the near term because it is still recovering from a cyber-attack that took place late last year, and the macro backdrop continues to be challenged, which has led to muted elective/discretionary sales across the business. The stock is trading well below the market, which we view as attractive given its above-average business quality. Quest Diagnostics is one of the largest independent clinical laboratory testing companies in the U.S. with a 24% market share of independent lab testing, and its scale gives it a cost advantage. The clinical testing industry sees steady volume growth, helped by increasing test volume due to an aging population, higher prevalence of chronic disease, and advancements in medical technology that continue to expand the scope of clinical testing. The broader lab industry is an $85 billion market, accounting for only 2% of total healthcare spending, yet influencing over 70% of medical decisions. Today, nearly 60% of diagnostic tests are performed in a hospital or at a hospital outreach laboratory. Importantly, performing the same diagnostic test at an independent lab can cost anywhere between two and five times less than performing the same test in a hospital lab. Quest's average revenue per requisition is under $50. There is a nationwide focus on increasing preventative healthcare and lowering healthcare costs in general. Independent labs are part of the solution, as there is a huge value to be reaped by pushing more volumes through them. In the past, Quest has seen reimbursement challenges from both government and commercial payors. We believe that reimbursement headwinds have largely abated due to all payors recognizing the large cost benefit of higher volumes flowing through the independent labs. We expect Quest to generate mid-single-digit topline growth and expand margins, leading to high-single-digit earnings growth. With Quest's dividend and share repurchases, there are prospects for a low-double-digit total annual return, which is attractive given the defensive nature of the business and well-below market valuation. Ryanair is Europe's largest airline by passenger volume (~20% market share). It employs a very simple, yet unique business model. It flies only point-to-point, books flights almost solely through its website/app, heavily utilizes secondary airports, flies a single-variant fleet, and has a widespread geographic distribution (40 countries and 96 bases), which helps mitigate the impact of strikes or unfavorable regulations that occur in a single geography. Ryanair is one of the only international airlines to post high growth and stellar returns through a full cycle, owing mostly to the company's obsessive focus around efficiency and agility. Ryanair has created a deep cost advantage that allows it to price fares at levels that would be unprofitable for the vast majority of peers, leading to continued market share gains. The current industry setup is favorable, as the European in-service short-haul fleet is in short supply. Elevated storage rates are unlikely to revert due to aircraft age and restoration costs. Additionally, there are supply chain challenges and large backlogs that are limiting the pace of delivery of new planes. Ryanair's mid-single-digit capacity growth is locked in through 2034. Recently, its fares have been a bit softer than expected due to a weak consumer in Europe, and capacity hasn't expanded as quickly as expected due to Boeing delivery delays. We view both issues as transitory in nature. Valuation is well below historical averages and is likely to recover over a 3-5 year time horizon. Thank you for your continued support of Fiduciary Management, Inc. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

ClearBridge International Growth ADR Strategy Q2 2024 Commentary

Market downdrafts often present buying opportunities where market risk perceptions differ from our own. We see banks as such an area and took advantage of price weakness to add two names, highlighting an active period of repositioning. By Elisa Mazen, Michael Testorf, CFA & Pawel Wroblewski, CFA International equities delivered mixed results in the second quarter, supported by initial interest rate cuts in the European Union and Canada that partially offset lingering concerns about inflation and economic growth in those regions. The benchmark MSCI EAFE Index declined 0.42% and the MSCI EAFE Small Cap Index fell 1.85%, while the MSCI Emerging Markets Index added 5.00%. From a regional standpoint, the U.K. and Asia Ex Japan delivered gains and outperformed the index, Europe Ex U.K. generally performed in line while Japan suffered significant losses for the quarter as the yen continued to fall and shorter-term investors took significant profits early in the quarter. Unexpected snap elections called in France significantly impacted that market in June, dragging down one of the more significant economies in Europe. International growth stocks declined and trailed value stocks as bond yields rose in most regions. Most of the style divergence occurred in April following a string of hotter than expected inflation prints in the U.S., which sparked a sharp rise in yields that caused longer-duration growth assets to sell off. The MSCI EAFE Growth Index fell 0.75%, underperforming the MSCI EAFE Value Index by 76 bps. Year to date, growth maintains a 173 bps advantage over value. Amidst these growth pressures, the ClearBridge International Growth ADR Strategy slightly underperformed its benchmark for the quarter. As has been the case for the last 18 months, international information technology ('IT') stocks continued to diverge from their generative AI-driven counterparts in the U.S. This created a relative performance headwind for the Strategy as renewed strength in Taiwan Semiconductor (TSM), the foundry of choice for chipmaker Nvidia (NVDA) and other AI silicon developers, was offset by weaker price performance in the quarter from semiconductor equipment maker Tokyo Electron (OTCPK:TOELY) and IT consultant Accenture (ACN). After a strong run, we had trimmed Tokyo Electron to fund the repurchase of TSMC, whose share price had lagged. We still maintain an active position in Tokyo Electron but felt that a better upside was in TSMC, where we maintain a meaningful active weight. Accenture, in IT services, announced weaker first-quarter earnings, but then followed up later in the quarter with a better than expected order book for AI projects. The stock has been volatile during the period. Broad-based exposure to IT capex and only a small percent of revenue so far from pure AI projects has caused it to lag. However, those AI projects are ramping up fast and will become increasingly meaningful. Additionally, in order to benefit from AI, companies need to digitize their operations and move software to the cloud; all this work is good for Accenture as it advises on digitalization and cloud. We have adjusted the position size downward as earnings volatility is likely to remain elevated. On the positive side, performance was supported by our diversified health care exposure. The primary contributors were European biopharma companies Novo Nordisk (NVO) and AstraZeneca (AZN) as well as medical device makers Olympus (OTCPK:OCPNF) and Alcon (ALC). In evaluating our performance, we look to both participate in as many sectors as we feel have long-term growth prospects and outperform in those sectors through our three defined growth groups -- secular, structural and emerging -- each of which should perform well in different market environments. The second quarter was volatile from this growth/value perspective. Significant performance in the portfolio in both the more core and growth stocks, which typically fall in our secular and emerging growth groups, contributed to better quarterly performance. From this standpoint, we are encouraged by recent portfolio moves and results and as they have stood up well against a benchmark that looks vastly different from U.S. and traditional growth indexes. We have discussed the narrowness of market breadth, and international markets too have seen limited participation, making it challenging to follow our convictions on ideas and maintain broad, sector allocated portfolios. Stocks have been volatile through earnings seasons and misses have been punished brutally, even small ones. As we have gone through the first-quarter earnings season, it has been clear that many of the previous strong areas of growth, like travel and leisure and autos, had become quite elevated, but are unlikely to continue at the same pace. Corporate spending habits seem tighter and more carefully allocated. Interest rates are still high and consumer spending more restrained -- nothing alarming, but it has our attention. Automobiles, putting aside newer position Ferrari (RACE), have been showing signs of this cyclical peaking for a long time. Those stocks had done quite well until June. Those familiar with our Strategy know we are not invested in this important area of consumer discretionary, save for Ferrari, which has hurt our relative performance in consumer discretionary. This quarter we feel validated by that underweight position in the large automotive manufacturing complex. We were quite active this quarter trimming and selling names at what we felt were at peak earnings, multiples or both. Our selling this quarter focused on reducing smaller positions impacted by higher for longer interest rates and with lower levels of market liquidity, exiting positions that reached target prices or where our confidence in a structural turnaround had eroded. As always, our portfolio moves are to improve growth, reduce portfolio level risk and increase downside protection. Market downdrafts often present opportunities to buy companies where the market's perceptions of risk are not aligned with our own. We see banks as an area where we can take advantage of temporary price weakness due to idiosyncratic factors. We reduced our bank underweight with the additions of U.K.-based Lloyds Banking Group (LYG) and Spain's BBVA. For Lloyds, we see sizeable tailwinds in net interest income over the next few years. Lloyds hedges interest rates when extending loans to lock in a spread and stands to benefit as its loan book rolls over to higher spread loans book that reflect materially higher interest rates. While loan growth has been weak for an extended period, we expect a pickup in the second half of the year. Healthy dividend and share buyback activity should also drive total returns. Banco Bilbao Vizcaya Argentaria (BBVA) is a very profitable bank with strong market positioning and well-developed digital capabilities in its core markets. Mexico is the bank's largest profit pool and growth contributor as an underbanked market where the company wins profitable market share. Additionally, Mexico's new government isn't expected to significantly weigh on the banking sector. We believe BBVA's intended takeover of Spanish rival Sabadell will close in the first quarter of 2025, assuming all regulatory bodies and shareholders agree. The takeover will be accretive and result in BBVA consolidating its role as a powerful player in the Spanish market. We initiated, and have increased, our position on share price weakness related to takeover uncertainty. Swiss electrical components maker ABB (OTCPK:ABBNY), in the structural growth bucket, was the largest addition. After its recent restructuring, ABB is a more streamlined business with better cost management and a more focused market position. Revenue growth should pick up in the medium term driven by strong secular demand trends. For example, the company's low and medium voltage solutions benefit from accelerating investments in electrification. Other solutions, like motor drives, are key technologies supporting energy efficiency improvements across most industrial processes. To make way for these new names, we exited several positions that had reached our price targets. These included Latin America e-commerce leader MercadoLibre (MELI), an emerging growth name that saw a strong price move from April lows and that has been a long-term winner for the portfolio. We took advantage to redeploy those profits into the repurchase of Singapore-based Sea Limited (SE), a non-emerging-market idea we believe has more upside and less risk. We exited Japan's pharmaceutical maker Daiichi Sankyo, a leader in developing antibody drug conjugates ('ADC') to treat cancer. We believe ADCs are the new modality for cancer treatment and that the company's key partner for marketing these drugs, portfolio holding AstraZeneca, has been doing an exceptional job with their breast cancer drug Enhertu and will likely see similar success for lung cancer drug Dato-DXd. Future pipeline ADCs with Merck could boost the stock price further, but we feel our price objective has been achieved and the sale keeps the portfolio's health care overweight more balanced. French contact center software maker NICE was also sold as the debate around AI's impact on its business has created exceptional price volatility. While we believe NICE will be a net winner, it will take time for AI revenue to build, weighing on near-term stock performance. The unexpected transition of its long-time CEO added another, more significant layer of uncertainty that caused us to look elsewhere for opportunities in technology. In total, the period saw us initiate seven new positions while eliminating nine others. The ECB took the lead in cutting rates during the quarter, which could provide temporary relief for sectors that have been pressured by higher costs of capital. While inflation remains sticky in the eurozone and further cuts could be data dependent, EU regulators set a positive tone with the move. Stabilization in the U.K. following the early July election of a centrist leader from the Labour Party could also be supportive of equities. Japanese equities took a breather in the second quarter from a currency- and reform-supported rally, but we expect actions taken by the government and exchanges to improve corporate returns and encourage greater equity ownership will continue to flow through to better earnings. Buybacks are also on the rise in Europe and Japan, which could offer a catalyst to help close the lingering performance gap between U.S. and international equities (Exhibit 2). Chinese equities rebounded in the second quarter from an extended malaise, but we have no immediate plans to invest directly in the Chinese market beyond our existing holdings in Zai Lab (ZLAB) and Hong Kong-based AIA Group (OTCPK:AAGIY). The Chinese economy may not get materially worse from here, nor do we feel it will get materially better until the ongoing housing problems are resolved, something that will take more time than the market believes. Certain industries are being targeted for growth at the expense of others. We have many stocks on our radar screen and most of our portfolio holdings have a portion of their business in China. The political rhetoric toward Europe, Japan and the U.S. and the companies that are key investors in that market remain unfavorable, something that in our mind is incongruous with developing a cohesive growth strategy. The U.S. political election season is also likely to highlight rhetoric unfavorable to continued investor fund movements into China. We believe recent results validate our diversified approach to growth, complementing our core holdings among secular growth companies with opportunistic ownership of structural growers and selective exposure to emerging growth names, many of which have seen their valuations become more compelling in recent quarters. While the Federal Reserve has pared back their easing efforts until gaining more confidence on the path of inflation, central bankers outside the U.S. have already begun to ease monetary conditions. We believe this transition sets up well for our portfolio of growth stocks with strong fundamentals and specific value creation strategies. During the second quarter, the ClearBridge International Growth ADR Strategy underperformed its MSCI EAFE Index benchmark. On an absolute basis, the Strategy experienced gains across three of the nine sectors in which it was invested (out of 11 total), with the health care sector the primary contributor while the IT sector was the main detractor. On a relative basis, overall sector allocation contributed to performance. In particular, an overweight to the health care sector, a lack of exposure to the real estate sector and stock selection in the consumer discretionary and health care sectors aided results. Conversely, stock selection in the IT and materials sectors and an underweight to the financials sector detracted from performance. On a regional basis, stock selection in North America, an overweight to emerging markets and underweight to Japan supported performance while stock selection in Japan, the U.K. and Asia Ex Japan, an overweight to North America and an underweight to Asia Ex Japan proved detrimental. On an individual stock basis, the largest contributors to absolute returns in the quarter included Novo Nordisk, AstraZeneca and Olympus in the health care sector, Taiwan Semiconductor Manufacturing in the IT sector and Atlas Copco (OTCPK:ATLKY) in the industrials sector. The greatest detractors from absolute returns included positions in Tokyo Electron, NICE and Accenture in IT, OTCPK:LVMHF in consumer discretionary and Canadian Pacific Kansas City (CP) in industrials. In addition to the transactions mentioned above, we initiated positions Unilever in the consumer staples sector, Bureau Veritas (OTCPK:BVRDF) in the industrials sector and UCB in the health care sector. Additional sales included Airbus (OTCPK:EADSF) and Computershare (OTCPK:CMSQF) in industrials, Shiseido (OTCPK:SSDOY) and Diageo (DEO) in consumer staples, Kering (OTCPK:PPRUF) in consumer discretionary and James Hardie Industries (JHX) in materials. Elisa Mazen, Managing Director, Head of Global Growth, Portfolio Manager Michael Testorf, CFA, Managing Director, Portfolio Manager Pawel Wroblewski, CFA, Managing Director, Portfolio Manager Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Patient Capital Management Q2 2024 Commentary

We've long thought an AI bubble was possible: I'd say we're there, though it may still be early. "It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way. . . ." A Tale of Two Cities, Charles Dickens I attended a refreshing value investing conference, Value x Vail, in June. Refreshing because there were true value investors, a dying breed, pitching some ugly and beaten-up value stocks. A breath of fresh air in a quality-compounder crazed environment. It took me back to my earliest days in the industry when the best investors were those with the heartiest guts of steel, best able to stomach the torment of a reviled but promising opportunity. Of course, in today's environment, investors pitched plenty of high growth names. Companies where you must dream the dream to make a case of undervaluation. There's now broad recognition that identifying quality companies with long runways for growth is the best path to top performance. A far cry from the days when Bill Miller was pilloried at a Columbia Business School Value Investing conference for not being a "true value investor" because he owned Amazon (AMZN). When lucrative opportunities become widely recognized, prices get bid up. As expectations ratchet up, future returns tend to ratchet down. It's one reason earning excess investment returns is so challenging. Generally, the best investments begin in a state of obscurity, neglect or disdain. High expectations are not the investor's friend. Nor are they a recipe for immediate underperformance. We see strong demand and high expectations for quality compounders, AI and technology. The bar for fundamentals is set high, with minimal room for error. We see better relative opportunities elsewhere. Performance momentum, however, resides squarely in the darlings. Year-to-date, the number of stocks on pace to outperform the index sits at a record low. As the market notched new highs, many stocks were left behind. Dichotomy characterized the second quarter. The S&P 500 (SP500,SPX) posted a strong quarter (+4.3%), outpaced only by the Nasdaq (+8.5%). Large cap technology stocks surged to new heights, while most stocks struggled to keep up. Only 26.4% of the S&P 500 constituents outperformed the index. Nearly 60% of its stocks declined. The more pedestrian and cyclical Dow Jones Industrial Average (DJIA) lost 1.3%. Smaller cap indices fared even worse, with the Russell 2000 (RTY) down 3.3% and the S&P 600 Small Cap index (SP600) losing 3.1%. More S&P 500 sectors declined than advanced. The Magnificent 7 alone contributed 61% of the S&P 500's year-to-date returns (+15.3%). The path to prosperity was a narrow one. Opportunity Equity declined 1.9% net of fees in the quarter, taking our year-to-date return to 9.6% net of fees, a respectable albeit lagging 6-month return. After two very strong quarters, consolidation isn't surprising. Our smaller cap and low multiple names dragged on performance. Fundamental underpinnings supported the performance divergence. First quarter year-over-year earnings growth for the Mag-7 was 50%, trouncing the rest of the S&P 500's 2% decline. The gap is expected to narrow in the second quarter but remain wide (+28% Mag 7 vs. +4% SPX ex-Mag 7). By the fourth quarter, equal growth is expected for both groups at +17%. While overall growth expectations appear too high, if it's even close to right, the laggards should perform strongly (and outpace the leaders) in the second half, much like we witnessed in 4Q23 and 1Q24. An important consideration is the clearly slowing economy. First quarter real GDP growth was +1.4%, 36% lower than a year ago. Retail sales barely grew in May. Housing starts have weakened. Manufacturing Purchasing Managers Index (PMIs) continue to suggest contraction. The unemployment rate has increased more than half a percentage point from the lows to 4.1%, triggering the Sahm recession rule*. A conclusion supported by the payroll employment report and Leading Economic Indicators (LEI). Yet nominal income growth remains strong (+5.1% year over year (YoY) in June) and overall employment gains are still solid. Slowing growth has helped inflation normalize. Core PCE, the Fed's favored metric, advanced only +2.7% YoY in May, down from 4.7% the prior year. Stories of price cuts fill the news. Fast-food chains compete to offer the biggest bargains, customers trade down, airlines compete on price and car companies discount to deal with high rates. Yet, the Fed wants more evidence we're on track to hit its 2% target before lowering rates. This creates the risk that a backward-looking, too-tight Fed waits too long. As inflation falls and rates remain stuck at a high level, restrictiveness grows. Not encouraging as signs of weakness grow. The Fed recognizes the risks and expects to cut rates later this year despite steady inflation forecasts. Fed governors Mary Daly and Austan Goolsbee recently spoke of the need to more seriously consider rate cuts. Growing recession risks are a factor weighing on certain stocks. This is partially why we took portfolio leverage down early in the quarter. The economy and jobs still seem OK despite the weakening. Most companies say demand remains solid, with weakness at the low end. Consequently, our base case is for rate cuts later this year that take the market, and laggards, to new heights. The longer the Fed waits though, the more likely a less benign scenario emerges. Given the weakness and discounted expectations of some cyclicals and small caps, we think some protection exists against a recession should it occur. Any recession, though, would cause broad market weakness. In the current bifurcated investment environment, winners win, and losers lose. Big time. Trends get taken to extremes. We've long thought an AI bubble was possible. I'd say we're there, though it may still be early. Fortunately, we recognized Nvidia's (NVDA) potential and bought it early in the year. It was capturing the bulk of AI profits with a significant market lead and deep competitive advantages. We believed it was more like Microsoft (MSFT) than Cisco (CSCO), which implied significant potential upside to its intrinsic value. It's since more than doubled and reached our bull case level. To justify current market expectations, we believe Nvidia needs to accomplish something unprecedented, like sustaining its current 65% operating margins for decades. That's possible, but unlikely. Even if it happens, it won't be linear. What's more likely is that Nvidia continues to surpass near-term expectations with the launch of its Blackwell chips later this year, which will be undersupplied. Markets would likely extrapolate any strength. Bill Miller once said markets go on a journey from undervaluation to overvaluation and back again. The same is true for securities. When we make an investment, we want to capture as much of that journey as possible. We recognize it's impossible to time your entry and exit perfectly. We work actively to mitigate our (and investors broadly) behavioral tendency to sell winners too soon. In this case, we still believe it's possible for the AI/quality compounder momentum to get more extreme. Nvidia currently trades at 47x fiscal 2025 earnings, which corresponds to Cisco's mid-1998 level (the ultimate peak in March 2000 was 152x!). Likewise, the S&P 500 Tech sector trades at 33x 2024 earnings, a similar level to late 1998 and early 1999. During that period, gains continued for another 12-18 months. We don't expect history to repeat but are cognizant that times of euphoria tend to last longer and get more extreme than most anticipate. This one may end the way of the Nifty Fifty euphoria of the late- 1960's or the Tech Bubble of the 90's, namely a crash. That would be a painful outcome. Though in those prior crashes, low multiple stocks vastly outperformed. We don't think we're there yet, especially as some of the Mag 7 still trade at reasonable valuations (Alphabet trades at 24x next 12-month earnings; Meta at 26x). For now, we are watching Nvidia closely. It continues to outperform on most days and the fundamental backdrop remains intact. The market will likely give us the first signal that change is afoot. We never like to sell our winners after only a matter of months, especially in taxable accounts. We aim to maximize returns, which requires we remain flexible. Nvidia's giant move this year closed the discount to intrinsic value. While we can't make the case that it's undervalued, we also don't believe it's significantly overvalued, which is typically where euphoria ends. We will be monitoring it carefully. We see the most compelling long-term opportunities in unloved areas of the market, which we've been shifting more into gradually. While that's hurt us short-term, we have conviction it's the right move long-term. Smaller cap companies' stock prices have continued to lag. We have been building current names and adding new ones. We initially bought IAC Inc (IAC, $46.85, $3.96B market cap) a year ago and added to it in the quarter. It's run by some of the best capital allocators in the world, Barry Diller and Joey Levin. It pulled back to levels below where we started buying despite significant improvement in business fundamentals. We think the stock is worth ~$90, including a 20% conglomerate discount, about double the current price. We've bought more Kosmos Energy (KOS, $5.54, $2.6B market cap), an offshore oil and gas exploration and development company on the verge of significant production growth, as well. Its significant reserves of low-cost, low-carbon energy are an attractive long-term asset. As development CapEx falls, free cash flow should surge. At current commodity strip prices, we expect it to generate $1.30 per share in free cash flow next year, a 23% yield on the current stock price. It will initially pay down debt but should be in a position to return cash to shareholders in the second half of 2025. KOS is one of the only energy names we've found with significant potential upside at $65 a barrel WTI crude. We think it's an acquisition candidate, and worth more than double the current price. We initiated a position in Everi Holdings (EVRI, $8.40, ~$700M market cap) in the quarter. Everi is a gaming hardware, technology and services provider. The stock traded at $15 a year ago and hit a low of $6.37 in the quarter. Sales have slowed with the economy and in advance of new game launches, which will come later this year. The company announced a merger with IGT's gaming business. The combined company will be a market leader in an oligopolistic industry (leaving 3 main players post deal) with significant cash generation capacity. We think the stock is worth mid-teens using conservative assumptions, roughly double current prices. We're not sure when smaller caps will start acting better, but as long as the market allows us to buy quality businesses at mouthwatering valuations, we will do so. We have confidence it will eventually prove profitable. Elsewhere, we aren't finding opportunities to double our money over a few years. We still have significant travel exposure. Travel remains a source of economic strength as people prioritize experiences. You can't tell from the stock prices. Expedia (EXPE, $125.99, $16.4B market cap) continues to execute on its technology transformation. Its B2B (business-to-business) segment is humming. People are just starting to understand its value. When properly valued, we think you're paying only 2-3x EV/EBITDA for the core consumer piece (which is still growing!). As Mr. Market is slow to reflect the value, the company is gobbling up its own stock. Repurchases alone should allow the company to compound earnings in the teens. We continue to own Delta Air Lines (DAL, $47.44, $29.9B market cap) and United Airlines (UAL, $48.66, $15.5B market cap), which earn the bulk of airline industry profits due to their premium positioning. Neither sees any signs of weakening travel demand. We think these are better businesses than the market discounts, and that time will prove this out. In the short term, both companies should begin buying back stock this year. Norwegian Cruise Lines (NCLH, $18.79, $7.5B) has been a volatile one. We pared it back in the twenties and recently added to our position around $16. We like the new management team's focus on costs and returns. If the company can hit its' 2026 $2.45 EPS guidance, which we think is likely in a normalized environment, the stock should nearly double over the next couple years. We've also built exposure to several healthcare names amidst recent weakness. These names should have more resilience in any recession we might face. Excluding our small biotechs, our exposure is 10.0%. Our holdings are Biogen (BIIB, $231.82, $32.9B market cap), Illumina (ILMN, $104.38, $17.4B market cap), CVS (CVS, $59.06, $71.1B market cap) and Royalty Pharma (RPRX, $26.37, $15.3B market cap). Biogen's new CEO Chris Viehbacher is executing well, and the company has a huge opportunity in Alzheimer's. Illumina is the market leader in genomic sequencing, where we expect long-term market growth. Following the Grail spin off, investors should see the earnings power of the core franchise shine through. ILMN's challenges gave us the opportunity to buy a quality compounder at an attractive valuation. CVS recently executed terribly in its Medicare business. It will take a couple years to sort through, but we believe the franchise is intact and the problems are fully discounted. As it gets back on track, we expect handsome returns. Royalty Pharma is misunderstood, but its team of savvy healthcare investors with a proven track record of funding royalties. More than half the portfolio (55%) is in small-to-mid cap names, healthcare names and travel names. Most of these stocks have lagged the market year-to-date. Our philosophy is that when business fundamentals remain solid, falling market expectations create opportunities. It can produce deferred outperformance. We have significant conviction in our investments over the next five years. In the shorter term, they could act much better in the second half if the Fed cuts rates and economic growth continues. One of the biggest challenges for investors is not to let simple mistakes destroy investment returns. Letting macro fears derail a sound investment portfolio. Letting FOMO (fear of missing out) suck you into what's hot at exactly the wrong moment. Throwing in the towel on laggards at the bottom. The current environment tempts fate in many ways. The best strategy we've found for resisting temptation is to stay focused on our investment process. Where is there a gap between company fundamentals and discounted market expectations? We stay focused on investment fundamentals as prices eventually follow. When we're right in our analysis and patient in our approach, it's a recipe for success. We hope we adequately conveyed the attractive opportunity set, and the potential risks. We have high conviction in the portfolio. We will do our best to navigate a tricky investment environment well, with equal doses of patience, prudence and opportunism. Opportunity Equity Annualized Performance (%) as of 6/30/24 Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Patient Capital Management Q2 2024 Investment Review

Relative to the index, the strategy was overweight in the Consumer Discretionary, Communication Services, Financials, Energy, and Health Care sectors on average during the quarter. With zero allocation to Real Estate, Utilities, Materials, and Consumer Staples, the strategy was underweight in these sectors along with the Information Technology, and Industrials sectors. The representative account portfolio added one position, Everi Holdings Inc. (EVRI), and eliminated two positions, Capital One Financial Corp. (COF) and Uber Technologies Inc. (UBER), during the quarter. The portfolio ended the quarter with 39 holdings where the top 10 stocks represented 49% of total assets compared to 34.2% for the index, highlighting the fund's meaningful active share of around 90%. The second quarter finished much like the first with the largest names continuing to lead the market. Nvidia Corp. accounted for an impressive 40% of the S&P 500's return in the period followed by Apple Inc., Alphabet Inc., and Microsoft Inc. accounting for 30%, 19%, and 10%, respectively. We benefited from our exposure to Alphabet Inc., Meta Platforms Inc., Amazon.com Inc., and Nvidia Corp. At the end of last quarter, we wrote about how select names within the Magnificent 7 were not yet pricing in euphoria. More of the names now look closer to fair value. We see more attractive opportunities elsewhere and have increased our exposure to idiosyncratic opportunities in underfollowed and underappreciated ideas. We continue to see attractive upside in both traditional value names and small and mid-cap companies. Our exposure to Health Care has increased throughout the year as a result of our bottoms-up fundamental analysis. We think the Health Care space is ripe with idiosyncratic opportunities that the market is not yet focused on. Illumina Inc. (ILMN) is a good example. We entered the name late last year as the company began to trade at a 5-yr low. The company is a leader in the genomic sequencing space but made an ill-advised acquisition of Grail, a blood-based multi-cancer early detection product, in 2021 for $8B dollars. Grail was an annual ~$600m drag on profitability hitting the financials at the same time that competition began to pick up and the overall demand environment began to weaken. Despite increased competition in the genome sequencing space, Illumina continues to be a leader with ~80% market share today. With the successful separation of Grail Inc. (GRAL) in June, Illumina has now returned to a pure-play sequencing company. As the company returns to historical profitability post Grail spin-off and as the demand environment normalizes post COVID, we believe you can buy a market leader in a secularly growing industry for less than a market multiple. Biogen Inc. (BIIB) is another name that we believe is underappreciated. As a global biopharmaceutical business, the company is most well known for their products in multiple sclerosis, spinal muscular atrophy, and most recently Alzheimer's disease. The new CEO, Christopher Viehbacher, is working to improve the company's pipeline, most recently with their acquisition of Human Immunology Biosciences Inc. in May. Chris has a strong track record of successful M&A and we expect him to continue that tradition. More importantly, we think the market is currently giving the company no credit for success in their Alzheimer's indication. While the uptake in Leqembi, their Alzheimer's product, has been slow, we still see strong long-term potential for a patient population that is dramatically underserved. We find the risk/reward extremely attractive. While Royalty Pharma plc (RPRX) is in the health care space, it is more like an investment firm that buys royalty assets in the healthcare space. The company has an extremely strong track record, running the business for over 20 years as a private fund before bringing it public. The market opportunity for external royalty funding has only grown as early-stage start-ups need funding and legacy players are looking to lower their debt levels. We think Royalty Pharma is perfectly positioned as the partner of choice. The company is disciplined, maintaining deal internal rate of returns (IRRs) in the low-teens despite the higher interest rate environment. We think as the company continues to deliver as a public company, the market will start paying attention. This quarter we entered one new position, while exiting two positions. We started a position in Everi Holdings Inc. during the quarter, a leading supplier of technology solutions for the casino gaming industry providing gaming machines, casino operational and management systems, as well as online gaming content. The company is in the middle of closing its acquisition of IGT's Global Gaming and PlayDigital business in a cash and stock deal worth $3.8B at the time of the announcement. The stock sold off following the news, given the historical record of revenue dis-synergies in prior industry M&A deals. We believe this isn't applicable here since neither company has meaningful product or market overlap. On a pro-forma basis, the combined company trades at just 4.2x 2025 EBITDA, an attractive valuation for what will continue to be a market leader in the industry. We believe that as we move past the acquisition, the market will gain confidence in the long-term opportunity for the combined businesses and appreciate its strong cash generating dynamics. Nvidia Corp. continued to lead both the market and the portfolio, remaining a top performer in the period gaining 36.7%. Nvidia is the market leader in designing and selling Graphics Processing Units ('GPU'), which has recently benefited from the insatiable demand of artificial intelligence ('AI') models. The company currently captures 92% market share of data center GPUs and grew revenue, earnings and free cash flow ("FCF") an astounding 126%, 392%, and 610%, respectively, over the last year. While we expect competition to increase, we think NVDA can continue to maintain top market share. While many are concerned with backlog times shortening, we think the rollout of the B100, which promises 2.5x better performance for only 25% more cost, later this year will create more shortages. With leading edge technology, an increasing innovation cycle and strong cash generation, the company is well positioned for the increased adoption of artificial intelligence ('AI'). Alphabet Inc. was a top contributor in the second quarter, finally catching up to its peers in the Magnificent 7. The company gained 20.8% in the period following strong first quarter earnings, a new $70B repurchase program (3% of shares outstanding) and the initiation of a cash dividend ($0.20 per share; 0.42% yield). We continue to believe the market underappreciates Google's exposure to AI with its Gemini model being integrated into search results, YouTube advertising and its cloud offering. We continue to think that the cloud players will be the AI winners in the long-term, with Google being well positioned to take advantage. While the company trades at 24x 2024 earnings, if you remove the money-losing and under-earning businesses, you realize that you are paying below a market multiple for the core Google business. We do not believe there are many other AI winners trading at such an attractive multiple. Amazon.com Inc. moved higher throughout the second quarter as AI demand helped to reaccelerate growth in their AWS business. It looks as though the cloud business is finally past the customer cost optimization period with customers restarting their cloud migrations as well as expanding spend on AI projects. Despite the top and bottom-line improvement seen in the first quarter, the company is significantly underearning its long-term potential as it continues to reinvest aggressively in the business. With 80% of global retail sales still being done in physical stores and 85% of global IT spending still on-premises, we see a long-run way for the dominant player in the cloud, retail, and increasingly logistics and advertising space. CVS Health Corporation declined in the period following a disappointing first quarter earnings announcement and cut to guidance. The company reduced full year EPS guidance by ~16%, almost entirely driven by higher-than-expected costs in Medicare Advantage. Skepticism remains on management's ability to execute and move past these issues but given the magnitude of the stock reaction (~19% decline) we think the risks are more than priced in at these levels. The issues with Medicare Advantage are now known and the company is working to fix them. With time, we believe they will be corrected. We continue to think CVS has an attractive long-term opportunity with its unique combination of assets owning a healthcare benefits business (Aetna), a pharmacy-benefits manager (Caremark), an in-home evaluation business (Signify Health) and in-home primary care business (Oak Street Health) supporting the industry transition to a value-based care model. While the most recent missteps are disappointing, the company still only trades at 8x lowered earnings estimates while continuing to pay a dividend (5% yield) and execute its repurchase program (16% of shares outstanding). Coinbase Global (COIN) was a top detractor following cryptocurrencies lower throughout the quarter. While cryptocurrencies are going through a digestion period following the all-time high reached by Bitcoin in March, we believe it is still the early innings for institutional adoption and exposure to cryptocurrencies. We believe Coinbase continues to solidify its position as the platform of choice for the crypto-ecosystem and will benefit from this increasing demand over time. Mattel Inc. (MAT) fell in the second quarter on a weaker top line despite margins coming in ahead of expectations. While many are concerned around lapping the hit Barbie movie this year, we believe the Barbie movie is just the beginning of Mattel's multi-year journey to transition to an IP-driven, high-performing toy company. Regardless of near-term topline results, margins should continue to expand as the company has made efforts to improve efficiencies and removed fixed costs. Longer-term, as the company executes its IP driven transition, returns on invested capital and free cash flow generation should improve, allowing the P/E multiple to expand. In the meantime, the company continues to return cash to shareholders with a repurchase program representing 16% of shares outstanding. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

L1 Capital Long Short Fund June 2024 Quarterly Report

Global markets were mixed over the quarter with the U.S. supported by gains in mega-cap technology stocks while Australian and European markets were relatively subdued. Global markets were mixed over the quarter, with divergent themes impacting key markets. The top 5 holdings in the S&P 500 now make up ~29% of the index, the highest concentration in 50 years. European markets were generally negative, as French elections and their impact on the country's future fiscal sustainability weighed on the broader region. The Australian market was also marginally negative (ASX200AI -1.1%), as real GDP growth continued to be subdued and inflation remained stubbornly high. The strongest sectors in the ASX 200 for the June quarter were Utilities (+13.3%), Financials (+4.0%) and Information Technology (+2.9%), while Energy (-6.8%), Materials (-5.9%) and Property (-5.6%) lagged. Portfolio gains were modest over the quarter, with solid returns in April and May offset by a decline in June. June performance was driven by a downturn in European markets as well as weaker commodity prices which weighed on several key holdings over the month. We see equity markets as being relatively fully priced overall with narrow market leadership in both Australia and the U.S. driving gains, ongoing risks from weakening consumer sentiment, geopolitical tensions and U.S. elections. We are currently finding numerous attractive opportunities in low P/E, highly cash generative companies where valuations remain compelling, along with select opportunities on the short side, particularly in some expensive growth stocks with overly optimistic market expectations. Equity market performance, both domestically and offshore, has been driven predominantly by a narrow group of large-cap stocks that have supported broader index returns. In the U.S., these have been the mega-cap technology stocks commonly referred to as the Magnificent 7 (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla), whereas in Australia, the domestic banks have done the heavy lifting. In the U.S., while markets remain buoyant, recent economic data has been weaker. U.S. real GDP growth forecasts for the first quarter came in well below market expectations and the ISM manufacturing index fell for a third straight month in June, as demand remained subdued. We believe caution is warranted at an index level given the narrow market leadership driving returns and some signs of a softening in the economic environment. From an Australian market perspective, the rally in domestic banks continued to support the broader index, contributing 3.6% of the ASX200AI 4.2% return on a calendar year-to-date basis (i.e. 86% of the total index return). The Banking sector's outperformance has been entirely multiple driven, with earnings estimates trending flat to down over the period. CBA currently trades at the most expensive valuation in its history, despite offering no earnings growth for the next two years. It also stands out as an outlier relative to the other major Australian banks, trading at a ~60% premium to peers on an earnings multiple basis compared to its long-term average premium of only ~17%, as illustrated in Figure 1. In our view, this performance is not supported by fundamentals, rather it indicates a level of crowding and over-valuation. The market is also discounting the risk of an uptick in bad debts and credit impairments. While these remain benign at current levels, there are increasing signs of stress emerging, which will be exacerbated by interest rates potentially having to stay higher for longer. We believe some of the shifts in market concentration and performance are providing compelling opportunities in stocks that have lagged the broader market rally. One such example is the domestic Resources sector, where performance has been much weaker than the market leading to a huge divergence in performance when compared to the Banking sector (see Figure 2). The Resources sector trades on an average forward EV/EBITDA multiple today of ~5.7x, which is 20% below its long-term average. This is despite commodity prices remaining at supportive levels and major mining companies continuing to generate strong cash flows. Figure 1: CBA - 12m forward P/E premium/ (discount) vs. peer average Figure 2: ASX 200 Banks vs. Resources returns YTD Another area of focus for the market has been inflation and the path to an easing in monetary policy by Central Banks. Over the quarter we have seen a divergence in the outlook and expectations for interest rate cuts in Australia versus the U.S. In the U.S., CPI has trended in line to slightly below forecasts in April and May. These data points, together with a softening in economic indicators, have reinforced market expectations for an interest rate cut towards the back end of this year. U.S. core PCE is now within 60bps of the Fed target (see Figure 3 on the next page) and futures markets are currently pricing in a ~70% probability of an interest rate cut in September this year. Jerome Powell, the Fed Chair, added further support to this view, with more dovish outlook commentary at a recent central banking forum. "We've made quite a bit of progress and in bringing inflation back down to our target...The last [inflation] reading and the one before it to a lesser extent, suggest that we are getting back on the disinflationary path. We want to be more confident that inflation is moving sustainably down toward 2% before we start the process of reducing or loosening policy." Jerome Powell - Fed Chair (2 July 2024) However, in Australia, the picture is quite different with CPI trending above market expectations over the last two months. In May, CPI increased by +4.0% year-on-year, which was ahead of market expectations of +3.8% and up from +3.6% in April . CPI is now ~170bps above the RBA target (see Figure 4). The futures market is currently pricing in a 32% chance of an interest rate hike at the next RBA meeting in August, in contrast to a month ago, where rates were expected to remain stable. It looks increasingly likely that interest rates will remain at or above current levels in Australia for the remainder of this calendar year. This adds to our caution on the domestic banks and Consumer Discretionary sectors. Figure 3: U.S. core PCE within 60bps of Fed target Figure 4: Australian inflation ~170bps from RBA target Positioning of the portfolio has remained broadly consistent with the prior quarter. The portfolio remains heavily skewed on the long side to lower P/E stocks that have strong cash flow generation and solid earnings growth. A key change we made over the quarter was to use the rally in copper equities to take profits in several positions and materially reduce the portfolio's net copper exposure. We continue to remain constructive on the medium-term dynamics of the copper sector and will look to add to our exposure at a more favourable entry point. We also exited our position in QBE over the quarter which has been a long-standing position for the LSF. We first invested in the Company in late 2020 at ~$9 / share when it was widely disliked by the market. Our view was that the market underappreciated the improvement in the operating backdrop and the strong catalysts for the company to deliver improving margins, dividends and ROE going forward. With many of our earlier views now reflected in the current market outlook, we exited the position around ~$18 / share, generating a ~100% return for the portfolio. The investment team travelled extensively over the quarter, with seven of the 10 members of the equities team heading offshore. The team travelled to the United States, Canada, United Kingdom, Taipei, South Korea and China. We had around 200 meetings in total with companies across the Automotive, Consumer Staples, Consumer Discretionary, Financials, Industrials, Health Care, Resources and Technology sectors. We have outlined some of the key feedback from our travels and its influence on our portfolio positioning below. From a U.K. perspective, our meetings supported a cautious optimism about an economic recovery with the companies we met flagging a generally improved macroeconomic environment and resilient consumer environment. At the time of our travel, the Labour Party was expected to win the U.K. General Election comfortably, which was confirmed in early July. Figure 5: U.K. FTSE All Share forward P/E ratio Most companies we spoke to viewed this as a low-risk event, with the party's manifesto and leadership viewed as relatively "business friendly" given its focus on economic growth, improving planning processes and limited proposed changes to corporate or personal taxes. Accordingly, we expect this outcome and in particular the post-election political and regulatory stability to be generally supportive for U.K. exposed equities. The U.K. market has lagged other developed markets for the last decade and even more so over the last five years, as the economy dealt with Brexit and COVID-19 overhangs. Figure 5 highlights the compression in the forward earnings multiple of the FTSE All Share index over time. Figure 6: U.K. vs. major markets 12m forward P/E ratio Figure 6 highlights the attractive earnings multiple that the U.K. market currently trades on relative to other regions. Since the start of this year, we have found several opportunities to add high quality U.K. businesses with robust growth outlooks that are trading at very attractive valuations relative to their peers. An example of one of these positions is Tesco, the U.K.'s leading supermarket chain with close to 30% market share. The company currently trades on a forward P/E of only 12x consensus earnings forecasts, offers a high single digit EPS growth outlook over the medium term and is actively returning capital to shareholders. We believe its valuation is very attractive given the company's strong and improving market position, significant property book, and further upside potential from a broader economic recovery. We carried out a number of meetings in the U.S. and Taipei focused on semiconductors and the exponential growth in artificial intelligence ('AI'). While we have not invested in NVIDIA directly, we have been active in the key "picks and shovels" businesses involved in the supply chain, namely Taiwan Semiconductor Manufacturing Company and SK Hynix. We also have some positions in lesser-known segments of the supply chain which we believe are under-appreciated beneficiaries of the AI spending wave. We expect a continued increase in the capital expenditure committed to generative AI, with our meetings indicating that many large companies are in the early innings of their investment and largely at a proof-of-concept stage. This should continue to support strong growth for our key positions in the sector. Figure 7: IT budget spend on AI computer hardware (%) The recent CIO Survey from J.P. Morgan, which covers 160 CIOs responsible for $123b in annual enterprise IT spending, reinforced the views from our trip. The survey indicated that spend on AI computing hardware is expected to increase from ~5% of IT budgets currently to ~14.5% of IT budgets in three years, implying a cumulative annual growth rate above 40% (see Figure 7). Our meetings indicated that consumer sentiment remains depressed due to the negative wealth effect from a declining property market and weak employment trends. Whilst there was some optimism in May as the Chinese government introduced policies to directly address excess supply in the housing market, these measures do not appear adequate in isolation to re-invigorate the property market. Accordingly, we remain relatively cautious on the Chinese market outlook and will be watching the Third Plenum closely for any further potential stimulus measures. The Third Plenum is a pivotal meeting of the Chinese Communist Party focused on economic policy and is set to take place from July 15-18. We met with a range of metals, mining and energy companies across the U.S. and Canada. In the Energy space, key oil and gas producers remain highly disciplined with regards to growth capex and continue to show a strong priority towards shareholder returns. This is a shift in mindset versus prior cycles and adds to our constructive view on the sector. Our favoured investments in the space remain the Canadian oil sands players, namely Cenovus and MEG Energy, which have very low break-even costs of production and disciplined management teams. In the precious metals space, our meetings confirmed the significant increase in cash generation that gold players should benefit from in the coming quarters given the rally in gold prices (up +21% over the past year). Although gold equities have moved higher, they have materially lagged the performance of the gold price over the past twelve months. The broader market remains sceptical on the sustainability of the gold price, whereas in our view there are several factors that support an underlying medium-term gold bull market. To date, the rally in gold prices has been driven by an increase in Central Bank buying and Chinese retail demand. This is despite a higher interest rate and stronger U.S. dollar environment which typically leads to lower gold prices. As Central Banks begin to cut rates and we see potential weakness in the U.S. dollar, this should support the gold price going forward. In addition, gold tends to be well supported when U.S. fiscal debt remains high and U.S. fiscal sustainability concerns remain elevated. Figure 8: Average U.S. budget deficit as % of GDP per U.S. President (1900 - present) Figure 8 highlights that Trump and Biden have been responsible for the two largest budget deficits in the U.S. in the past 80 years. The U.S. debt balance is currently rising by approximately ~US$1 trillion every 100 days! Figure 9: U.S. interest rate payments As Figure 9 highlights, interest payments have increased exponentially and are set to nearly double relative to pre-COVID levels. At the current run-rate, interest payments are now larger than spending for national defence or Medicare, and about four times as much as the spend on education. Regardless of the outcome of the U.S. Presidential election in November, it is clear the U.S. has a mounting debt problem that will be difficult to resolve. While gold remains under-owned by many active managers, we believe it is a valuable hedge in mitigating against some of these key risk factors. Finally, from an M&A standpoint, our discussions with companies continued to highlight the challenges with major new projects, which are becoming far costlier to build and taking much longer, as companies navigate a myriad of regulatory, taxation and local community issues. Accordingly, we believe M&A in the resource sector will remain elevated as it remains significantly cheaper and lower risk to buy existing assets in production or close to production relative to undertaking greenfield developments. During the quarter, LSF was a beneficiary of some of this M&A activity, with Anglo American (OTCQX:AAUKF) receiving a takeover proposal from BHP. We exited the position post the strong rally in the share price. AGL Energy (OTCPK:AGLNF, Long +30%) shares performed strongly after upgrading FY24 earnings guidance ~6% above market expectations. Recent challenges in supply have led to volatility in wholesale pricing and a higher futures price. This provides strong support for earnings growth into FY26. There is a growing realisation that the energy transition is going to take longer to complete. AGL is well positioned to navigate this change, with its key baseload power assets in Victoria and New South Wales and its solid near-term cash generation that will enable the funding of transition-related capital expenditure. Hudbay Minerals (HBM, Long +31%) shares rallied over the quarter driven by rising copper and gold prices, as well as strong production results. The company's first quarter results showed higher gold production and robust operating performance at both its major assets, which exceeded consensus expectations. In addition, the company announced a ~US$400m equity raise to support balance sheet de-leveraging and fund its key growth projects. Hudbay is a mid-tier mining company primarily producing copper, alongside gold and zinc, with its key assets located in Canada and Peru. We are attracted to Hudbay due to our positive medium-term outlook for copper and the company's strong near-term free cash flow generation. This cash generation potential will allow the company to de-lever and recycle capital back into its highly prospective exploration program and major growth projects, most notably its Copper World project in Arizona. Newmont (NEM, Long +18%) shares outperformed as the company released its first quarter results where gold production exceeded consensus estimates. Newmont also sold a non-core gold asset for US$330m. This move is consistent with the company's strategy to focus on execution at its large, low-cost and high free cash flow generative assets, while divesting smaller operations to simplify the portfolio. We became shareholders of Newmont following the acquisition of Newcrest in October 2023. With the recent share price rally, we exited the position and rotated into other gold equities where we see greater near-term upside potential. Qantas (QABSY, Long +11%) shares gained over the quarter after outlining plans to improve its Loyalty offer to enable easier access for Frequent Flyer members to use their points. The revision to the Loyalty offer had a smaller impact on earnings than the market had expected and the company clearly articulated the strong medium-term benefits of investing in the program. We believe Qantas remains very well placed over the next few years, given it has Australia's best loyalty business (which is expected to double earnings over the next 5-7 years), a raft of brand new, more fuel-efficient aircraft to be delivered over the next few years along with Project Sunrise, which will enable direct flights from Melbourne/Sydney to London and New York from 2026. It also has sufficient balance sheet capacity to continue buying back shares and to recommence fully franked dividends next year. The new CEO, Vanessa Hudson, is rapidly and methodically addressing customer 'pain points', which should improve sentiment from both customers and potential investors. Qantas trades on a FY25 P/E of only ~6.3x, despite a dominant industry position, exposure to the structural tailwinds of Asian inbound tourism to Australia and a high growth, capital-light loyalty division, which remains incredibly underappreciated by the market. SK Hynix (Long +29%) shares performed strongly as the market better recognised the turnaround in its NAND memory storage business where spot prices have recovered strongly in 1H 2024 and demand for its AI datacentre product continues to remain strong. Micron, a competitor in the space, also reported strong operating results in June although tempered by low yields in high bandwidth memory (HBM) and higher expected capex. News flow around its only other major competitor, Samsung, continues to suggest that it will be delayed in its HBM qualification process with NVIDIA. This positions SK Hynix well to maintain its market leadership position in HBM with the company's capacity already sold out into 2025. Mineral Resources (OTCPK:MALRF, Long -24%) shares declined during the quarter due to softness in its key commodity end markets, most notably with lithium spodumene and iron ore prices down 16% and 7% in June, respectively. This more than offset some positive operational announcements from the company including the delivery of first ore from its Onslow Iron project ahead of schedule and the sale of a 49% interest in the Onslow haul road for A$1.3b. Once this transaction closes, the company will be well placed to drive future growth and shareholder returns. While the lithium market continues to be volatile, Mineral Resources remains on track to more than double production over the coming years to exceed 1,000kt of spodumene concentrate. We continue to believe that all key areas of Mineral Resources' core business (iron ore, lithium, mining services and gas) have favourable medium-term tailwinds and its valuation remains attractive, being underpinned by the value of the long life and infrastructure-like Mining Services division's earnings. NexGen (NXE, Long -10%) weakened as uranium prices fell -7% over the quarter. We continue to see the uranium market as having positive fundamental supply/demand tailwinds over the medium to long term. NexGen is preparing to develop the world's largest undeveloped uranium deposit, Arrow, located in Saskatchewan, Canada. This would be a major, new, strategic Western source to address the anticipated uranium market deficit. We anticipate that NexGen will have completed all regulatory requirements over the course of 2024, providing a clear pathway to full scale construction of the project. Arrow has the potential to generate more than C$2b of cash flow annually, once developed (2028) - a highly attractive proposition given NexGen's current market cap of ~C$5.5b. CRH (Long -13%) shares weakened over the second quarter after a strong first quarter performance. While there was no company specific news driving the weakness, market sentiment softened in the U.S. on adverse weather conditions and slowing economic data. Heavy rains have impacted building volumes over the quarter and are likely to result in weaker aggregates and road paving volumes. While this may impact near-term earnings, it is largely a deferral of demand rather than any structural weakness. CRH remains exposed to strong secular growth in the U.S. market from U.S. infrastructure spending which will underpin many years of robust demand. The Infrastructure Investment and Jobs Act ('IIJA'), Inflation Reduction Act ('IRA') and the Chips and Science Act will together add roughly US$2 trillion in investment to ageing U.S. infrastructure. We took advantage of the sell-off to add to our position, with CRH trading on only 12.5x FY25 consensus earnings and our view that the company can deliver consistent double-digit earnings growth over the medium term.

Aristotle Capital Small/Mid Cap Equity Q2 2024 Commentary

As we look out to the second half of 2024, we are cautiously constructive as encouraging signs of economic stability are balanced by now consensus expectations of a soft landing scenario and the pricing of risk. Markets Review SMID caps gave back some of their first quarter gains with the Russell 2500 index delivering a total return of -4.27%. Potential slowing in the US economy weighed on investor sentiment but lent credence to a soft landing scenario in 2024. The Consumer Price Index ('CPI') drifted lower during the quarter, coming in below expectations at 3.0% as inflationary pressures have eased. Employment was muddled during the period as non-farm payroll growth was positive but volatile while unemployment steadily climbed to 4.1%. Despite softening data, the Federal Reserve (Fed) held its ground on easing, at its June meeting, forecasting only one Fed funds rate cut in 2024, down from 3 cuts from its March meeting. The U.S. Treasury yield curve steepened with the yield on the 10-year note rising 16 basis points ('bps') to end June at 4.36%. Stylistically, growth stocks outperformed their value counterparts during the quarter as evidenced by the Russell 2500 Growth Index returning -4.22% compared to -4.31% for the Russell 2500 Value Index. Two of the largest names in the growth index for the first quarter, Super Micro (SMCI) and MicroStrategy (MSTR), were the worst performers in the second quarter. Whether the underperformance was a function of decreasing AI enthusiasm or selling in advance of the two companies graduating to the larger Russell 1000 Index, it's fair to say that the concentration and performance impact from both companies will be discussed by active SMID cap managers and academics for years to come. Pockets of exuberance can still be seen in the SMID cap universe as noted by the fact that Carvana (CVNA), a volatile used car selling platform that had completed a distressed debt exchange in the fall of 2023, was a top contributor in the Russell 2500 Value and Growth indices. At the sector level, only one of the eleven sectors in the Russell 2500 Index recorded positive returns during the second quarter, led by the Utilities (+6.17%), Consumer Staples (-1.41%), and Real Estate (-1.43%) sectors. Conversely, Consumer Discretionary (-7.18%), Industrials (-6.53%), and Materials (-6.50%) all lagged. Looking at market factors, profitable companies outperformed loss makers for the third time in the past four quarters. Sources: CAPS Composite Hub, Russell InvestmentsPast performance is not indicative of future results. Returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. Net returns are presented net of actual investment advisory fees and after the deduction of all trading expenses. Aristotle Small Cap Equity Composite returns are preliminary pending final account reconciliation. Please see important disclosures at the end of this document. Click to enlarge Performance Review For the second quarter of 2024, the Aristotle Small/Mid Cap Equity Composite generated a total return of -1.83 % net of fees (-1.69 % gross of fees), outperforming the -4.27% total return of the Russell 2500 Index. Outperformance was primarily driven by security selection while allocation effects also contributed. Overall, security selection was strongest in the Industrials, Financials, and Information Technology sectors and weakest in Consumer Discretionary, Health Care, and Real Estate. From an allocation perspective, the portfolio benefited from an underweight in Consumer Discretionary and an overweight in Information Technology, however, this was partially offset by an underweight in Real Estate and an overweight in Industrials. Relative Contributors Relative Detractors Dycom Industries (DY) Carter's (CRI) MACOM Technology Solutions (MTSI) Charles River Laboratories (CRL) Baldwin Insurance Group (BWIN) Supernus Pharmaceuticals (SUPN) Merit Medical Systems (MMSI) Acadia Healthcare (ACHC) ACI Worldwide (ACIW) ASGN Click to enlarge Contributors Dycom Industries (DY), a provider of engineering and construction services to the telecommunications and cable television industries, benefitted from continued growth in its core business, funding tailwinds, and expanding margins as demand for wireline services continues to grow. We maintain a position as we believe the company remains well positioned for longer term growth alongside secular trends for expanding fiber deployments to support faster broadband connectivity speeds and opportunities to deploy fiber to rural or underserved areas across the country. MACOM Technology Solutions (MTSI), a designer and manufacturer of high-performance semiconductor products, appreciated amid strength within its Defense and Telecom segments. We maintain our position, as we believe the company's meaningful exposure to growing demand from Data Center and 5G end market applications along with the integration of recent acquisitions should drive additional shareholder value in periods to come. Detractors Carter's (CRI), a leading marketer of baby and young children's apparel in North America, declined amid a cautious consumer spending environment and weak direct-to-consumer trends for the business during the quarter. We maintain our position as we believe the company has a strong brand in a stable category and that store rationalization efforts and an improving demographic backdrop can drive a sales recovery in the business in periods to come. Charles River Laboratories (CRL), a clinical testing, research, and manufacturing provider for the pharmaceuticals and biotechnology industry, declined despite beating fiscal first-quarter earnings as cautious client spending weighed on the revenue growth and the near-term outlook. We maintain our position as we believe the company is well positioned to benefit from the established trend of outsourcing drug discovery and early-stage development functions. Recent Portfolio Activity Buys/Acquisitions Sells/Liquidations Chart Industries (GTLS) AZZ Littelfuse (LFUS) Newell Brands (NWL) PowerSchool (pwsc) Click to enlarge Buys/Acquisitions Chart Industries (GTLS), an industrial equipment manufacturer that provides cryogenic equipment for storage, distribution and other processes within the industrial gas and LNG, hydrogen, helium, carbon capture and water treatment industries was added to the portfolio. Strong forward demand for LNG and accelerating hydrogen opportunities coupled with company-specific improvement initiatives should benefit the company moving forward. Littelfuse (LFUS), a designer and manufacturer of circuit protection, power control, and sensing products for the automotive, industrial, medical, and consumer end markets, was added to the portfolio. We believe the company's dominant position in circuit protection and growing presence in automotive sensors and power semiconductors/components should benefit from ongoing efforts to solve power control and connection problems between the digital and physical worlds. Sells/Liquidations AZZ (AZZ), a provider of hot dip galvanizing and coil coating solutions, was sold during the quarter as the company's stock price appreciated significantly since our initial purchase causing the reward to risk ratio to compress. Newell Brands (NWL), a global consumer goods company was sold due to deteriorating fundamentals exacerbated by inflationary pressures creating a leveraged balance sheet that would take too much time to repair. PowerSchool (PWSC), a leading provider of cloud-based software for K-12 education in North America, was removed from the portfolio following the announcement the company was being taken private by investment firm Bain Capital. Outlook We continue to remain optimistic about the long-term potential for the SMID-cap segment of the U.S. market as valuations and potential tailwinds bode well for the asset class. As we look out to the second half of 2024, we are cautiously constructive as encouraging signs of economic stability are balanced by now consensus expectations of a soft landing scenario and the pricing of risk. So, despite greater clarity over the Fed's path from here, there remains a long list of items creating uncertainty that could lead to greater volatility in 2024 including, but not limited to, signs that inflationary pressures have not yet fully dissipated, geopolitical tensions, U.S. equity index concentration issues, ongoing commercial real estate and regional banking concerns, and the looming presidential election. We are well aware that most of these issues are well known, but the timing and magnitude of the impact of any and all of these issues remains unpredictable. Therefore, as we always have, we will continue to avoid the temptation to forecast their outcome in favor of assessing the potential impact from a range of potential outcomes within our company‐specific, bottom-up analysis, and quality focus. From an asset class perspective, valuations of SMID versus large continue to remain near multi-decade lows, which we believe suggests a more favorable setup for SMID caps relative to large caps in the periods to come (16.3x P/E for the Russell 2500 Index vs. 24.8x P/E for the Russell 1000 Index). Against a backdrop of moderating inflation, normalized interest rates, and a still growing U.S. economy, it looks to us that small and mid caps stretch of underperformance has the potential to end. In the event that the economy continues to stabilize, our view is that valuations are likely to rise for those businesses that have largely sat out the mega cap performance regime. It also helps that the well-noted concentration in large caps is reaching 50-year highs and SMID cap valuation relative to large cap is at multi-decade lows, therefore any fundamentally driven repositioning is likely to benefit SMID caps more than larger companies, in our view. Lastly, we believe SMID caps remain better positioned to benefit from the reshoring of U.S. manufacturing, a pickup in M&A activity, the CHIPS Act, and several infrastructure projects on the horizon. Positioning Our current positioning is a function of our bottom-up security selection process and our ability to identify what we view as attractive investment candidates, regardless of economic sector definitions. Overweights in Industrials and Information Technology are mostly a function of our underlying company specific views rather than any top-down predictions for each sector. Conversely, we continue to be underweight in Consumer Discretionary, as we have been unable to identify what we consider to be compelling long-term opportunities that fit our discipline given the rising risk profiles of many retail businesses and a potential deceleration in goods spending following a period of strength. We also continue to be underweight in Real Estate as a result of structural challenges for various end markets within the sector. Given our focus on long-term business fundamentals, patient investment approach and low portfolio turnover, the strategy's sector positioning generally does not change significantly from quarter to quarter. However, we may take advantage of periods of volatility by adding selectively to certain companies when appropriate. Disclosures The opinions expressed herein are those of Aristotle Capital Boston, LLC (Aristotle Boston) and are subject to change without notice. Past performance is not indicative of future results. The information provided in this report should not be considered financial advice or a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account's portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account's entire portfolio and, in the aggregate, may represent only a small percentage of an account's portfolio holdings. The performance attribution presented is of a representative account from Aristotle Boston's Small/Mid Cap Equity Composite. The representative account is a discretionary client account which was chosen to most closely reflect the investment style of the strategy. The criteria used for representative account selection is based on the account's period of time under management and its similarity of holdings in relation to the strategy. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions Aristotle Boston makes in the future will be profitable or equal the performance of the securities discussed herein. Aristotle Boston reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. Recommendations made in the last 12 months are available upon request. Returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. Net returns are presented net of actual investment advisory fees and after the deduction of all trading expenses. As of December 31, 2014, there were no non-fee-paying accounts in the Composite. All investments carry a certain degree of risk, including the possible loss of principal. Investments are also subject to political, market, currency and regulatory risks or economic developments. International investments involve special risks that may in particular cause a loss in principal, including currency fluctuation, lower liquidity, different accounting methods and economic and political systems, and higher transaction costs. These risks typically are greater in emerging markets. Securities of small‐ and medium‐sized companies tend to have a shorter history of operations, be more volatile and less liquid. Value stocks can perform differently from the market as a whole and other types of stocks. The material is provided for informational and/or educational purposes only and is not intended to be and should not be construed as investment, legal or tax advice and/or a legal opinion. Investors should consult their financial and tax adviser before making investments. The opinions referenced are as of the date of publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Aristotle Capital Boston, LLC is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Aristotle Boston, including our investment strategies, fees and objectives, can be found in our Form ADV Part 2, which is available upon request. ACB-2407-13 Performance Disclosures Sources: CAPS Composite Hub, Russell Investments Composite returns for periods ended June 30, 2024, are preliminary pending final account reconciliation. *The Aristotle Small/Mid Cap Equity Composite has an inception date of January 1, 2008 at a predecessor firm. During this time, Jack McPherson and Dave Adams had primary responsibility for managing the strategy. Performance starting January 1, 2015 was achieved at Aristotle Boston. As of December 31, 2014, there were no non-fee-paying accounts in the Composite Past performance is not indicative of future results. Performance results for periods greater than one year have been annualized. Returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. Net returns are presented net of actual investment advisory fees and after the deduction of all trading expenses. Please see important disclosures enclosed within this document. Index Disclosures The Russell 2500 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2500 Growth® Index measures the performance of the small/mid cap companies located in the United States that also exhibit a growth probability. The Russell 2500 Value® Index measures the performance of the small/mid cap companies located in the United States that also exhibit a value probability. The Russell 1000 Index is a subset of the Russell 3000® Index, representing approximately 90% of the total market capitalization of that index. It includes approximately 1,000 of the largest securities based on a combination of their market capitalization and current index membership. The volatility (beta) of the composite may be greater or less than the benchmarks. It is not possible to invest directly in these indices. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Click to enlarge Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. Aristotle Capital Management is an independent/employee-owned investment management organization that specializes in equity and fixed income portfolio management for institutional and advisory clients worldwide.