ClearBridge Strategies: Q2 2024 Market Insights Across Multiple Sectors

ClearBridge Mid Cap Growth Strategy Q2 2024 Commentary

Rather than chase near-term winners, we continue to follow our philosophy of investing in companies with great business models, strong growth prospects and stellar balance sheets. By Brian Angerame | Jeffrey Bailin, CFA | Aram Green | Matthew Lilling, CFA Deceleration Creates Headwinds for Growth - 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 the benchmark Russell Midcap Growth Index returning -3.21%, slightly ahead of the Russell Midcap and Russell Mid Cap Value Indexes, which returned -3.35% and -3.40%, respectively. From a sector standpoint, utilities (+11.25%) generated the best performance in the benchmark, followed by the communication services (+10.83%), energy (+4.98%) and information technology (IT, +0.89%). The financials (-2.61%) sector posted negative performance, but still outperformed the broader benchmark. Meanwhile, consumer staples (-10.61%) was the biggest detractor, followed by materials (-10.23%), health care (-8.85%), industrials (-5.45%), real estate (-4.88%) and consumer discretionary (-4.25%), all of which underperformed the overall Russell Midcap Growth Index. 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 nonresidential 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. Additionally, mid cap growth stocks were not immune to the broader market trends toward consolidation. In fact, the rebalancing of the benchmark Russell Midcap Growth Index has resulted in its greatest concentration in recent memory, with historically oversize exposure to IT hardware companies, the perceived beneficiaries of buildouts in data centers and AI. While we have some exposure to these broader trends though companies like Monolithic Power Systems, which makes semiconductor-based power electronics, the uncertainty surrounding the demand and timeframe for AI means balancing short-term performance with longer-term risk management concerns. However, it is not all doom and gloom for mid growth stocks, 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). "We believe that these companies can compound through headwinds to become bigger and better on the other side." Stock selection in the industrials sector was the leading detractor from relative performance, as the prospect of a higher-for-longer interest rates environment weighed on investors' outlooks for industrial and nonresidential construction. This included our holding in WillScot Mobile Mini (WSC), the North American leader in turnkey modular space and portable storage solutions. The company's stock price pulled back amid a decline in nonresidential construction starts and a less optimistic outlook for short-cycle industrials. However, WillScot continues to have high cash flow yields and a strong order backlog, which should help the company to weather near-term headwinds. Stock selection in IT also weighed on 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. Our largest detractor in the sector was Workday, which provides software for enterprise functions including human resources, talent management, finance and resource planning. As spending-conscious clients have broadly reprioritized spending away from back-office software, Workday (WDAY) issued a more conservative full-year revenue guidance to the disappointment of investors. The Strategy's relative performance benefited from positive stock selection in the consumer staples sector, primarily driven by our top-performing stock, 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 be a long-term compounder for the portfolio. Portfolio Positioning Our largest new position during the quarter was Clean Harbors (CLH) in the industrials sector. The company provides environmental and industrial services which include the transportation, treatment and disposal of hazardous and non-hazardous waste, resource recovery, wastewater treatment, landfill disposal and waste incineration. Clean Harbors' unique assets, such as landfills and incinerators, leave it well positioned as a leader in an industry categorized by very few players and a substantial regulatory moat. The company's high value, high price product mix has resulted in strong fundamentals, while long-term trends such as nearshoring and the increasing regulation around the PFAS chemical creates a long growth runway for the company. Finally, we believe Clean Harbors stands to gain even greater market share after the recent acquisition of a competitor. Rubrik, meanwhile, is a next-generation data storage, backup and recovery provider showing 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 exited our position in health care company Stevanato (STVN), which makes products and processes to provide integrated solutions for biopharma and healthcare. The company has struggled with broader industry headwinds, including a delayed destocking and difficulty navigating a recovery from the COVID-19 pandemic. Our conviction in the company's management team was further weakened after they announced an additional equity offering and subsequently reduction of Stevanato's full-year guidance. Ultimately, we elected to exit the position in favor of other opportunities with greater risk/reward profiles. Outlook Despite the challenges of the second quarter, mid cap growth stocks continue to outpace both the broader mid cap market and mid cap value stocks on a year-to-date basis. 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 Growth Strategy underperformed its Russell Midcap Growth Index benchmark during the second quarter. On an absolute basis, the Strategy had gains across three of the 10 sectors in which it was invested during the quarter (out of 11 sectors total). The leading contributor was the communication services sector, while the industrials and health care sectors were the largest detractors. On a relative basis, overall stock selection detracted from performance. Specifically, stock selection in industrials, real estate and IT sectors weighed on performance. Conversely, stock selection in the health care and consumer staples sectors benefited performance. On an individual stock basis, the biggest contributors to absolute returns in the quarter were Monolithic Power Systems (MPWR), Pinterest (PINS), Casey's General Stores, Palo Alto Networks (PANW) and AppLovin (APP). The largest detractors from absolute returns were Five Below (FIVE), CoStar (CSGP), WillScot Mobile Mini, Charles River Laboratories (CRL) and Stevanato (STVN). In addition to the transactions mentioned above, we initiated new positions in Celsius (CELH) in the consumer staples sector, Chewy (CHWY) and Deckers Outdoor (DECK) in the consumer discretionary sector, Raymond James (RJF) in the financials sector, Vertiv (VRT) in the industrials sector and Vistra (VST) in the utilities sector. We exited positions in ServiceNow (NOW) in the IT sector, Americold Realty Trust (COLD) in the real estate sector, Etsy (ETSY) in the consumer discretionary sector, Spotify Technology (SPOT) in the communication services sectorand Shockwave Medical (SWAV) in the health care sector. During the period, portfolio holding Pioneer Natural Resources (PXD), in the energy sector, was acquired by Exxon Mobil (XOM) whose shares we did not retain. Brian Angerame, Managing Director, Portfolio Manager Jeffrey Bailin, CFA, Director, Portfolio Manager Aram Green, 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.

ClearBridge Small Cap Value Strategy Q2 2024 Commentary

Our investment process takes a holistic approach to evaluating what makes a 'good' investment, including considering the risks to shareholders from rising CEO compensation. By Albert Grosman & Brian Lund, CFA Small Value Falls Amid Concentrated Leadership - Market Overview The second quarter proved exceptionally challenging to navigate for small cap stocks, as investors continued to narrow their focus on a small handful of AI beneficiaries and bitcoin plays, while economic deceleration and a higher-for-longer interest rate outlook weighed on the rest of the market. The result was a broad retreat for small value, with all 11 Russell 2000 Value Index sectors posting negative returns and a -3.64% decline for the overall index. Small cap growth and core indexes fared only marginally better, with the Russell 2000 Growth Index returning -2.92% and the core Russell 2000 Index returning -3.28%. Portfolio Performance The ClearBridge Small Cap Value Strategy underperformed its benchmark in the second quarter, as detractors in the materials and industrials sectors overcame positive contributors from our health care holdings. Stock selection in the materials sector weighed on relative performance. Eagle Materials (EXP), last quarter's top-performing holding, pulled back as macro uncertainty and higher-for-longer interest rates resulted in weaker industrial and construction outlooks. However, we continue to have high conviction that the company's strong pricing power in its cement business and cost advantages versus its peers in its wallboard business should allow Eagle to continue to maintain attractive returns on capital. Stock selection in the industrials sector was a significant detractor from performance, as many of our holdings felt the impact of economic deceleration. For example, Forward Air (FWRD), an asset-light freight and logistics company, faced pressure from weak end markets, resulting in excess carrier capacity and pricing pressures. Additionally, the company has struggled to unlock synergies from its acquisition of Omni Logistics in the first quarter, further fueling concerns about increased leverage. Given the lack of insight into the company's general strategic direction under its new CEO, we ultimately decided to sell the position. Health care results lifted relative performance during the period and included our top two individual performers in Lantheus (LNTH) and newer portfolio addition Corcept Therapeutics (CORT). Lantheus, which makes diagnostic and therapeutic products that help clinicians diagnose and treat heart, cancer and other diseases, saw its share price rise on strong first-quarter results. Corcept, which was added last quarter, announced that it had successfully reached its main goal in its Phase 3 trial for its treatment for patients with Cushing's syndrome. We believe the new drug's efficacy and safety significantly increases its likelihood of approval and offers an attractive growth runway via possible extension into other indications. Portfolio Positioning New positions in the quarter were from a variety of sectors. Criteo (CRTO), in the communication services sector, provides digital advertising technologies that help drive clients' e-commerce businesses. While the company was previously reliant on third-party cookies to help optimize its products, management has spent the past five years pivoting away from this technology and focusing on building a leading presence in the burgeoning retail media space. We believe this transformation has reached a tipping point, and that the inherent growth opportunities in this new end market represent a higher growth rate than is currently reflected in the company's valuation. We also added a new position in SkyWest (SKYW), a regional airline operator. The company reported strong quarterly earnings as its pilot attrition declines and fleet utilization improves. We believe that SkyWest continues to find opportunities to deploy capital in a value-accretive manner, acquiring more planes under long-term contracts. We think earnings should hold up in a potential recession and perhaps even improve further if major airlines reduce capacity and more pilots become available for SkyWest. Meanwhile, we exited our position in Unum, in the financials sector, which provides financials insurance products including long- and short-term disability, group life and accidental death insurance as well as group pension products. With the company's market cap reaching the upper bounds of the small cap category and its share price nearing our target valuation, we elected to exit the position in favor of other opportunities with greater return potential. The Rising Risk from CEO Compensation Given the tumultuous and sentiment-driven market conditions, it can be easy to overlook the advantages that a rigorous, fundamental investment philosophy offers investors. There are many criteria that we look at in assessing whether a company is a "good" investment - some of which are more apparent than others. While things like cash flow generation, the strength of a company's balance sheet and its long-term strategy are obvious considerations, one of the most important - but less talked about - considerations is how these companies treat their shareholders. While the rise of environment, social and governance (ESG) criteria has helped cast a light on how companies are tackling the "E" through things like reduced emissions, and the "S" through things like providing workers living wages, less attention has been applied to the "G." Meanwhile, there has been a rapid and escalating rise in CEO compensation. "We always take stock-based compensation into account when evaluating a company." A recent report from Equilar estimates that the spread in compensation between the CEO and the median worker at the largest 100 companies in America reached 312:1 in 2023, with the top 100 CEOs realizing a 20% increase in median total compensation actually paid.1 Much of that comes from stock awards, which many companies ignore when reporting adjusted earnings and many investors ignore when calculating valuations. However, those awards are not free. Stock-based compensation decreases the per-share value of future cash flows and represents a transfer of future value creation from the existing shareholders to top management. Ultimately, the better the company does, the more value management gets over other shareholders. And it is management: while employees often get grants, the vast majority go to the bosses. How much value are we talking about? Public companies gave $700 billion in stock-based compensation from 2005 to 2014. From 2014 to 2023, that figure rose to $1.6 trillion and shows no sign of slowing (Exhibit 1). The strength in the stock market adds significantly to that enormous transfer of wealth, which one could argue is good for shareholders. But is it causal? That is, did the stock market do well because CEOs got large stock grants? Are the CEOs just the lucky recipients of a windfall when the market goes up and their employees perform well? Or do they require huge grants to do their jobs that no one else could possibly do as effectively? Exhibit 1: Stock-Based Compensation Accelerates Tesla, and most of its shareholders, certainly think the latter is true. In 2018, Tesla's board of directors crafted a pay package for CEO Elon Musk that would award him 12 tranches of 10-year, fixed-price options on 1% of company stock for every $50 billion in market cap the stock added. In total, the options would be for 304 million shares of the company at $23.34 a share. He would receive no other compensation, until or unless the board decided otherwise. Shareholders approved that pay package, and the stock added all that market cap and more, giving Musk the right to buy 10% of the company for $50 billion less than it was worth, adding to his existing 13% stake. Minority shareholders sued, and a court sided with them and expunged the package in January 2024. "The process leading to the approval of Musk's compensation plan was deeply flawed," ruled Judge Kathaleen McCormik of the Delaware Court of Chancery as part of a 200-page decision. It seemed like a long-awaited check on excessive compensation to one individual for the achievements of an entire company. But no. Tesla (TSLA) responded by proposing that they reincorporate the company in Texas to avoid Delaware courts and reinstate the pay package as previously outlined. Proxy advisory firms recommended shareholders reject the deal, noting that owning 13% of the company should incentivize Musk sufficiently. However, approximately 70% of shareholders, including some large index fund managers, voted to reinstate the package, this coming merely one week after reports surfaced that Musk had diverted precious Nvidia (NVDA) chips away from Tesla toward other companies he controls. It also came after significant production issues at Tesla, such as multiple recalls on the new Cybertruck and fatalities from Autopilot. The most egregious issue here is the lack of concern for shareholders and proper governance that large index fund managers exhibited. They allowed a CEO to overstep shareholders in their funds, despite concerns from proxy advisors and overt acts to disadvantage Tesla in favor of other companies he controls. Is Musk - or any CEO - really worth this level of deference and compensation? Is Tesla's success really so reliant on one person? More than one hero CEO has subsequently been shown to be just in the right place at the right time. With the economy seemingly slowing and extreme concentration in the market, we believe that the risks posed by this growing, but largely unaddressed, threat requires even greater attention and understanding than are outside the purview of passive investors or large index managers. In managing our strategies, we always take stock-based compensation into account when evaluating the governance of a company, as well as the amount going to top executives and the independence of the board. Outlook The small cap Russell 2000 Index has underperformed the large cap Russell 1000 Index by more than 10 percentage points annually since the end of 2020. Within small cap, growth has outperformed value by almost 8 percentage points annually over that period. Those trends have been in place since the end of 2016. With large cap valuation spreads reaching record levels, we think the odds of small cap and small cap value outperformance over the next few years are high. To that end, we continue to apply a disciplined process to stock selection and refine our positioning in our goal to deliver attractive, long-term returns over a full market cycle. Portfolio Highlights The ClearBridge Small Cap Value Strategy underperformed its Russell 2000 Value Index benchmark during the second quarter. On an absolute basis, the Strategy had losses across nine of the 11 sectors in which it was invested during the quarter. The leading contributor was the health care sector, while the industrials sector was the largest detractor. On a relative basis, overall stock selection detracted from performance but was mildly offset by positive contributions from sector allocation effects. Specifically, stock selection in the materials, industrials, energy and consumer discretionary sectors weighed on performance. Conversely, stock selection and an underweight allocation to the health care sector proved beneficial. On an individual stock basis, the biggest contributors to absolute returns in the quarter were Lantheus, Corcept Therapeutics, Primoris Services (PRIM), Murphy USA (MUSA) and Anterix (ATEX). The largest detractors were Olin, Bloomin' Brands (BLMN), Wabash National (WNC), Eagle Materials (EXP) and Hillman Solutions (HLMN). In addition to the transactions listed above, we initiated new positions in Allegiant Travel (ALGT) in the industrials sector, Scholar Rock (SRRK) and Acadia Healthcare (ACHC) in the health care sector, MP Materials (MP) in the materials sector and Abacus Life (ABL) in the financials sector. We exited positions in QuidelOrtho (QDEL) in the health care sector, Veritex (VBTX), Third Coast Bancshares (TCBX) and NCR Atleos (NATL) in the financials sector, NCR Voyix (VYX) in the IT sector, Macy's (M) in the consumer discretionary sector and Alaska Air (ALK) in the industrials sector. Albert Grosman, Managing Director, Portfolio Manager Brian Lund, CFA, Managing Director, Portfolio Manager Footnote 1 We always take stock-based compensation into account when evaluating a company. 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 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 Global Infrastructure Value Strategy Q2 2024 Commentary

With increased confidence that we are at the end of the rate hiking cycle and now looking toward the start of the rate-cutting cycle, we believe this could be the start of the turn for many of our long-duration assets such as towers and renewables. By Charles Hamieh, Shane Hurst, Nick Langley & Simon Ong Rate Pivot Poised to Help Towers and Renewables Market Overview Infrastructure and global equities rose in the second quarter, with infrastructure trailing global equities modestly as strength in defensive sectors faded late in the quarter, despite a moderation in bond yields. Overall, as investors began to appreciate the growing power demand from data centers supporting AI, this was positive for electric utilities. Energy infrastructure also benefited from an improving natural gas price outlook and growing acknowledgment that midstream infrastructure plays a key role to back up renewable power as AI demand grows. Airports were weaker, by contrast, amid lower summer traffic expectations for some European airports, while a mix of coal haulage, fuel headwinds and a loose truck market placing pressure on tariff increases for the rails weighed on that sector. By region the U.S. and Canada delivered the strongest performance, with returns centered around the abovementioned drivers for electric utilities and energy infrastructure, while concerns over possible government intervention in Brazil weighed on performance in Latin America. Japan's rail traffic recovery plateaued and looked to settle on a new normal, meanwhile, dragging down Asia Pacific Developed. We used the opportunity to crystallize some gains and exited our positions in Japanese rail operators Central Japan Railway and East Japan Railway. In addition to airports weighing on Western Europe, U.K. water lagged largely due to political turmoil in the U.K., with a snap election and a water regulator ruling set for early July. Listed water companies there have also been unduly discounted due to trouble at an unlisted peer. Near-term political volatility could represent a buying opportunity for listed U.K. water utilities, however. Their spending on improving environmental impacts adds to the bottom line, and their investments can earn attractive allowed returns, which translates to better earnings and dividends. The listed water infrastructure companies we like are leaders in environmental responsibility with strong track records and targets for environmental performance that we believe the regulator and investors will reward over time. Electric utilities were the top contributors for the quarter, with U.S. utilities NextEra Energy (NEE) and Public Services Enterprise Group (PEG) the lead performers. NextEra Energy is an integrated utility business with a regulated utility operating in Florida and is the largest wind business in the U.S. NextEra's regulated business, including Florida Power & Light, serves nine million people in Florida. Shares benefited from a positive readthrough to power and renewables demand as a result of data center growth from AI. Public Services Enterprise Group operates the largest utility business (~90% of earnings) in New Jersey, along with a generation business (~10% of earnings) comprising nuclear assets. PEG's share price benefited from the company's potential to sign a data center deal where nuclear will provide power at a premium price. U.S. rail operators CSX and Norfolk Southern (NSC) were the largest detractors. CSX operates the second-largest listed U.S.-centric railroad in terms of market cap operating in the East Coast. The company owns over 20,000 miles of track and operates across 23 states. Norfolk Southern is one of the five leading North American rail companies, engaged in the transportation of rail freight in the Southeast, East and Midwest U.S. and, via interchange with other rail carriers, to and from the rest of the U.S. and Canada. The U.S. railroad sector was weak in the quarter after rail companies talked down second-quarter results during conference season. This was on the back of a loose truck market, which has placed pressure on tariff increases for the railroads. While the pace of recovery in the U.S. freight market has been slower than our original expectations, we still expect an improvement in the operating environment in the back half of 2024 and early 2025, as excess trucking transportation capacity continues to rationalize in the softer pricing environment. We expect transportation supply and freight demand rebalancing to bode well for U.S. rails. Outlook Whilst the past 12-18 months have been challenging for infrastructure due to the sharp rise in bond yields and bond volatility, in addition to the narrow market breadth, we think the macro headwinds are starting to become tailwinds. Historically, we have seen infrastructure outperform global equities over several time periods as interest rates have peaked (Exhibit 1), something to keep in mind as inflation indicators slow and allow major central banks to move toward easing. We also believe bond yields need not roll over for investors to benefit from infrastructure returns, but that merely reduced volatility of bond yields could be supportive of valuations, something we have seen in the past. Exhibit 1: Infrastructure Performance Following Last Fed Rate Hikes As of March 31, 2024. Source: ClearBridge, FactSet, Bloomberg. The RARE 200 is the combination of the investment universes (updated on a quarterly basis) for ClearBridge Investments' infrastructure strategies. Constituents as of March 31, 2024, measuring total return in local currency. Global equities: MSCI AC World Index, gross returns in local currency. Performance reflective of the six-month, one-year, three-year and five-year period following the last Fed rate hike prior to cutting cycles in 1989, 1995, 2001, 2007 and 2019. Click to enlarge We remain generally balanced between more defensive regulated utilities and more GDP-sensitive infrastructure names. With increased confidence by market participants that we are at the end of the rate hiking cycle and now looking toward the start of the rate-cutting cycle, we believe this could be the start of the turn for many of our long-duration assets such as towers and renewables. Notwithstanding near-term supply-side constraints around labor and aircraft deliveries, we are positive on airports, where valuations are attractive. Utilities should continue to benefit from themes of electrification, renewables growth and more recently higher electricity demand from data centers, and we remain constructive on the sector, given reduced valuations. Portfolio Highlights We believe an absolute return, inflation-linked benchmark is the most appropriate primary measure against which to evaluate the long-term performance of our infrastructure strategies. The approach ensures the focus of portfolio construction remains on delivering consistent absolute real returns over the long term. On an absolute basis, the Strategy saw positive contributions from two of the eight sectors in which it was invested in the second quarter, with the electric and energy infrastructure sectors the main positive contributors and rail, airports and communications the main detractors. Relative to the S&P Global Infrastructure Index and on a U.S. dollar basis, the Strategy underperformed in the second quarter, driven primarily by stock selection in the rails sector. Stock selection in the renewables sector also detracted, although most of this was offset by an overweight allocation to that sector. Stock selection in the electric and water sectors, a communications overweight and an underweight to the ports sector also detracted, while an airports underweight contributed positively. On an individual stock basis, the top contributors to absolute returns in the quarter were NextEra Energy, Public Service Enterprise Group, Cheniere Energy (LNG), Pembina Pipeline (PBA) and Enel (OTCPK:ENLAY). The main detractors were CSX, Norfolk Southern, Aeroports De Paris (OTCPK:AEOXF), Union Pacific (UNP) and Centrais Eletricas Brasileiras (EBR). Charles Hamieh, Managing Director, Portfolio Manager Shane Hurst, Managing Director, Portfolio Manager Nick Langley, Managing Director, Portfolio Manager Simon Ong, 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. All returns are in local currency unless otherwise indicated. Performance source: Internal. Benchmark source: Morgan Stanley Capital International. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information. Performance is preliminary and subject to change. Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI's express written consent. Further distribution is prohibited. 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 All Cap Value Strategy Q2 2024 Commentary

By Reed Cassady, CFA, Albert Grosman & Sam Peters, CFA Although extreme market concentration and lack of breadth in broad U.S. equity indexes, driven by the ascendance of mega cap tech levered to AI, is proving frustrating for diversified investors, it is also creating immense opportunities for those that remain true to an economically grounded valuation process - like we do. On the surface, broad equity indexes seem to suggest that everything is great. The S&P 500 Index (SP500, SPX) , for instance, closed the second quarter at highs, up nearly 25% on a total return basis over the prior year and a respectable +33% over the trailing three years. However, these returns were far from fairly distributed (Exhibit 1). The S&P 500 Equal Weighted Index returned just +15% over that period, or below 5% annually - less than what you can currently earn in a money market mutual fund - while the small cap S&P 600 Index (SP600) was actually down. Breadth - a measure of how many stocks are performing well - is categorically abysmal. The S&P 500 is on pace this year for the lowest percentage of constituents outperforming in at least 50 years, yet the market continues to make new highs (Exhibit 2). AI companies are truly sucking all the air out of the room, starving the rest of the market and presenting the question as to how and when this reverses. Exhibit 1: Positive Performance Masks Concentrated Returns Similar to the Internet, it's likely that AI has the potential to change the way we all work and live. However, despite what the market is telling investors, it is not as obvious where the value from AI's proliferation will ultimately accrue. Will the mega cap tech incumbents continue to extract most of the rents - charging so much for cloud computing, access to AI models and tools and so forth - that the benefits of the coming efficiency gains flow only to them? This seems to be conclusion the market is currently coming to, as investors cheer ramping capex plans and the resulting collapse in free cash flow ('FCF') generation at the so-called hyperscalers, as the returns are presumed to be strong and deliver better earnings and FCF growth in the medium and long term. However, the long history of capitalism shows large capital cycles like this one usually lead to excess capacity, commoditization and, ultimately, sub-par returns on invested capital. If these mega cap companies are so immensely profitable and have such a large incumbency advantage, and AI proves winner-take-all to the company or companies who reach the promised land first, the market would be right on their meaningful upward rerating. However, just as plausible is that some combination of an overbuild, AI model commoditization and lack of near- to-medium-term use cases (and, subsequently, revenue generation) results in a lack of return on capital. If so, capex plans will get reset, earnings estimates will collapse, and GPU-maker Nvidia (NVDA) will materially reset lower as demand for its leading-edge chips evaporates. "Ultimately, we believe the carnage in small and mid cap stocks only plays to our advantage." Nevertheless, the stakes around making a call on AI cannot be understated. In the last three years, the mega cap AI "winners," which we would argue are the Magnificent Seven minus Apple (AAPL) ("Mag6"), have gone from 20% to 27% of the S&P 500. This is an immense amount of market cap; estimated at $3.4 trillion based on current market values, it is encroaching on the $3.8 trillion market cap of the S&P 400 Midcap and S&P 600 Small Cap indexes, combined. Imagine the relative performance of those smaller stocks if even some of that value were to flow back to other parts of the market. This potential energy is massive and, in our view, is one of the most important issues in the market today given the potentially huge returns available. While much has been made of the better fundamental profile of the AI winner bucket, a clear-eyed look at the actual data paints a less optimistic picture. Based on current analyst consensus, the 2024 FCF of perceived AI mega cap winners have fallen - materially - over the period even as this group has massively outperformed the market (Exhibit 3). This decline is partially due to the huge capex bet these companies are making, which will need a very good return to keep their fundamental, as well as stock performance, momentum going. Given strong stock performance in the face of declining FCF, multiples for this cohort have exploded higher, currently trading well in excess of 40x. This holds true for the group both including and excluding Tesla (TSLA) and Nvidia. Expectations have meaningfully increased for these companies, and only time will tell whether returns on invested capital are sufficient to keep the party going. And, while the market has taken a decidedly optimistic view, base rates and an assessment of competitive strategy argue for a more balanced one. While it's way too early to call long-term winners and losers in AI development, there are reasons to believe that the hyperscalers will continue to ramp capex over the next few years. First, it will take time for use cases to emerge downstream of the infrastructure that they're currently building, and the strategic urgency of developing models and bringing compute capacity online only all argues for a continuing upward trajectory on capex. Second, these companies are in a race to develop so-called artificial general intelligence (AGI), something that may require not the building of a mountain of compute power, but rather an entire mountain range. In some ways, the market has returned to a gold rush mentality. However, rather than go all in on the prospectors, we are more inclined to own the companies providing metaphorical "picks and shovels" to these risk takers. These include some of our top performers in the second quarter, including merchant power producers Vistra (VST) and Constellation Energy (CEG) in the utilities sector and memory maker Micron Technology (MU) in the IT sector. While we attempt to handicap the return potential of all this AI spend, we are concrete in our belief that these stocks will be beneficiaries. Hyperscalers will need increasingly large amounts of memory from Micron and semiconductors from portfolio holding Marvell Technology (MRVL), and they will need to compete for power at premium prices from Vistra and Constellation Energy. Thus, while we are exposed to the AI theme, we have taken a more calculated approach by carefully managing our exposure via position sizing as well as taking on much less valuation risk than there appears to be among the mega cap AI cohort. In the meantime, we continue to find and exploit opportunities that are steadily emerging as the market ignores increasingly attractive opportunities outside of the very top of the index. The All Cap Value Strategy outperformed its benchmark in the second quarter, as strong stock selection in the IT and consumer discretionary sectors overcame weakness in our consumer staples stocks. Stock selection in the IT sector was led by holding Micron Technology, which continues to benefit from the increasing demand for memory amid data center buildouts and AI development. Additional contributions came from Oracle (ORCL), the dominant provider of on-premise database software for large enterprises globally, after it reported strong backlog growth and signed a new client in OpenAI, which intends to use Oracle's cloud infrastructure to train its AI models. The company also received tailwinds from it announced partnership with Google's Cloud Platform (GCP) to build Oracle's cloud infrastructure directly into GCP, which we believe will help accelerate the growth of Oracle's cloud database services. Our holdings in the consumer discretionary sector also contributed to relative outperformance, primarily as a result of strong performance from convenience store and gas station operator Murphy USA (MUSA). A strong competitor earnings report in the period shows that Murphy and its well-positioned gas station peers continue to take market share from smaller operators who are struggling to keep pace with higher inflation and tepid volumes. As such, these smaller companies must charge steadily higher prices for their fuel, creating a growing and attractive pricing umbrella for Murphy and its lower-cost peers that will continue to underpin strong earnings growth for the foreseeable future. Positive performance was partially offset by detractors in the consumer staples sector. Our worst-performing holding in the sector, general merchandise retailer Target (TGT), faced pressure after its first-quarter earnings fell short of market expectations. In addition to higher expenses, driven by a focus on newer, higher-quality goods, the string of higher-than-anticipated inflationary readings and declining consumer confidence created a more difficult environment for discretionary spending. Opportunities to improve the return profile of the portfolio, increase resiliency and diversify our risk exposure abound, and we are finding evidence of great values among mid cap names. These companies, with 10%+ FCF yields, durable growth prospects and sound competitive positions, are trading at truly distressed valuations, much to our benefit. For example, new addition Wesco (WCC), an electrical and broadband distributor, should enjoy mid-single-digit end market growth, likely modest growth above that of the market given its leading scale, and a wave of FCF once the supply chain for things like transformers loosens. Despite a depressed valuation, the company is levered to many of the same themes such as electrification and data center buildouts as stocks with much higher multiples. We believe it is merely a matter of when, and not if, it catches up. We have also watched as lower credit spreads, market volatility and the gravity of mega cap AI winners have pushed more defensive stocks lower than at any time in recent memory. American Tower (AMT), which we also added this quarter, is a great example of a new position that has a less expansive upside, but immensely compliments our overall portfolio positioning and utility. The company, which boasts incredible fundamental stability and built-in growth and inflation protection via its customer contracts, currently trades near decade lows across a variety of valuation measures. Ultimately, we believe that the current carnage in small and mid cap stocks only plays to our advantage, and that even the slightest reduction in market concentration would position us well for strong performance. The Strategy remains well positioned to benefit from the eventual broadening out in the market, which would likely flatter the performance of smaller cap companies, value over growth and, depending on the specific drivers, likely defensives as well. As a result, are actively leaning into each of these opportunities. Our valuation remains decidedly below the benchmark, so we believe a value cycle would further flatter results. Similarly, our weighted average market cap remains below the index, which has recently been a drag on performance, but should be a meaningful performance driver when small and medium-size companies catch up. Lastly, given the emerging opportunities among defensive assets, we are refining our positioning for when volatility inevitably increases from its currently constrained level. Ultimately, we believe these factors will be strong drivers of relative performance. The ClearBridge All Cap Value Strategy outperformed its Russell 3000 Value Index during the second quarter. On an absolute basis, the Strategy had gains in five of the 11 sectors in which it was invested during the quarter. The leading contributor was the IT sector, while the health care sector was the largest detractor. On a relative basis, overall stock selection and sector allocation effects positively contributed to performance. Specifically, stock selection in the IT, consumer discretionary, communication services and utilities sectors and an overweight allocation to the utilities sector benefited performance. Conversely, stock selection in the consumer staples, health care and financials sectors weighed on returns. On an individual stock basis, the biggest contributors to absolute returns in the quarter were Vistra, Micron Technology, Oracle, Murphy USA and Seagate Technology (STX). The largest detractors from absolute returns were Block (SQ), CVS Health (CVS), Target, Fiserv (FI) and Vulcan Materials (VMC). Albert Grosman, Managing Director, Portfolio Manager Sam Peters, CFA, Managing Director, Portfolio Manager Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.