Q2 2024 Investment Strategies: A Comprehensive Market Analysis

ClearBridge SMID Cap Growth Strategy Q2 2024 Commentary

We are finding many opportunities of oversold companies with great business models, strong growth prospects and stellar balance sheets trading at attractive free cash flow yields. By Brian Angerame, Jeffrey Bailin, CFA, Aram Green & Matthew Lilling, CFA Uncertainties Weigh on SMID Growth Market Overview The second quarter proved a tale of two markets, as large cap market indexes saw rising concentration in mega cap tech companies and positive returns, while mid and small cap stocks faced a broad retreat. As a result, the Russell 1000 Index returned 3.57%, continuing its streak of outperforming the Russell 2500 Index, which returned -4.28%. Growth stocks held up only marginally better than their value counterparts, with the benchmark Russell 2500 Growth Index returning -4.22% compared to the -4.31% of the Russell 2500 Value Index. 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 prints 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 (US10Y) with yields going from 4.2% to 4.7% before ending the period at 4.4%. 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 production, transports, software budgets and large pharma R&D/sales and marketing spending. However, there were some bright spots in the quarter that leave us feeling optimistic. One was the rebalancing of the benchmark Russell 2500 Growth Index, and the removal of Super Micro Computer (SMCI) and MicroStrategy (MSTR) from the index. Despite having their market caps outgrow the category, these companies had an outsize, negative impact on our year-to-date performance due to our eschewing them in favor of true SMID cap stocks. We explained this impact last quarter and believe their removal will result in a more accurate representation of the broader SMID growth universe. "We believe the Strategy has an appropriately balanced spectrum of growth businesses." Additionally, we are finding many opportunities of oversold companies with great business models, strong growth prospects and stellar balance sheets trading at attractive free cash flow yields. Many of these stocks exhibit still strong revenue growth rates, despite slight decelerations, and can compound through this period of weakness and become bigger and better companies on the other side of this economic malaise and top-heavy market. Finally, 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). Against this backdrop, the ClearBridge SMID Cap Growth Strategy underperformed its benchmark. With strong contributions from a handful of companies across various sectors, the degree of relative underperformance was minimal during the second quarter, however we remain disappointed by recent Strategy results. We believe the Strategy has an appropriate and balanced spectrum of growth businesses and, with the unprecedented concentration at the top of the benchmark being addressed by index rebalancing, we anticipate that we should see less distortions in the underlying benchmark performance. Stock selection in industrials 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 proved a headwind for companies like Trex (TREX), which manufactures wood alternative decking products made from recycled wood fibers and plastic waste for residential and commercial customers. Also impacted was 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 the financials sector provided a positive offset, led by Houlihan Lokey (HLI), an investment bank specializing in mergers and acquisitions. The company benefited from increased capital markets activity, seeing upticks in demand for M&A and restructuring. Shift4 Payments (FOUR), a software and payment processing solutions company, also saw positive returns during the period, with management increasing the top end of their full-year guidance for end-to-end payments volume. Stock selection in the consumer staples sector also proved beneficial, primarily driven by our holdings in Casey's General Stores (CASY) and BJ's Wholesale Club (BJ). 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 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. Likewise, BJ's, which operates warehouse clubs providing perishable, general merchandise, gasoline and other ancillary services, continues to exceed expectations. With inflation continuing to weigh on consumer spending, the company's membership channel continues to grow due to its perceived value to customers. Another top individual contributor was Monolithic Power Systems (MPWR), in the IT sector, which makes semiconductor-based power electronics for the computing and storage, automotive, industrial, communications and consumer markets. Continued demand for AI-related companies and beneficiaries and anticipation of greater demand for data center components such as power management hardware for CPUs helped drive strong performance in the quarter. We believe Monolithic is one of the most attractive semiconductor plays within the SMID universe and that the company will continue to gain share in analog semiconductors as it wins design contracts. Portfolio Positioning We initiated a new position in online pet retailer Chewy (CHWY) 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, which has built a loyal base through peerless customer service, is set up to improve 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 exited our position in health care company Stevanato (STVN), which designs, produces, and distributes products and processes to provide integrated solutions for biopharma and health care customers. The company has struggled with broader industry headwinds including a delayed destocking and recovery from the COVID-19 pandemic, and our conviction in the company's management team was further weakened after it announced an additional equity offering and subsequent 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 Thus far in 2024 we have seen bouts of 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 permanent changes versus typical normalization following an unprecedented shutdown and then an incentive-fueled restart of the global economy. 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 growth trajectories with solid fundamentals will continue to prove itself over the long term. Portfolio Highlights The ClearBridge SMID Cap Growth Strategy underperformed its Russell 2500 Growth Index benchmark during the second quarter. On an absolute basis, the Strategy had positive contributions across two of the 10 sectors in which it was invested during the quarter (out of 11 sectors total). The leading contributors were the consumer staples and financials sectors, while the industrials and consumer discretionary sectors were the chief detractors. On a relative basis, overall stock selection detracted from performance, but was partially offset by a positive contribution from sector allocation. Specifically, stock selection in the industrials, consumer discretionary, communication services and energy sectors weighed on performance. Conversely, stock selection in the financials, consumer staples and IT sectors and an overweight to the consumer staples sector benefited performance. On an individual stock basis, the biggest contributors to absolute returns in the quarter were Insmed (INSM), Monolithic Power Systems, Casey's General Stores, Wingstop (WING) and BJ's Wholesale Club. The largest detractors from absolute returns were Five Below (FIVE), Trex, Stevanato, WillScot Mobile Mini and IDEX. In addition to the transactions mentioned above, we initiated new positions BCG in the financials sector, Coherent (COHR) and Lattice Semiconductor (LSCC) in the IT sector, Colliers International (CIGI) in the real estate sector, Valvoline (VVV) in the consumer discretionary sector and Weatherford International (wrfd) in the energy sector. We exited positions in Shoals Technologies (SHLS) in the industrials sector, Americold Realty Trust (COLD) in the real estate sector and Mettler-Toledo International (MTD) and Shockwave Medical in the health care sector. Brian Angerame, Portfolio Manager Jeffrey Bailin, CFA, Director, Portfolio Manager Aram Green, Managing Director, Portfolio Manager Matthew Lilling, CFA, 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 Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. 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 Value Improvers Strategy Q2 2024 Commentary

Eliminating waste and pollution, circulating products and materials and regenerating nature are three basic principles at the heart of the circular economy that align with ClearBridge's fundamental ESG framework. By Grace Su & Jean Yu, CFA, PhD Improvers Outperform on AI Demand Market Overview Global equities rose in the second quarter, with the MSCI World Index returning 2.63%, as largely positive corporate earnings, signs of stabilizing inflation and the first rate cuts from central banks in Europe and Canada overcome increased political uncertainty from a number of elections worldwide. Continued investor enthusiasm for AI-related companies helped drive strong performance in growth stocks, with the MSCI World Growth Index returning 6.35%, while the benchmark MSCI World Value Index declined 1.20%. As a result, growth extended its year-to-date lead versus value to over 1,100 basis points. The U.K. proved the best-performing region in the benchmark, overcoming a mid-quarter pullback due to increased uncertainty spurred by the call for early elections, as reports showed a stabilizing GDP, a steady increase in consumer confidence and a continued easing of inflation indicators. Asia Ex Japan also saw positive overall performance as China, which has struggled with weaker domestic consumption and issues in its real estate market, also saw positive performance due to a pickup in export data. Japan, the best-performing market in the first quarter, delivered the weakest regional performance as investors took pause after a strong run-up and a weakening of the yen. International investors faced an onslaught of political elections during the quarter. In the U.K., Prime Minister Rishi Sunak called for a new national election several months earlier than expected, resulting in a widely anticipated landslide victory for the opposition Labour party - the most meaningful power shift in over a decade. European markets also saw increased volatility due to the surprise gains by far-right parties in European parliamentary elections, leading to further uncertainty about the future of fiscal and policy agendas in France after President Macron called for snap elections in July, which ended with no clear winner. Mexican equities and the peso retreated meaningfully after incoming President Claudia Sheinbaum's Morena party made substantial electoral gains, raising concerns over potential judicial reforms that would allow for easier constitutional changes. Opposition parties also won victories in Korean and Indian elections, causing concerns over the impact that new alliances and deals may have on government policies. The ClearBridge Global Value Improvers Strategy outperformed its benchmark in the second quarter, as strong stock selection in the industrials sector overcame headwinds to our holdings in the financials sector. Despite the prospect of higher-for-longer interest rates, fatigued consumer spending and global economic weakness, our industrials holdings continued to see robust performance. Top-performing holding Hitachi (OTCPK:HTHIY) continues to benefit from the demand and buildout of data centers and upgrading of global electrical grids. After of a decade of meaningful restructuring, Hitachi has now become a model for value creation in Japan, which in turn motivates its management team to find further avenues for growth and returns. French industrials company Nexans (OTCPK:NXPRF), which makes cable systems for offshore wind farms, subsea interconnections, power transmission, telecom networks, fiberoptics and electrical systems, also saw positive performance as the market priced in higher demand for power and grid investment from additional AI demand. "We remain constructive on the ongoing reforms in Japan." Stock selection in the health care sector positively contributed, led by the strong performance of U.K.-based global biopharmaceutical company AstraZeneca (AZN). The company's share price rallied from a strong showing of results from several of its existing and pipeline oncology products presented at the American Society of Clinical Oncology annual meeting in June, highlighting the breadth and depth of its leadership in oncology treatments and particularly within breast and lung cancer - the two largest oncology markets. The positive reception at the presentation further reinforces our conviction in the company's ambitious long-term growth targets that it announced during the quarter. Stock selection in the financials sector, meanwhile, weighed on relative performance as political uncertainty, particularly in Europe, resulted in in broadly higher risk premiums and bond spreads. Such was the case with BNP Paribas (OTCQX:BNPQF), a French banking and financial service, which was particularly impacted as investors contemplated market unfriendly policies such as new bank taxes and threats to Europe's banking union that have been discussed by both far-left and right parties amid European elections. Spanish bank Banco Bilbao Vizcaya Argentaria (BBVA), a top-performing holding in the first quarter, also saw a pullback as the bank's planned acquisition of Spanish peer Sabadell (OTCPK:BNDSF) transformed into a takeover bid, spurring investor concerns that a prolonged takeover or engorged premium to complete it could dilute its strong performance in Mexico and dampen its overall returns. Regionally, stock selection in Japan was a positive contributor for the quarter, driven primarily by Hitachi. Overall, we remain constructive on the ongoing reforms in Japan. In addition, we see management teams more willing to engage with investors to improve governance practices and ultimately include shareholders in their capital allocation decisions. Stock selection in North America also proved beneficial, with the largest contributor being U.S. headquartered Oracle (ORCL) - the dominant provider of on-premise database software for large enterprises globally. The company's share price rose 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 shares 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. Conversely, stock selection in Europe Ex U.K. weighed on performance due to the increases in political uncertainty and concerns that growing nationalistic movements within these countries could ultimately weaken the eurozone overall. Additionally, construction slowdowns in the U.K. and Europe placed several of our holdings in the region under additional pressure. Portfolio Positioning We added a new position in Siemens Energy (OTCPK:SMEGF), in the industrials sector, a German energy technology company that manufactures a wide range of products such as transformers, wind turbines and electrical equipment, and that provides crucial services to facilitate the global energy transition. We believe that the growing need to upgrade long-neglected energy grids globally will prove a long-term tailwind to the company. We also initiated a new position in PayPal (PYPL), in the financials sector, which operates financial technology platforms to enable digital and mobile payments globally. We see PayPal as an interesting turnaround opportunity as the stock suffered in recent years due to difficult Covid comparisons and ineffective management strategy. Under new leadership, there is a renewed sense of urgency to refocus the business and integrate PayPal's multiple premium assets and bring out the power inherent in its platform to resume profit growth. With a modest valuation and low embedded expectations, there is significant upside if new management can right the ship. We trimmed our exposure to Vertiv (VRT) during the quarter on recent strength. A global manufacturer of power, precision cooling and infrastructure management systems for mainframe computer, server racks, and critical process systems, Vertiv continues to see elevated demand in the AI value chain and anticipation of greater demand for data center components. Data centers running AI severs consume five times more power, generate five times more heat and require ten times more cooling. Vertiv's products improve data center power efficiency and are solutions to the environmental challenges posed by the rapid growth of AI data centers. While we continue to have strong long-term conviction in the company and maintain a meaningful position, we made the decision to capture gains and trim the position size. Outlook The ClearBridge Global Value Improvers Strategy targets companies which are both undervalued and underappreciated for their ESG progress. In recent months, political risk and policy uncertainty have become an increasing overhang on equity markets, particularly as it relates to important ESG areas such as renewables and energy policy, labor regulation and immigration, to name a few. Our overall view is that concerns are overblown. For example, in the U.S., there are still different scenarios for the outcome of the election. Even in the most extreme case of a Republican sweep, a full repeal of the Inflation Reduction Act ('IRA') would be difficult and unfavorable to many states where it has been a meaningful job creator. Even stress testing a full repeal scenario, many of the benefits to a company like U.S. renewable power producer AES, for example, already existed prior to IRA passage and would now just return to the situation before the bill with the biggest negative impact being the need to have those tax credits extended periodically since their first expiration in 2007. Offsetting this, we believe surging data center demand will continue to provide additional tailwinds for both growth and returns. In the EU, recent French election results seem to indicate that the risk of far-right control in EU has decreased, while renewables and, more broadly, the energy transition, continue to receive support across society. Overall, we believe that these sentiment swings will prove to be temporary and provide opportunities for us to add interesting new ideas to power the portfolio in the coming years. Portfolio Highlights The ClearBridge Global Value Improvers Strategy outperformed its MSCI World Value Index benchmark during the second quarter. On an absolute basis, the Strategy had gains across six of the 10 sectors in which it was invested (out of 11 sectors total). The industrials and health care sectors were the main contributors, while the financials sector was the main detractor. On a relative basis, overall stock selection benefited performance. Specifically, stock selection in the industrials, health care, communication services and IT sectors, an underweight to the consumer discretionary sector and overweight allocation to the utilities sector positively contributed. Conversely, stock selection in the financials sector, an underweight to the IT sector and an overweight to the industrials sector weighed on performance. From a regional standpoint, stock selection in Japan and North America as well as an overweight allocation to the U.K. benefited performance. Conversely, stock selection in Europe Ex U.K. and an out of benchmark allocation to emerging markets weighed on performance. On an individual stock basis, Hitachi, AstraZeneca, Oracle, Unilever (UL) and Nexans were the leading contributors to absolute returns during the quarter. The largest detractors were Banco Bilbao Vizcaya Argentaria, PT Bank Rakyat Indonesia (OTCPK:BKRKY), Coty (COTY), Compass and Fiserv (FI). Plastic Alchemy: Transforming Waste into Profit 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 (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. Molecular Recycling Takes a Step Forward 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. "Food waste is an avoidable crisis that has both environmental and societal costs." 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 1). 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 1: Eastman Chemical's Molecular Recycling Methods Sustainable Food Needs Sustainable Plastic 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. Supplying the Auto Aftermarket 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. Circular Economies Span All Sectors 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. Grace Su, Managing Director, Portfolio Manager Jean Yu, CFA, PhD, 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: 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. 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.

The Boyar Value Group's Q2 2024 Letter

Individual investors stack the odds of investment success in their favor when they stay the course and take a long term view. It doesn't make sense for value investors to bar investments simply because (a) they involve high-tech companies that are widely considered to have unusually bright futures, (b) their futures are distant and hard to quantify, and (c) their potential causes their securities to be assigned valuations that are high relative to the historic averages. The goal at the end of the day should be to figure out what all kinds of things are worth and buy them when they're available for a lot less. -Howard Marks S&P 500 Rallies 15% in the First Half of 2024, Led by AI Heavyweights The first half of 2024 brought a robust 15% surge in the S&P 500 (SP500,SPX), fueled mostly by a handful of stocks that investors see as the prime beneficiaries of artificial intelligence ('AI'). Meanwhile, the broader market, as reflected by the S&P 500 Equal Weighted Index, posted a modest gain of 5%-the third-largest gap between the two indices since 1989. In fact, nearly 40% of the S&P 500 (roughly 200 stocks) actually declined in the first half of the year. The Nasdaq Market Intelligence Desk neatly summed up the current state of affairs: "Q1 was a rising tide that lifted all boats, but Q2 revealed a tale of two tapes with poor market breadth and selective gains among large-cap growth stocks." This technology-driven advance isn't a recent phenomenon. Over the past 3 years, the S&P 500 Equal Weighted Index has risen by a cumulative 8% even as the tech-heavy market-cap-weighted index has gained 27% (through June 30). Such subpar performance by the Equal Weighted Index is a far cry from its historical average gain of about 33% over all rolling 3-year periods since 1980. Index concentration plays a big role in this divergence. As of June 30, the 25 largest components of the S&P 500 had a market cap equal to the rest of the index combined, with the top 10 stocks alone accounting for 37% of the S&P 500's total market cap-a level of concentration we haven't seen since the dotcom bubble. Jason Zweig of the Wall Street Journal notes that such high levels of concentration have historically been unsustainable, and although only time will tell whether history will once again repeat itself, we're betting it will. The period leading up to the dotcom crash, when we saw similar divergences, suggests other parallels as well. Following the crash, for example, growth stocks lagged, and value stocks experienced a catch-up phase after prolonged underperformance. The Magnificent Seven's Dominance Seven tech titans, popularly called the "Magnificent Seven," were the stars of the show in 1H 2024, contributing ~61% of the S&P 500's gains. (Nvidia alone accounted for 31% of the index's rise.) In 2Q gains were even more concentrated, with Nvidia (NVDA), Apple (AAPL), and Microsoft (MSFT) alone accounting for over 90% of the S&P 500's price appreciation amid continued enthusiasm about AI. According to the Wall Street Journal, AI companies soared an average of 14.7%, while non-AI firms saw a 1.2% decline during 2Q. But Magnificent Seven stocks are far from cheap, trading at an average of 37x their forward earnings versus the S&P 500's 21x. The Magnificent Seven have significantly influenced S&P 500 returns since 2021, contributing 33% in 2021, 56% in 2022, 63% in 2023, and 61% so far in 2024 (as of June 30). But their performance has varied widely. In 2021, the worst-performing member advanced by a modest 2%, while the best-performing stock surged by an impressive 125%. In 2022, they weren't so magnificent at all, with a performance range that spanned from -27% to -65%, and a median decline of 44%. Then in 2023, not a single Magnificent Seven constituent was left out of the rebound rally, as they posted a range of returns from +48% to +239%. And this year the volatile trend continues, with year-to-date performances varying from -20% to +149% through June 30. Sector Performance In 1H 2024, Technology led all market sectors with a +28.2% gain, closely followed by Communication Services at +26.7%. By contrast, Real Estate shares underperformed, losing 2.4%, and Materials saw a modest +4.1% gain. Interestingly, normally sleepy Utilities had a good showing, advancing +9.4% for the first half. But even this advance had an AI component, with investors wagering that the massive electricity demand needed for AI computing would be good for certain utilities. Small Cap Underperformance Small-cap stocks continued their underperformance, and as of June 30 they still sell ~17% below their all-time highs. Without the standout performance of Super Micro Computers, which gained 188%, the Russell 2000 would have posted a negative return for the first half of 2024, a lag largely explained by the small-cap universe's lack of AI exposure. A Shift in Market Leadership or Another Head Fake? The July 11 CPI report, which showed easing inflation, sparked optimism among investors for a September rate cut. On the day of the report's release, the Russell 2000 surged by 3.6%, benefiting from lower interest rate expectations-a logical advance since small-cap companies, being more reliant on floating rate debt, stand to benefit from a lower-interest-rate environment. In contrast, the tech-heavy Magnificent Seven saw significant losses, collectively shedding $597 billion in market value in a single day. While the knee-jerk rotation out of some high-flying names and into these forgotten small-caps makes sense, the magnitude of the reaction is puzzling-after all, technology stocks should still be beneficiaries of lower interest rates. This divergence, though only recent, has continued. Could it signal the beginning of a broader rotation out of the Magnificent Seven and into smaller company stocks, or is it merely a temporary pause in large-cap dominance? Time will tell- and it's worth remembering that there have been numerous false starts for small-cap stocks in recent memory. History does provide some hope for small-cap investors, however. During the 1994-1999 tech boom, the S&P 500 outpaced the Russell 2000 by 93%. After the bubble, small-caps significantly outperformed the S&P 500 by 114% through 2014, according to Spencer Jakab of the Wall Street Journal (although whether history will repeat remains to be seen). The current market environment, characterized by high valuations and concentrated gains in a few large-cap stocks, may provide an opportunity for small caps to shine once more. Market Valuations and the Fed The S&P 500 index level (5,460 as of June 30, 2024) has advanced ~14% since January 3, 2022 (the previous market peak), when it stood at 4,797, but it currently trades at a similar 21.0x (fwd.) multiple of earnings. While that is an elevated multiple historically speaking (the 30-year average is 16.7x), back in March 2000 the S&P 500 traded for 25.2x (before losing 49% of its value over the following 2 calendar years). It is worth noting that the S&P 500 equal-weighted index currently sells for a more modest (but far from cheap) 16x (fwd.). The Fed started 2Q 2024 signaling three rate cuts for the year but in the face of stubbornly high inflation is now predicting just one or two cuts, although recent inflation data have convinced the market that a September rate cut is almost an absolute certainty. We do note just how badly both the Federal Reserve (which started 2024 predicting three rate cuts) and the bond market (which began the year forecasting six to seven rate cuts) have failed at predicting both the direction and the magnitude of interest rates. In our opinion, investors are better off not trying to forecast when the Fed will cut rates (which even the Fed itself seems unable to do!) and instead concentrating on finding businesses that will perform well regardless of where interest rates stand. At the risk of echoing our last quarterly letter, whether the Fed reduces interest rates twice this year or only once, investors should view current interest rates in their proper historical perspective. At 4.36% and 0.95% (as of June 30, 2024), respectively, nominal and real yields are still low, historically speaking. The economy can function-and has repeatedly functioned-with rates at these levels or even higher. If today's figures seem high, they are high only relative to recent history. Presidential Election Year Dynamics Many investors are concerned about investing in a market that has seen one of the strongest first half performances since the dotcom bubble. However, Bank of America research suggests that a large first half advance has historically been bullish for stocks, noting that the S&P 500 has advanced 10%-20% in the first half of the year 26 times. In 88% of these instances, the index saw further gains in the 2H, with a median return of 10.1%. Even so, as we've already mentioned, we believe-and have believed for some time-that the best values are in the small-cap arena, not the S&P 500. Another concern for investors is the upcoming presidential election. Historically, presidential election years have been positive for stocks, especially when a clear winner emerges before the election. However, as Jack Hough of Barron's points out, 46 presidents is a relatively small sample size, so statistics regarding presidential election years and stock market performance should be taken with a grain of salt. According to Ed Clissold, chief strategist at Ned Davis Research, since 1950 the S&P 500 has risen from April 30 to October 31 during 77.8% of election years, with a 3.3% median advance from May to November. He cautions that years with a close presidential contest have seen the worst stock market performance, whereas landslides tend to produce the best. We think that staying the course and not adjusting your portfolio based on which party holds the White House is the wisest strategy, and history bears us out. According to Charles Schwab, an investor who put $10,000 in the S&P 500 in 1961 and held only when Republicans were president would have made $102,293 by the end of last year, versus $500,476 for Democrats-but one who stayed in the index no matter which party held the White House would have made $5,119,510! Investor Sentiment 2024 has been highly unusual in its lack of major market pullbacks. According to JP Morgan, since 1980 the average intra-year pullback has been 14.2%. The biggest S&P pullback thus far in 2024 has been a mere 5.5%, a figure that is particularly remarkable amid stubborn inflation, uncertainty surrounding interest rates, a wild presidential election contest, and significant geopolitical tensions. Financial advisor Edward Jones Investments notes that the intra-year pullback was smaller in only 4 years (1993, 1995, 2017, 2021) out of the past 4 decades. Moreover, the stock market has been relatively calm on a day-to-day basis, with only one daily 2% move in the S&P 500 thus far this year, versus an average of 21 occurrences per year since 2015. This extended period of minimal downturns has naturally fueled bullish sentiment among both professional and amateur investors alike. According to the latest Investor's Intelligence survey, the number of bullish investors has increased to the highest level since 2021 (when the S&P 500 ended up declining by 18% the following year). What's more, bearish investors have declined to the lowest level since late March. As contrarians, we are somewhat concerned by this widespread bullishness. Interestingly, despite the overall bullish sentiment, investors have not been voting with their wallets. According to the Investment Company Institute, investors withdrew a net $9.3 billion from U.S. stock funds in the quarter and invested $81.1 billion into bond funds. How Can I Invest in a Market That Is Selling at All-Time Highs? As value investors with a contrarian streak, we like to invest when no one else wants to buy, so investing while the market is at or near all-time highs naturally feels uncomfortable to us. Historically, however, not investing simply because the market is at (or near) an all-time high has been a mistake. Trying to time the market is extremely difficult, and the pitfalls of doing so are well documented. Since 1950, the S&P 500 has closed at an all-time high in 6.6% of trading sessions, making today's situation less rare than it might seem. And historically there hasn't been a significant difference in future returns between investing on a random day versus investing on days when the S&P 500 was at an all-time high. Most important, we invest in stocks, not markets. Although the major indices are arguably overextended at present, we are still finding stocks that we believe are intrinsically undervalued (particularly among small and mid-cap shares). The Long-Term View We've said it before and we'll say it again: individual investors stack the odds of investment success in their favor when they stay the course and take a long-term view. According to data from J.P. Morgan, there has never been a 20-year period when investors did not average a gain of at least 6% per year in the stock market. Past performance is certainly no guarantee of future returns, but history does show that the longer a time frame you give yourself, the better your chances become of earning a satisfactory return. As always, we're available to answer any questions you might have. In addition, you can reach us at [email protected] or (212) 995-8300. Best regards, Mark A. Boyar | Jonathan I. Boyar IMPORTANT DISCLAIMER Important Disclosures. The information herein is provided by Boyar's Intrinsic Value Research LLC ("Boyar Research") and: (a) is for general, informational purposes only; (b) is not tailored to the specific investment needs of any specific person or entity; and (C) should not be construed as investment advice. Boyar Research does not offer investment advisory services and is not an investment adviser registered with the U.S. Securities and Exchange Commission ("SEC") or any other regulatory body. Any opinions expressed herein represent current opinions of Boyar Research only, and no representation is made with respect to the accuracy, completeness or timeliness of the information herein. Boyar Research assumes no obligation to update or revise such information. In addition, certain information herein has been provided by and/or is based on third party sources, and, although Boyar Research believes this information to be reliable, Boyar Research has not independently verified such information and is not responsible for third party errors. You should not assume that any investment discussed herein will be profitable or that any investment decisions in the future will be profitable. Investing in securities involves risk, including the possible loss of principal. Important Information: Past performance does not guarantee future results. Any companies mentioned in this are for informational purposes only and the performance of the stock selected is not indicative of the performance of the stocks profiled in Boyar Research, the performance of the stocks selected, and the performance of Boyar Research may in fact diverge materially. This information is not a recommendation, or an offer to sell, or a solicitation of any offer to buy, an interest in any security, including an interest in any investment vehicle managed or advised by affiliates of Boyar Research. Any information that may be considered advice concerning a federal tax issue is not intended to be used, and cannot be used, for the purposes of (i) avoiding penalties imposed under the United States Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter discussed herein Click to enlarge Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. The Boyar Value Group was established in 1975. Through our research division we publish Asset Analysis Focus & Boyar's Micro Cap Focus which provides some of the world's largest hedge funds, family offices, mutual funds and sovereign wealth funds with in-depth research reports utilizing a private equity approach to public markets. We seek possible investment opportunities across the market capitalization spectrum and within a diverse range of industries. A large number of the companies featured in our publications are not widely followed by Wall Street.In addition, we have been providing money management services utilizing our proprietary in-house research since 1983 for institutions, individuals and family offices. To learn more about our firm, please visit boyarresearch.substack.com or email [email protected]

ClearBridge Large Cap Value ESG Strategy Q2 2024 Commentary

U.S. equities continued to be a tale of two cities, as enthusiasm for artificial intelligence and new weight loss drugs drove an increasing concentration of "winners" while slowing economic indicators weighed on the broader market. Against this backdrop, the Russell 1000 Value Index trailed its growth counterpart in the quarter, returning -2.17% to the Russell 1000 Growth Index's 8.34% return. Value stocks took a defensive turn in the quarter, with utilities and consumer staples leading as the market rotated out of more cyclical sectors toward companies with more stable earnings, and as some utilities began to get credit for their role in powering the data centers on which AI relies. More economically sensitive and commodity-linked sectors, such as materials and energy, trailed due to rising disinflation and cracks in industrial and consumer activity, which also weighed on consumer discretionary stocks. Against this backdrop the Strategy modestly underperformed the benchmark, despite strong showings from health care and communication services holdings. In health care, McKesson (MCK), a drug distributor, raised its EPS guidance to reflect mid-double-digits growth for the coming fiscal year. The company is benefiting from a stable competitive environment, as well as large share gains such as its recent partnership with UnitedHealth's (UNH) OptumCare business. McKesson is also a beneficiary of the growth of GLP-1 medications for diabetes and obesity, with revenues from GLP-1s making up a sizable portion of recent growth in its U.S. pharmaceutical segment (albeit at relatively low profitability). We continue to see the company as a durable compounder, with limited sensitivity to the broader macro economy, and which we believe warrants a higher valuation. In communication services, Alphabet (GOOG,GOOGL) remains an online advertising leader, with AI tailwinds starting to ramp up while Google Search is trending above expectations. AI overviews are not yet moving the needle, but query volume and conversion rates are picking up. Main contributors also included Air Products and Chemicals (APD), which signed a 15-year agreement to supply TotalEnergies' (TTE) European refineries with 70,000 tons of green hydrogen a year starting in 2030. The hydrogen will avoid around 700,000 tons of CO₂ each year and help TotalEnergies reduce its net greenhouse gas emissions (Scope 1 and 2) by 40% by 2030 compared to 2015. The deal represents an important step as APD begins to execute on a large backlog of major hydrogen projects that can provide commercial scale green hydrogen to decarbonize heavy industry. It also accounts for one-third of the initial capacity of APD's Neom project, so other transactions, with TotalEnergies or other parties, appear likely. If future deals have similar economics, they will continue to support double-digit returns for the Neom project. "PC and server markets remain depressed, but we believe that aging infrastructure and the ongoing growth of IT workloads will lead to a cyclical recovery." Utilities rose largely on merchant power companies serving the data centers powering AI; the rest of the sector, along with real estate, suffered as rate cut expectations were pushed out. One exception was our holding Sempra (SRE) - a well-managed and diversified utility holding company. Sempra possesses large franchises in Texas and California, as well as a large LNG business. Sempra is a leading player in each of its markets and all its segments enjoy robust growth outlooks, which should drive high-single-digit growth for the company overall. Sempra, along with other California utilities, recently filed a California Public Utilities Commission application for hydrogen blending demonstration projects to help reduce methane emissions and achieve the state's net-zero goal in 2045. The massive ramp up in spending on AI spending has crowded out spending in other technology verticals such as software and traditional enterprise infrastructure. This has also driven a market where "AI winners" have enjoyed strong multiple expansion, while perceived "AI losers" have been severely punished. One example of a perceived AI loser was the Strategy's top detractor for the quarter, Intel (INTC), whose shares declined as it put out financial targets for 2027 that were below Wall Street expectations, and also noted that demand for its core PC and server chips remained depressed. We take a contrarian view of Intel and do not think it will be an AI loser, but rather see underappreciated opportunity as AI PCs ramp over the next few quarters in enterprises, where Intel has a stronghold. We also believe that the company's technology roadmap remains intact, which we believe will lead to a stabilization in market share in its core PC and server markets. Both markets remain depressed, but we believe that aging infrastructure and the ongoing growth of IT workloads will lead to a cyclical recovery in both markets, which should benefit shares. Also among detractors, CVS Health (CVS) is coping with a prolonged uptick in the utilization of medical services by its Medicare Advantage clients, which has coincided with government pressure on payer reimbursements. In this environment, CVS severely mispriced its Medicare Advantage book in an attempt to gain share, which has led to large losses in its insurance business. While we believe it will take some time to recover profitability in the segment, the short cycle nature of managed care insurance along with the company's focus on "margins over members" gives us confidence that it will be able to grow earnings over the next few years. With the stock trading at a very low multiple, we believe the market is capitalizing these losses in perpetuity, which we view as overly pessimistic and which should set the stock up for strong returns over the medium term. Our industrials holdings weighed on relative performance as we are more exposed to transports such as "less than truckload" provider XPO (XPO) and parcel delivery company United Parcel Service (UPS), which are struggling with weak volumes during the post-COVID freight recession. With industry volumes down to pre-COVID levels and strong pricing power in the LTL space in particular, we believe that the next upcycle will prove to be very strong for earnings. As a result, we added to XPO in the quarter while reducing our position in UPS on concerns that industry capacity remains excessive. Meanwhile, we have less exposure to electrical equipment stocks, which have been rewarded by views that they will benefit from the buildout of AI data centers. Portfolio adjustments were modest during the quarter as we maintain our thesis on most of our holdings despite near-term sentiment. We continued to build out our position in Nestle (OTCPK:NSRGY), which we initiated late in the first quarter. Nestle is a large global manufacturer of foods and beverages with a high-quality portfolio of brands across many categories. It is especially strong in pet care, coffee and nutritional beverages, which are all advantaged categories enjoying superior growth. Recently, Nestle stumbled with an enterprise resource planning ('ERP') transition in its health science division, resulting in missed orders and a period of out of stocks in some of its U.S. vitamins, minerals and supplements. This drove negative revisions in guidance, and (along with overall sector sentiment) caused the stock to sell off to levels not seen since 2019. Our research shows that the disruptions from the ERP transition are temporary, and Nestle's brand portfolio should offer consistent mid-single-digit revenue growth, which should merit a re-rating back to a premium multiple versus the lower-growth food and beverage group. Following the selloff, the stock is trading at an attractive valuation. The only outright sell was Charter Communications (CHTR), which we had reduced to a marginal position, and which we sold amid ongoing competitive threats to its broadband business from fixed wireless and fiber. We are aware of potential volatility from several quarters - the U.S. presidential election, interest rate uncertainty, economic slowing - but look at the portfolio with a bottom-up perspective focused on the strength of the franchises we own and their competitive positioning, which we believe will provide strong stable returns through any macroeconomic environment. We also believe that the divergence in valuations between perceived AI winners and losers has created a number of attractive opportunities where high-quality companies are being underappreciated. The ClearBridge Large Cap Value ESG Strategy underperformed its Russell 1000 Value Index benchmark during the second quarter. On an absolute basis, the Strategy saw positive contributions only from the utilities sector of the 11 sectors in which it was invested. The IT, industrials and health care sectors were the main detractors. On a relative basis, overall stock selection detracted from performance while sector allocation was positive. In particular, stock selection in the IT, industrials and consumer staples sectors detracted from relative returns. Conversely, stock selection in the health care and communication services sectors, a utilities overweight and a consumer discretionary underweight were beneficial. On an individual stock basis, the largest contributors were Alphabet, Sempra, McKesson, Air Products and Chemicals and Motorola Solutions (MSI). Positions in Intel, CVS Health, Sherwin-Williams (SHW), Travelers (TRV) and Martin Marietta Materials (MLM) were the main detractors. 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 (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 1). 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 1: 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. Dmitry Khaykin, Managing Director, Portfolio Manager Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

GreensKeeper Value Fund Q2 2024 Letter

Our biggest laggard in the quarter was Berkshire Hathaway (BRK.B). The Value Fund was up +1.6% net of fees and expenses in the second quarter, is up +11.5% year to date (YTD), and +19.3% over the past 12 months. The US dollar added about +1.0% to our returns for the quarter. The Value Fund's first-half performance beat both the S&P/TSX (+6.1%), and the DJIA (+8.2%), and trailed the S&P 500 (+19.1%). We concede that most of these are good businesses. However, capital flowing into these names, driven by indexing and momentum traders, has resulted in many of them trading at frothy levels. It is worth remembering that Icarus (ICRS:CA) was once a high-flyer, too. For example, NVDA is currently trading on 99x FY24 EPS. Analysts expect the company's rapid growth to continue, with earnings projected to increase nearly 5x from $1.19 in 2024 to $5.49 in 2028. While not impossible, given AI's pace of adoption and NDVA's dominant position in the GPU market, we believe significant risk is embedded in NVDA's current valuation. Markets have started to recognize this risk, with the stock down -12.6% in the past seven trading days (as of writing). At GreensKeeper, we will stick to buying high-quality companies at valuations that provide our clients with a large margin of safety. "Must-own" AI stocks are not for us: we are immune from the FOMO virus. When markets are frothy, we are comfortable patiently waiting for opportunities to present themselves. Our top contributor in the second quarter was Alphabet Inc. +20.7%. The company posted 31% adjusted operating earnings growth y/y in Q1, bolstered by double-digit revenue increases across all its major segments. GOOGL's search revenues continue to advance at a healthy rate despite investor fears that they will begin losing search market share to emerging AI competitors like ChatGPT. ChatGPT4 has been accessible to the public for 16 months now, and GOOGL's search market share stands at 91%, down marginally from 93% at ChatGPT4's launch. Importantly, GOOGL also continues to make progress in developing its own AI capabilities. We highlight that GOOGL's compute costs for its AI search platform fell 80% y/y, along with an increase in queries driven by its Search Generative Experience. Our second largest contributor in Q2 was Vertex Pharmaceuticals (VRTX) +12.1%. VRTX's cystic fibrosis ('CF') portfolio continues to generate robust revenue growth, and on July 1, the FDA announced approval for the improved Vanza Triple therapy. This new CF therapy is subject to meaningfully lower royalty payments compared to the rate payable on the current CF portfolio. During the quarter, the company also announced positive results for a pipeline therapy, VX-880, a stem-cell therapy that can potentially restore the body's ability to regulate glucose levels and reduce or eliminate the need for insulin injection in type-1 diabetics. Our third largest contributor in the quarter was Elevance Health (ELV) +4.5%. ELV continues to perform well despite headwinds from fewer Medicaid enrollees following the unwinding of government-funded Medicaid programs in response to COVID-19. Elevance's conservative approach to underwriting policies has allowed the company to avoid the margin compression experienced by some of its major competitors. ELV's earnings grew 15.5% y/y in Q1. Our biggest laggard in the quarter was Berkshire Hathaway (BRK.B) -3.3%. Berkshire's railroad and utility segments continue to struggle due to weakening volumes and wildfires, respectively. Despite these challenges, operating income continues to grow steadily, aided by acquisitions. Book value per share also continues to compound yearly, and we remain confident owning BRK.B as a core position in the Value Fund. Our second largest detractor in the quarter was Visa Inc. (V) -6.0%. Visa continued to chug along with revenues increasing +10% y/y on payment volume growth of +8%. In March, Visa announced it had reached a settlement on a long-standing antitrust lawsuit that would result in slightly lower credit interchange rates and cap fees at current levels for five years. However, in June, the judge informed Visa that she deemed the changes inadequate and rejected the settlement. A potentially more costly settlement, combined with concerns of payment volumes decreasing as the American economy softens, have weighed on the stock price. However, we remain convinced that Visa's growth algorithm will continue to drive double-digit earnings growth for the foreseeable future. In Q1, we made one new addition to the portfolio: The Hershey Company (HSY). Our top 10 holdings are shown in the table below. Additional portfolio disclosures, including performance statistics, can be found on the pages immediately following this letter. We get asked this question a lot. An entertaining story we shared with clients at our recent Annual Meeting provides a different perspective and is worth repeating. Suppose you are introduced to tennis at a young age and become pretty good at it. You handily beat all the neighbourhood kids, winning 80% of your points. Eventually, you advance to playing in tournaments with other high-quality amateur players. You still win most of your matches, but your points won percentage decreases to 70%, given the tougher competition. Fast forward a few years, and your childhood dream comes true-you are playing professional tennis for a living. Competing against the best in the world, your points won rate naturally declines. But you still manage to win 54% of all points played over your professional career. How do you think your career turned out? It may surprise you to learn that you would be on par with Roger Federer, arguably one of the greatest players ever to play the game. That 54%-point win percentage led to Federer winning 82% of his matches over his entire career and 20 Grand Slam titles. Compare Federer's record with that of Andy Roddick, who won 53% of his career points (1% fewer than Federer) but only 62% of his matches and a single Grand Slam. The lesson? A tiny edge, consistently compounded over a very long time, leads to amazing results. Casinos work on the same principle. Casino games of chance are structured to give the house a slight edge of just a few percent over its customers. But over long periods, the house is guaranteed to come out ahead despite fluctuations in their daily profits and losses. That small edge on every roll of the dice and spin of the slot machine resulted in US casino gaming revenues of $49.4 billion last year. Do you think that casino operators think about the best days to open the casino to the public or which games they should offer? Do you think Roger Federer ever woke up in the morning and asked himself if today was a good day to play tennis? Obviously not. In both cases, these professionals knew the odds were in their favour. Despite the occasional bad day, exceptional results were sure to follow over the long run. The stock market is no different. Stock markets increase over time primarily due to earnings growth (companies generally retain a portion of their earnings) and inflation. Measured daily, over the past 50 years, the stock market has been positive 53.6% of the time. A win rate very similar to our prior examples. And like Roger Federer and casino operators, that slight edge compounds. A study of the US stock market over the past 152 years (1871 to 2023) showed that the market was positive in 69% of those years. Over rolling 10-year periods, that figure increases to 89%. Over rolling 20-year periods-100%. In other words, over those 152 years, the US market has never declined over any 20-year period. Market crashes trigger fear and panic in our primitive brains and lead investors to make poor short-term decisions. But zoom out (per the chart on the following page) and see those pullbacks for what they are: mere blips in the market's long-term rise. On a recent safari in South Africa, I was reminded that evolution is an exemplar of this concept. Over hundreds of thousands of years, small advantages compound over generations, leading certain species to adapt and thrive at the expense of others. Instead of focusing on the ideal time to invest, we posit that intelligent investors should ask themselves a better question: What is the stock I am contemplating buying worth? All the effort that goes into unknowable questions comes at the expense of things we can know. - Shane Parrish, Farnam Street For certain businesses with sustainable competitive advantages (e.g., Value Fund holdings Fiserv (FI), Richemont (OTCPK:CFRUY), Vertex Pharmaceuticals (VRTX), Visa (V)), that question is answerable. With that answer in hand and knowing that stock prices tend to fluctuate around intrinsic value, the decision to purchase or not becomes apparent very quickly, based on the market quote. If the stock is undervalued, buy it. If it isn't, then look for bargains elsewhere. Thanks to the 40+ people who attended GreensKeeper's 2024 Annual Meeting last month. Our firm's growth continues, with assets under management ('AUM') up over 50% over the past year and a new full-time employee joining us next month. However, our goal as a firm has never been to hit a certain level of AUM or employee count. Our goal remains to deliver attractive returns to our clients while prudently managing risk. GreensKeeper's growth is a natural byproduct of delivering on that mission. Every one of our employees has their entire investment portfolio invested at GreensKeeper. In my case, it represents over 70% of my household's net worth. We invest in the same stocks as our clients, and our approach is one of partnership. If our partnership approach resonates with you or someone you know, please give us a call. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Distillate Capital Q2 2024 Letter To Investors

Editor's note: Seeking Alpha is proud to welcome Distillate Capital Partners as a new contributing analyst. You can become one too! Share your best investment idea by submitting your article for review to our editors. Get published, earn money, and unlock exclusive SA Premium access. Click here to find out more " The first half of 2024 has produced an enormously divergent set of returns and valuations with a very small set of stocks riding a wave of artificial intelligence enthusiasm while the rest of the market has lagged sharply behind. Of the S&P 500's 15.3% total return, just 7 stocks accounted for two-thirds of that total with only another 50 making up the rest such that all of the market's gains came from just 12% of its stocks. Leadership is extraordinarily narrow. While there has been fundamental improvement underpinning the strong rally in this small subset of stocks, the vast majority of the rally has come from valuation expansion. This valuation expansion has left Distillate's valuation-focused U.S. FSV strategy far behind the S&P 500 this year even though the strategy has seen estimated free cash flows rise by more than the overall S&P 500 even including the largest leading stocks (See Figure 1 below). Consequently, Distillate's free cash flow yield is now at a record high relative to the S&P 500. Though it is frustrating to lag behind the broader market by such a large degree in the first half of this year, we are steadfast in the view that valuation matters in the longer-term just as it always has and that the extreme concentration and valuation disparity of the current market are critical risks to avoid while we take advantage of those valuation-situations left behind. U.S. Fundamental Stability & Value (U.S. FSV): Distillate's U.S. FSV strategy's 1H24 total return of 4.85% substantially lagged the broader S&P 500's gain of 15.29%, which was driven by a very narrow subset of large stocks that now trade at a significant premium to the rest of the market. Strategy performance was more similar to the Russell 1000 Value ETF's total return of 6.53%. Annualized net of fee performance since inception is 1.00% ahead of the S&P 500 and 4.68% ahead of the Russell 1000 Value ETF. U.S. Small/Mid Cap Quality & Value (SMID QV): Our SMID QV strategy's 1.47% return slightly trailed the Russell 2000 ETF benchmark by 0.21% and outpaced the Russell 2000 Value ETF benchmark by 2.45% in H1 2024. Annualized excess returns since inception and net of fees are 8.62% and 8.76% ahead of those benchmarks. International Fundamental Stability & Value (Intl. FSV): Our International FSV strategy returned 0.15% after fees in the first half of 2024 and trailed the MSCI All Country Ex US ETF benchmark gain of 5.58%. Annualized net of fee performance since inception trails the benchmark by 0.24%. U.S. Large Cap Value Long 130%/Short 30% (U.S. Value 130/30): Our 130/30 strategy returned 10.17% net of fees in H1 2024 vs. the S&P 500 Index comparable rise of 15.29%. It remains 3.99% ahead of the S&P 500 ETF on an annualized net of fee basis and above the Russell 1000 Value ETF by 10.35%. The S&P 500's 14.5% price gain this year has far eclipsed it's 5% increase in rolling next-twelve-month (NTM) consensus estimated free cash flows in the first half of 2024 (See Figure 2). The free cash flow yield has dropped to just 4.1% from 4.5% at the start of the year. Price increases for the S&P 500 continue to exceed free cash flow gains. This increase in price in excess of fundamentals continues a recent pattern of valuation expansion that is evident looking at changes in price and rolling next-twelve-month consensus estimated free cash flow changes, whether examining performance year-to-date, from the October '23 market low, or from the end of '22 (see Figure 3). Recent price gains have outpaced free cash flow gains for the S&P 500. This comparison of price and valuation change for the headline S&P 500 Index, however, masks an even more exaggerated divergence under the surface in which a small handful of stocks are responsible for the majority of the changes. In the first half of this year, the 15.3% total return (including dividends) for the S&P 500 came entirely from just 60 stocks. Just seven stocks made up 10% of the 15.3% total, with a single stock (NVDA) comprising 30% of the total gain (See Figure 4). Just 7 stocks contributed for 10% of the total S&P 500 15.3% H1 2024 gain and 60 made up the full total with the average stock and S&P 500 Equal Weight lagging well behind. Another way of looking at the unusually concentrated performance of the broader S&P 500 is to compare it to an equally-weighted index of the same stocks. The equal-weighted index has outperformed the standard cap-weighted over time averaging around 1.5% better per year, but it can lag considerably in periods when the largest stocks in the capitalization-weighted benchmark become larger and more expensive as is currently occurring (see Figure 5). Combining YTD performance with last year's figures would be the worst approximately two-year period for the equal weight benchmark relative to the cap weighted S&P 500, with only the combination of 1999 and 1998 being more severe. The equal-weighted S&P 500 typically outperforms the capitalization-weighted version over time, but can lag in periods in which the largest stocks become more expensive. While concentration on its own is not necessarily problematic (though size can make future growth more difficult and incumbency may limit innovation), it is concerning when it is the result of stretched relative valuations, which in our view is very much the case currently. If we add to the Mag 6 (MSFT, NVDA, AAPL, GOOGL, AMZN, META) the next most expensive six stocks with market capitalizations over $250 billion, that group saw a 32.4% increase in market cap in the first half of the year relative to just a 9.5% increase in rolling next-twelve month consensus estimated free cash flows. Valuations for those 12 stocks consequently increased by 21%, accounting for a significant majority of the total increase in market cap1. For the rest of the market that has available free cash flow data, a 4.2% increase in market cap and a 3.7% rise in free cash flows resulted in a negligible expansion in valuation. For the overall S&P 500 (excluding stocks without free cash flow data), 12% of the 14.2% return came from the Big 12 and virtually all of the valuation expansion came from the same small group of stocks (See Figure 6). Distillate's U.S. FSV strategy, by contrast, rose by 4.1% but rolling next-twelve-month free cash flows for the strategy were up 7.9% in the first half. This fundamental increase was actually greater than that of the S&P 500 even with the dominant Big 12 stocks, but was offset by valuation contraction of 3.5% vs. the market's 8.4% increase. Gains in the S&P 500 were dominated by a few select stocks that benefited primarily from valuation expansion. Distillate's U.S. FSV strategy saw a greater gain in fundamentals (measured by Free Cash Flow) than did the S&P 500, but experienced multiple contraction rather than expansion. While Figure 6 shows the valuation expansion that has occurred for a small subset of stocks year-to-date, it does not tell us anything about the richness of those stocks presently. Given significant growth expectations for this group, we can look at multiples on free cash flows further into the future to give them more credit for anticipated 4% gains in sales and free cash flows. For NVDA, for example, sales are projected to grow from $85 billion in the trailing twelve months to $137 billion in the next twelve months and then to $171 billion in the twelve months ending in June of 2026. Considering the valuation on free cash flows over that June 2026 period then gives the stock credit for this expected growth. Even with this growth benefit looking two years into the future, valuations on free cash flows for the twelve months ending June 2026 shows that the group of Big 12 stocks trades at a 74% premium to the rest of the market with several stocks well above that level (See Figure 7). This substantial premium to the rest of the market on estimates that already reflect significant growth expectations looks to be a substantive valuation risk for the overall market. The Big 12 stocks that represent over 40% of the S&P 500 (for which there is free cash data) trade at a 74% premium to the rest of the market on 12-month estimated free cash flows spanning July 2025 to June 2026. While the valuation expansion among a small subset of now very large stocks has meant that the overall S&P 500's valuation has become increasingly rich, the same has not occurred for Distillate's U.S. FSV strategy. This is evident in a longer-term comparison of the free cash flow to enterprise value (EV) on consensus next twelve month estimates in Figure 8. This highlights that the S&P has seen its yield fall sharply to a level that was only previously reached in the middle of the pandemic when estimates were depressed by economic conditions, while the Distillate yield has remained relatively steady around 6% and is actually above where it was when the strategy started in 2017. As the S&P has gotten richer, Distillate's U.S. FSV strategy has not. To compare the valuation for Distillate's U.S. FSV strategy and the S&P 500 even more directly, Figure 9 (next page) plots the difference between the two. This shows that as the market has gotten increasingly expensive driven by a small number of very large stocks, Distillate's adherence to its valuation discipline has led to a substantially widening valuation spread that is now at a record high and well above the 1.5% average since launching in 2017. Distillate's U.S. FSV strategy's NTM FCF to EV valuation is at a record level relative to the S&P 500 benchmark. Among smaller stocks, while there has been some of the same dynamic as in the large cap space where AI enthusiasm has propelled certain stocks higher, it has happened to a much smaller degree in aggregate. Super Micro Computer is the largest small stock in the Russell 2000 and its nearly 200% year-to-date return contributed 1% to the benchmark. While having less AI related stocks has meant much less of a headwind to performance in the small cap space, it has also meant that smaller stocks in general have lagged significantly behind large cap stocks. This is evident in Figure 10 which plots the relative performance of the S&P 500 vs. the Russell 2000 index and shows that larger stocks on this metric are back near where they were roughly a quarter of a century ago. The S&P 500 has sharply outperformed the Russell 2000 recently. While part of the reason that small stocks in aggregate have lagged is that relatively few of these companies are expected to benefit from AI, another element is that small cap benchmarks are bogged down by unprofitable and highly indebted stocks. Almost 15% of stocks in the Russell 2000 benchmark by weight are not expected to generate positive next-twelve-month free cash flows and over 25% of the benchmark trades at a free cash yield on next twelve months of under 2%. Debt is another key issue for small stocks and one that we have written about extensively in the past. Even though smaller stocks have more volatile fundamentals than their larger cap peers and should perhaps therefore carry smaller debt burdens, the opposite is true, and small cap stocks have much higher debt loads on average. As small companies gradually roll low-cost debt issued in the past to more expensive debt, this debt burden is likely to eat into a larger share of profits and increasingly burden the most highly leveraged small companies. Our Small/Mid Quality Value strategy sets out to avoid both of these issues. By being selective on valuation and taking advantage of the wide dispersion in free cash yields among smaller stocks, our Small/Mid Quality Value strategy achieves a free cash flow to enterprise value yield on next twelve month estimates of 8.3% which is more than double the Russell 2000's 3.6%. The strategy does this while also being disciplined on leverage and has a debt burden that is significantly less than that of the small cap benchmarks and the larger S&P 500. Both of these characteristics are plotted in Figure 11 and highlight the degree to which Distillate's Small/Mid Quality Value strategy is differentiated along these lines. Small stocks in aggregate do not look especially attractive vs. large stocks when leverage and negative earning stocks are included, but Distillate's Smid QV strategy does. Fifteen years ago, international stocks were more expensive than U.S. stocks on the basis of a free cash flow yield. They also had more debt and a legacy of less stable cash flow generation. In combination, this made the U.S. look like the clear winner from an investing perspective despite much commentary to the opposite. From the period starting in 2010, this starting valuation advantage and better growth led U.S. stocks to a return of roughly 400% compared to just under 120% for the MSCI All Country World Ex the US Benchmark (MSCI ACWI Ex US). But after this long stretch of underperformance, international stocks are finally less expensive than their U.S. counterparts and the wide range of valuations means that many are considerably cheaper. International stocks do still have more debt and less stable cash flow profiles, but our international strategy seeks to take advantage of this array of attractive valuations by limiting leverage and investing only in companies with stable cash generation. Given some similar dynamics around valuation as in the U.S., our international strategy is likewise now trading at a relative valuation that is at a record premium to its benchmark. This is evident in Figure 12 which shows the growing gap between our strategy's valuation and that of the MSCI ACWI Ex US benchmark (and that of the S&P 500). Distillate's Intl. FSV's FCF/EV yield is well above that of key benchmarks. Our observation is that the current environment on many levels is reminiscent of the late 1990s. AI, like the development of the internet then, could in fact be a transforming technology. Ultimately though, as was the case in the late 1990s, business models must develop that support the capital deployed and the share prices that the market is willing to pay. Then as now, we believe it is paramount to remain disciplined on valuation. Valuation by itself is pretty unhelpful in predicting short-term returns and periods in which valuations look stretched can be both long and painful for value-disciplined investors to endure. This is evident in Figure 13 (going back to when free cash flow data first became available), which compares the trailing free cash flow yield on the overall market to the subsequent market return over the next twelve months. Valuation thus provides little guide to short-term outcomes. The trailing free cash yield does a poor job of predicting 1-year returns. But over the longer term, when the same starting free cash yield from Figure 13 is plotted against 10-year returns, the relationship is quite strong, as is evident in Figure 14. So while the one-year results seem random and free cash flow valuation looks largely irrelevant for the direction of the market, the price paid is of enormous consequence for returns over the long term. Starting valuation does a much better job predicting longer-term returns. With that view, it is worth noting that the S&P 500's current trailing yield of 3.3% ranks in the 14th percentile in the roughly 40-year history of this data. Said differently, the overall market has been less expensive than it is currently 86% of the time. Fortunately, though, because of the enormous dispersion in valuations across the market and the concentration in expensive stocks, investors are not resigned to having to accept this valuation risk and can achieve a much more attractive starting valuation while still emphasizing quality. This is precisely what Distillate's U.S. FSV seeks to do and what the trailing 6% free cash yield attests that it does. Staying true to our valuation discipline has meant our strategy has looked very different from the broad market. At the same time, many of the major benchmarks now look very concentrated and very similar given the dominance of several of the largest stocks. Figure 15 shows the percentage of various benchmarks constituted by the Big 6 stocks and how much overlap there is across holdings of these various indexes and the funds that are linked to them. Only the Russell 1000 Value resembles our U.S. FSV strategy in not owning these six stocks. Though we more closely resemble the value benchmark in that sense and are at our core a value-driven firm, we built our firm in large part because we believe that current value benchmarks and many of the strategies that track them use an outdated valuation measures that would fail to own these Big 6 stocks and other asset-light companies if they were ever to become inexpensive. It was not that long ago that several of them were actually the cheapest stocks in the market on measures of free cash flow and we did own them. The Big 6 make up a large share of many indices, but presently have no weight in Distillate's U.S. FSV Strategy and the Russell 1000 Value benchmark. Ultimately, as in the past, we do not know what might cause the current environment to change, but we believe that also like the past, it will. The fickle nature of markets is why we designed our process around what is knowable -- valuation -- rather than what is not -- sentiment -- and why we will never stray from our philosophy. It is also why we focus on doing what we believe is right in the long term even if it brings short-term frustration.

Madison Covered Call And Equity Income Fund Q2 2024 Investment Strategy Letter

The sectors that drove performance in the index were those that housed the mega-cap leaders such as Technology and Communication Services. Covered Call strategies, by their nature, are defensive. They are structured to knowingly sacrifice a portion of upside growth potential in order to provide additional downside protection. The Madison Covered Call & Equity Income Fund does exactly that by owning a very high quality portfolio of individual equities and selling equity call options on the portfolio holdings. The Fund offers a solid total return platform which includes capital appreciation and a high distribution rate which is primarily sourced from call option premiums and realized capital gains on the underlying portfolio. It is a relatively concentrated, actively managed portfolio, providing a risk-reduced way to participate in US equity markets. Fantasy Vs Reality Noted market strategist Theodor Geisel (aka Dr. Seuss) once said, "Fantasy is a necessary ingredient of living. It's a way of looking at life through the wrong end of a telescope". To us, that seems like an appropriate metaphor to describe the recent condition of the S&P 500. The underlying performance weakness of most index constituents and the steady weakening of economic fundamentals are being completely overshadowed by the dominance of a small number of very large companies. In the most recent quarter, the S&P 500 Index gained 4.3% while 57% of index constituents had negative returns. The equally weighted S&P 500 (compared to the market weighted version) actually fell 2.6%. None of this is new. We've had many periods throughout history of stock markets moving to levels of unsustainable euphoria even while underlying fundamentals deteriorate. It may be fun while it lasts, but the longer this condition persists, the more painful the ensuing reversal. Reminiscent of the dot-com era, anything related to "AI" has been bid significantly higher. The Technology sector peaked in size in early 2000 at 33.6%... It is now at 32.5% and this is without the likes of Alphabet (GOOG) and Meta (META) which were shunted to the Communication Services sector in 2018. The three largest companies in the S&P 500 (Microsoft (MSFT), Nvidia (NVDA) and Apple (AAPL)) make up a record 21% of the index while the top five companies make up over 28%. At the peak of the dot-com bubble, the top three companies (Microsoft (MSFT), General Electric (GE) and Cisco (CSCO)) made up 12% of the S&P 500 weight. Clearly, a very small number of companies have an undue influence on performance and perceived earnings growth of the overall index. In reality, this influence can also work in reverse order. Performance data shown represents past performance. Investment returns and principal value will fluctuate, so that fund shares, when redeemed, may be worth more or less than the original cost. Past performance does not guarantee future results and current performance may be lower or higher than the performance data shown. Visit Madison Funds or call 800.877.6089 to obtain performance data current to the most recent month-end. Click to enlarge While Nvidia and other "AI" related companies have been grabbing the headlines, there has been very little focus on the underperformance of small-cap stocks. The small business sector is an important engine of the economy, representing about 40% of total economic growth and employment. While earnings expectations for large-caps remain relatively steady, estimates for small-caps have continued to slide. For over two years, small business owners have expressed historically low levels of optimism about future business conditions. We ignore such an important portion of our economy at our peril. For now, the fantasy continues. While many may believe that the current state of the market can continue indefinitely, we think that view is short-sighted, the result of looking through the wrong end of the telescope. We would rather be prepared for the inevitable return of reality. That requires flipping the telescope around to be used for its intended purpose... to take in a longer and wider view of the world. Q2 2024 Performance Review Following a brief respite during the first 2 weeks of the quarter, the S&P 500 continued its move higher, setting new all-time highs on a regular basis. The index closed out the quarter with a 4.3% return, adding to the 10.6% move in the first quarter. The main driver of performance continues to be a handful of mega-cap growth companies, with the six largest components of the index rising 17% while the other 494 components in total were down 0.6%. The same S&P 500 measured using equal holding weights was down 2.6%. In comparison, the Madison Covered Call and Equity Income Fund (Class Y) fell 1.1%. The CBOE S&P 500 Buy-Write Index (BXM), being a hedged version of the S&P 500, rose 1.5% in the quarter. The Fund entered the quarter positioned to protect against the end of the narrowly driven market forces, lagging as those forces continued to dominate. The sectors that drove performance in the index were those that housed the mega-cap leaders such as Technology and Communication Services. The Utilities sector rebounded as bond yield tailed off through the quarter. All other sectors were either marginally positive (Consumer Discretionary and Staples) or negative. Given the higher valuation risk in the mega-caps, the Fund has been very lightly positioned in these holdings and therefore did not benefit from their continued momentum. As a result, the Fund was underweighted in the 2 leading sectors, most notably, the Technology sector. The Fund remained focused on more defensive areas in the market such as Utilities, Consumer Staples and Health Care, all of which, aside from Utilities, lagged. The Fund also maintained its overweight in the Energy sector, which was negatively impacted early in the quarter as crude oil prices declined, however, prices reversed higher in the last few weeks of June. Performance of the Fund's individual equity positions lagged relative to index during the quarter. This was as much attributable to what the Fund didn't own compared to what it owned. The Fund has relatively small mega-cap growth exposure and, as such, did not benefit from that leadership group. Areas of weakness included CVS Health (CVS), which guided earnings lower due to higher costs in their Medicare Advantage business unit. Las Vegas Sands underperformed mainly on concerns that China's economic revival appears weaker than hoped. Offshore rig operator, Transocean (RIG), was also weaker primarily due to softer oil prices, as was Apache. Optical equipment manufacturer, Ciena (CIEN), has been a beneficiary of demand for their switches and routers by data centers, however, this has been offset somewhat by short-term weakness from their telecom clients. On the positive side, gold related companies (Newmont (NEM), Barrick (GOLD)), which had struggled earlier in the year, rebounded as the gold price gained over 4% in the quarter and is 16% above its February lows. Air Products (APD) rebounded following a better than feared quarterly earnings report and increased visibility on some of its green hydrogen projects. Renewable utility giant NextEra Energy (NEE) also rebounded strongly in the aftermath of a late 2023 growth downgrade in affiliated company, NextEra Energy Partners LP. From a positioning standpoint, the Fund remained very defensively postured. Call option coverage ended the quarter at 85%, slightly lower than the March level of 89%. Although lower than year-end levels, cash levels have remained high given the dearth of investment ideas at attractive valuations and meaningful option assignment activity due to the rising market. Given the inverted shape of the yield curve, cash is achieving a good rate of return while we await better buying opportunities. With the strong upward move in the market during the quarter, both the option overlay and the cash position were a drag on Fund relative performance. Given its overall defensive posture, the Fund was unable to keep up with the strong market performance during the quarter, however, it performed slightly better than the more broadly positioned S&P 500 Equal Weighed Index. The Fund's income generation capabilities remain strong and its defensive characteristics are positioned to provide a measure of protection against future market dislocation. Outlook In this "big get bigger" world, keeping up with the market has become an exercise in folly for most long only strategies, let alone a strategy such as ours that is defensive and utilizes the option market for a measure of downside protection. Having said that, the narrowness of the market can also work in reverse. If the economic fundamentals continue to worsen and a risk-off posture is adopted by more investors, the sheer size and influence of the mega-caps can result in a much larger than expected drawdown. Valuations of the leaders have become elevated and as much as "AI" is a real phenomenon, its impact must surely be largely priced into market levels at this point. The Federal Reserve may begin cutting rates in the near future, possibly by year-end. Expectations of multiple rates cuts have been high since late last year. Again, rate cuts have been factored into stock prices for quite some time now. If the economy continues to falter and cuts are needed to protect against a possible recession rather than to just increase market liquidity, equities could struggle. In truth, we have been expecting such an environment for several quarters. Our early defensive positioning is likely because we underestimated the impact of two years of excessive money supply growth... it drove risk taking for longer than expected. However, we continue to believe that once that impact has been normalized, the liquidity bubble that has resulted will deflate. How quickly it deflates is unknowable, but we would rather be too defensive in any unwinding scenario than not defensive enough. To paraphrase a well-known saying, "patience can be bitter but its fruit is sweet". We remain patiently defensive. Sincerely, Ray Di Bernardo & Drew Justman Disclosures Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only, and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. The CBOE S&P 500 BuyWrite Index (BXM) is a benchmark designed to track the performance of a hypothetical buy-write strategy (i.e., holding a long position in and selling covered call options on that position) on the S&P 500 Index. The S&P 500® is an unmanaged index of large companies, and is widely regarded as a standard for measuring large-cap and mid-cap U.S. stock-market performance. Results assume the reinvestment of all capital gain and dividend distributions. Yield Curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. There are three main types of yield curve shapes: normal (upward sloping curve), inverted (downward sloping curve) and flat. Yield curve strategies involve positioning a portfolio to capitalize on expected changes. "Madison" and/or "Madison Investments" is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC ("MAM"), and Madison Investment Advisors, LLC ("MIA"). MAM and MIA are registered as investment advisers with the U.S. Securities and Exchange Commission. Madison Funds are distributed by MFD Distributor, LLC. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison's toll-free number is 800-767-0300. Any performance data shown represents past performance. Past performance is no guarantee of future results. Non-deposit investment products are not federally insured, involve investment risk, may lose value and are not obligations of, or guaranteed by, any financial institution. Investment returns and principal value will fluctuate. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Consider the investment objectives, risks, and charges and expenses of Madison Funds carefully before investing. Each fund's prospectus contains this and other information about the fund. Call 800.877.6089 or visit Madison Funds to obtain a prospectus and read it carefully before investing. Although the information in this report has been obtained from sources that the firm believes to be reliable, we do not guarantee its accuracy, and any such information may be incomplete or condensed. All opinions included in the report constitute the authors' judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Madison Asset Management, LLC does not provide investment advice directly to shareholders of the Madison Funds. Opinions stated are informational only and should not be taken as investment recommendation or advice of any kind whatsoever (whether impartial or otherwise). Madison Funds are distributed by MFD Distributor, LLC, member FINRA. Madison-571129-2024-07-10 Click to enlarge Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. Madison Investments is 100% employee-owned and has been based in Wisconsin's capital city since its founding in 1974. In that time, Madison has grown from a local firm into a manager entrusted with approximately $22 billion in assets across a suite of mutual funds, active ETFs, managed accounts and customized portfolios.