August 13, 2022

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Clearbridge Investments Mid Cap Strategy Q1 2022 Commentary

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Current market Overview and Outlook

Markets observed elevated degrees of uncertainty and volatility all through the quarter, placing stress on mid cap shares. The S&P 500 Index declined 4.60% for the interval, while the benchmark Russell Midcap Index fell 5.68%. With macro catalysts restricting visibility into sector effectiveness, buyers continued to favor worth shares above advancement, with the Russell Midcap Worth Index returning -1.82%, outperforming the Russell Midcap Development Index by over 1,000 basis factors.

Even the very best operate providers have struggled to navigate the world wide turmoil, inflation and offer chain disruptions noticed during the quarter. Uncertainty about the clinical and economic affect of the COVID-19 Omicron variant weighed on effectiveness in the commencing of the time period. Having said that, these worries pivoted to the effect of rising inflation, exacerbated by ongoing labor shortages, which brought on shopper prices to working experience the maximum year-more than-year enhance in 40 decades. To mood inflationary pressures, Fed policymakers raised rates for the very first time given that 2018 but Fed Chair Powell’s recommendation of a a lot more intense mountaineering cycle released even further coverage uncertainty.

Russia’s invasion of Ukraine in February spurred more problems to global provide chain disruptions and will increase in commodity and electricity price ranges, contributing to higher world inflation. The conflict has increased the chance of a economic downturn in Europe that could unfold to other made economies.

Finally, this rapid succession of big macro drivers has established a tough environment to navigate.

From a sector standpoint, vitality (+40.45%) was the very best performer in the benchmark, adopted distantly by purchaser staples (+5.49%), utilities (+3.69%) and materials (+3.50%). The financials (-3.53%) and real estate (-4.55%) sectors lagged, but continue to outperformed the broader Russell Midcap Index. Buyer discretionary (-14.50%) was the worst undertaking sector in the benchmark, followed by information and facts technologies (IT, -11.16%), interaction expert services (-10.13%), wellness care (-9.95%) and industrials (-9.69%).

Our underweight to the energy sector weighed on efficiency, as electrical power rates skyrocketed from inflationary pressures and the danger of lowered offer. We have a confined footprint within the sector but proceed to appear for corporations that will crank out robust, prolonged-term returns this kind of as Pioneer Organic Sources.

Pioneer is an oil and gasoline exploration and output corporation that gives a combination of a solid asset foundation, top quality harmony sheet and powerful free of charge hard cash move generate at current commodity prices. We consider Pioneer has sturdy fundamental motorists that will deliver desirable risk-modified returns over and above shorter-term fluctuations in strength price ranges.

The Strategy’s IT holdings had been a beneficial contributor in the course of the quarter. This provided firms these kinds of as Aspen Technological know-how (AZPN), a leader in asset optimization solutions and software program for money- intense industrial industries. The enhance in vitality creation offered a tailwind to the stock cost, as the company’s application is utilized by quite a few vitality producers. Splunk (SPLK), a info analytics software business, noticed its share price climb right after potent fourth quarter earnings which exceeded analyst expectations and the set up of a new, business veteran CEO. Splunk has robust momentum motorists in its cloud platform and heightened safety imperatives that ought to deliver a robust expansion runway for the firm in excess of the up coming number of many years.

Portfolio Positioning

We carry on to be energetic in refining our portfolio positioning and looking for the most attractive companies throughout the industry.

Though we recognize that macro catalysts will have some affect on sectors, our course of action and philosophy of looking for excellent value by superior-high-quality providers has not improved. We have a sturdy pipeline of potential candidates and stand at the prepared to acquire action when we see possibilities to increase the portfolio’s risk-return profile.

We initiated a new placement in Bloomin’ Brand names (BLMN), in the purchaser discretionary sector. The proprietor and operator of upscale informal dining manufacturers, like Outback Steakhouse and Bonefish Grill, the enterprise used the worries of the COVID-19 pandemic to apply new productivity functions for its waitstaff and aim on enhancing corporate margins. As we changeover from pandemic to endemic, the firm ought to be ready to meet the rebound in restaurant attendance with an improved value framework and improved working leverage. We imagine these very long-expression advancements and improved need for eating are not mirrored in the recent share selling price.

We also initiated a new placement in Workiva (WK) in the IT sector. The firm delivers cloud-based compliance and regulatory software program that will allow users to improve the efficiency and efficiency of their reporting. It is the field leader with around 50% sector share for its reporting software and is earning significant development in growing its geographical footprint outdoors the U.S. Workiva is also functioning to grow its product or service choices into ESG reporting to meet the growing desire from U.S. businesses and satisfy new EU polices. As this sort of, we see an beautiful growth runway as a strong returns compounder in excess of the foreseeable long term.

We exited our situation in Old Dominion Freight Lines (ODFL), in the industrial sector. Though our belief of the freight carrier’s enterprise top quality is unchanged, we believe the stock’s recent value displays a lot less probable than some of the new chances we have been analyzing.

Outlook

This unparalleled, immediate succession of macro gatherings has injected elevated uncertainty into the markets and shifted traders to favor undifferentiated, value-using companies about increased-high quality enterprises with solid fundamentals. Even though navigating this cacophony of dangers has established tough, we will leverage this possibility to further refine our analysis with new knowledge and continue to target on investing in superior-high quality companies with interesting extensive-expression worth generation options. We are assured in our recent portfolio construction and consider our holdings will persevere by these short-expression worries and assist prolonged- expression performance.

Portfolio Highlights

The ClearBridge Mid Cap Strategy underperformed its Russell Midcap Index all through the very first quarter. On an absolute foundation, the Strategy experienced losses across eight of the 11 sectors in which it was invested throughout the quarter. The foremost detractors had been the industrials and client discretionary sectors, even though the top contributor was the vitality sector.

On a relative basis, total stock selection and sector allocation detracted from effectiveness. Exclusively, stock assortment in the industrials, supplies, buyer discretionary, wellbeing treatment, genuine estate and financials sectors and an underweight allocation to the energy sector weighed on returns. Conversely, stock choice in the IT sector contributed to returns.

On an person inventory basis, the most significant contributors to absolute returns in the quarter were Pioneer Normal Assets (PXD), Splunk, Functionality Meals Team (PFGC), Arch Cash (ACGL) and SolarEdge Technologies (SEDG). The greatest detractors from absolute returns have been Vertiv (VRT), Aptiv (APTV), Western Alliance Bancorp (WAL), Carvana (CVNA) and Black Knight (BKI).

In addition to the transactions listed above, we initiated a position in Coty (COTY) in the purchaser staples sector, SailPoint Systems (SAIL) in the IT sector, 6 Flags Amusement (Six) in the client discretionary sector and Blue Owl Capital (OWL) in the financials sector. We also exited positions in Purple Innovation (PRPL), Carnival (CCL) and Lear (LEA) in the client discretionary sector.

Editor’s Notice: The summary bullets for this post had been selected by Trying to find Alpha editors.