Clearbridge Investments Q1 2022 Mid Cap Strategy Commentary

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Market overview and outlook

Markets experienced high levels of uncertainty and volatility during the quarter, which put pressure on mid-cap stocks. The S&P 500 Index fell 4.60% for the period, while the benchmark Russell Midcap Index fell 5.68%. With macro As catalysts limited visibility into market performance, investors continued to favor value stocks over growth, with the Russell Midcap Value Index returning -1.82%, outperforming the Russell Midcap Growth Index by more than 1,000 basis points.

Even the best-run companies struggled through the global turmoil, inflation and supply chain disruptions seen in the quarter. Uncertainty over the medical and economic impact of the COVID-19 Omicron variant weighed on performance early in the period. However, these concerns hinged on the impact of rising inflation, exacerbated by continuing labor shortages, which caused consumer prices to see the biggest increase ever. year to year in 40 years. To temper inflationary pressures, Fed policymakers raised rates for the first time since 2018, but Fed Chair Powell’s suggestion of a more aggressive hike cycle introduced additional policy uncertainty.

Russia’s invasion of Ukraine in February led to further complications from global supply chain disruptions and increases in commodity and energy prices, contributing to higher global inflation. The conflict has increased the likelihood of a recession in Europe which could spread to other developed economies.

Ultimately, this rapid succession of great macro pilots created a difficult environment to navigate.

From a sector perspective, Energy (+40.45%) was the best performer in the benchmark, followed distantly by Consumer Staples (+5.49%), Utilities ( +3.69%) and materials (+3.50%). The financials (-3.53%) and real estate (-4.55%) sectors lagged, but still outperformed the broader Russell Midcap Index. Consumer Discretionary (-14.50%) was the worst performing sector in the benchmark, followed by Information Technology (IT, -11.16%), Communication Services (-10.13 %), healthcare (-9.95%) and industrials (-9.69%) .

Our underweight to the energy sector detracted from performance as energy prices soared on inflationary pressures and the threat of reduced supply. We have a limited presence in the sector, but we continue to look for companies that will generate strong returns over the long term, such as Pioneer Natural Resources.

Pioneer is an oil and gas exploration and production company that offers a combination of a strong asset base, quality balance sheet and compelling free cash flow performance at current commodity prices. We believe Pioneer has strong underlying drivers that will generate attractive risk-adjusted returns beyond short-term swings in energy prices.

The Strategy’s IT holdings contributed positively during the quarter. This included companies such as Aspen Technology (AZPN), a leader in asset optimization solutions and software for capital-intensive industrial industries. The increase in energy production boosted the stock price, as the company’s software is used by many energy producers. Splunk (SPLK), a data analytics software company, saw its share price soar after strong fourth-quarter results that beat analysts’ expectations and the installation of a new industry veteran CEO industry. Splunk has strong momentum drivers in its cloud platform and heightened security requirements that should provide a strong growth avenue for the company over the next few years.

Portfolio positioning

We continue to be active in refining our portfolio positioning and seeking out the most attractive companies in the market.

While we recognize that macroeconomic catalysts will have some influence on sectors, our process and philosophy of finding exceptional value through high quality companies has not changed. We have a strong pool of potential candidates and are ready to act when we see opportunities to improve the risk-return profile of the portfolio.

We initiated a new position in Bloomin’ Brands (BLMN), in the consumer discretionary sector. Owner and operator of high-end casual dining brands including Outback Steakhouse and Bonefish Grill, the company has taken advantage of the challenges of the COVID-19 pandemic to implement new productivity operations for its service staff and focus on improving the company’s margins. As we transition from pandemic to endemic, the business should be able to respond to the rebound in restaurant footfall with an improved cost structure and better operating leverage. We believe these long-term improvements and increased demand for restoration are not reflected in the current share price.

We also initiated a new position in Workiva (WK) in the IT sector. The company provides cloud-based compliance and regulatory software that enables users to improve their reporting productivity and efficiency. It is the industry leader with over 50% market share for its reporting software and is making significant progress in expanding its geographic footprint outside of the United States Workiva is also working to expand its product offerings in the ESG reporting to meet the growing demand from American companies and to meet new European regulations. As such, we see an attractive growth streak as a driver of strong returns for the foreseeable future.

We exited our position in Old Dominion Freight Lines (ODFL), in the industrial sector. While our view on the cargo carrier’s business quality remains unchanged, we believe the current share price reflects less potential than some of the new opportunities we have assessed.

Outlook

This rapid and unprecedented succession of macroeconomic events injected elevated uncertainty into the markets and caused investors to favor undifferentiated, price-taking companies at the expense of higher quality companies with strong fundamentals. While navigating this cacophony of risk has proven difficult, we will use this opportunity to further refine our analysis with new data and continue to focus on investing in high-quality companies that offer attractive opportunities to create long-term value. We are confident in the construction of our current portfolio and believe that our holdings will weather these short-term challenges and support long-term performance.

Portfolio Highlights

The ClearBridge Mid Cap strategy underperformed its Russell Midcap index during the first quarter. On an absolute basis, the Strategy recorded losses in eight of the 11 sectors in which it was invested during the quarter. The main detractors were the industrials and consumer discretionary sectors, while the main contributor was the energy sector.

On a relative basis, overall stock selection and sector allocation detracted from performance. Specifically, stock selection in the Industrials, Materials, Consumer Discretionary, Healthcare, Real Estate and Financials sectors and an underweight in the Energy sector weighed on performance. returns. Conversely, stock selection in the information technology sector contributed to returns.

On an individual stock basis, the top contributors to absolute returns in the quarter were Pioneer Natural Resources (PXD), Splunk, Performance Food Group (PFGC), Arch Capital (ACGL) and SolarEdge Technologies (SEDG). The biggest detractors from absolute returns were 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 consumer staples sector, SailPoint Technologies (SAIL) in the IT sector, Six Flags Entertainment (SIX) in the consumer sector discretionary and Blue Owl Capital (OWL) in the financial sector. We also exited our positions in Purple Innovation (PRPL), Carnival (CCL) and Lear (LEA) in the consumer discretionary sector.

Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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