Commentary: All Cap Growth Strategy

• With bond yields falling, growth remained in favor during the quarter, capping a year that saw large cap growth stocks top large value stocks by the second-largest margin in history.
• The Strategy outperformed, supported by broad contributions across the technology and communication services sectors.
• We believe broadening participation and an expected increase in volatility will be supportive of our diversified approach, leading us to increase exposure to both faster growing, higher beta names as well as durable compounders in the IT and industrials sectors.

Stocks rose strongly in the fourth quarter, boosted by plunging bond yields and growing optimism that the U.S. economy will pull off a soft landing. Signs of cooling inflation and a slowing labor market not only reversed a two-year climb in yields but also increased the likelihood that the Federal Reserve had completed its tightening cycle, sending the S&P 500 Index 11.69% higher.

With the 10-year Treasury yield declining 70 basis points (bps) during the quarter, growth remained in favor among larger cap stocks with the benchmark Russell 3000 Growth Index rising 14.09% and outperforming the Russell 3000 Value Index by 426 bps. Easing financial conditions also led to improving market breadth, with the Russell Midcap Growth Index rising 14.55%.

Much of that differential can be attributed to the performance of the Magnificent Seven (Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia and Tesla), a basket of mega cap growth stocks that accounted for a significant portion of the benchmark return for the quarter and the year.

The ClearBridge All Cap Growth Strategy maintains exposure to six of the seven stocks, with overweights in Amazon.com and Meta. Those stocks, as well as Microsoft and Nvidia, were among the leading contributors to Strategy performance for the quarter. We also saw support from IT holdings lower down the market cap spectrum, including Broadcom, CrowdStrike and Palo Alto Networks.

The recent market upswing enabled us to harvest profits from some of our larger holdings and put the proceeds to work across two new positions. New purchase Cintas maintains a leading position in a fragmented, $40 billion market for uniform rental and facilities services. The company’s scale gives it better purchasing power, route density and technology, which have historically led to better price and service levels. Its position also enables industry-leading retention rates and sustainably higher returns on invested capital. Finally, Cintas has demonstrated a strong track record of improving margins. This addition not only supports our efforts to increase the aggregate quality and growth of the portfolio, but also acts to further diversify our industry exposures.

Application software is an area where we have seen success with disruptors HubSpot and CrowdStrike. New addition ServiceNow is a leading provider of workflow automation software. We see the company as a key enabler of modernization and digital transformation, which is well-positioned as enterprises look to converge on a single platform solution. Despite its sizable customer base, we believe ServiceNow still has substantial room to expand spending with existing customers, as most have not fully leveraged its full product suite. We also are encouraged by the company’s strong leadership team and history of innovation which should enable it to continue to expand wallet share. Additionally, despite ongoing investments in growth, ServiceNow continues to drive healthy operating leverage.

We sold Unity Software, a name purchased in early 2022 to participate in the growth of the global video game market, as our thesis no longer remains valid. Via M&A, Unity has diversified away from its game engine subscription business into the less differentiated advertising segment and most recently saw negative customer reaction to price increases, calling into question the offering’s pricing power.

After the first three quarters of market returns dominated by the Magnificent Seven, market breadth improved to end 2023. While AI will remain a key trend supporting parts of technology, we believe broadening participation should be beneficial to our diversified approach. After healthy returns in 2023, parts of the IT sector, for example, appear fairly valued, leading to better risk/reward opportunities in other areas outside of technology and shadow tech.

Our discussions with company managements point to a broad macro deceleration, from package volumes at UPS, to weaker iPhone sales at Apple and weaker food revenues at Target. In addition, price cuts are no longer stimulating demand and costs are not falling as much as revenue. Taken together, we expect this to lead to greater volatility in the year ahead.

Against this backdrop, we want to own growth companies with cash flow support. Given our commitment to balance and active approach to portfolio construction, we remain opportunistic in seeking out good growth businesses that can improve the quality and growth profile of the portfolio. High on our watchlist heading into the new year are companies in the consumer discretionary and industrials sectors as well as financials which are less interest-rate sensitive.

The ClearBridge All Cap Growth Strategy outperformed its benchmark in the fourth quarter. On an absolute basis, the Strategy posted gains across the nine sectors in which it was invested (out of 11 sectors total). The primary contributors to performance came from the IT sector.

Relative to the benchmark, overall stock selection contributed to performance. In particular, stock selection in the IT, communication services and industrials sectors drove results. Conversely, an overweight to the health care sector and stock selection in real estate detracted from performance.

On an individual stock basis, the leading absolute contributors were positions in Amazon.com, Broadcom, Microsoft, CrowdStrike and Netflix. The primary detractors were Aptiv, Match Group, Comcast, Guardant Health and Biogen.

In addition to the transactions mentioned above, we closed a position in Warner Bros. Discovery in the communication services sector.