Commentary: Growth Strategy

• The relative outperformance of mid cap growth stocks versus large and small cap growth through the first quarter correction is an important indicator of a broadening market and creates compelling opportunities for high active share managers like ourselves.
• The Strategy marginally underperformed as weakness among our information technology and consumer staples holdings was counteracted by solid performance from a cohort of durable compounders with defensive characteristics.
• We took advantage of the market dislocation to add oversold stocks in utilities and consumer discretionary while opportunistically scaling up newer positions. We also enhanced our focus on higher-conviction names by exiting five smaller positions with less predictable growth prospects.

Equities sold off sharply in the first quarter, with volatility accelerating into April, as a rotation out of mega caps followed by a raft of U.S. tariff actions raised fears of an economic slowdown and higher inflation. The large cap S&P 500 Index declined 4.27% while the small cap Russell 2000 Index fell 9.48%. While growth stocks suffered the widest losses, the “mid cap plus” segment of growth stocks we target, most of which reside in the benchmark Russell Midcap Growth Index (-7.12%), held up better than both the Russell 1000 Growth Index (-9.97%) and Russell 2000 Growth Index (-11.12%).

We believe the relative outperformance of mid cap growth stocks is an important indicator of a broadening market environment. The unwind of the generative AI trade beginning in January was sparked by the introduction of China’s DeepSeek, a large language model built more cheaply and efficiently than those of the Magnificent Seven. We see this shift away from the mega cap leaders of the last two years creating compelling opportunities for high active share managers like ourselves.

The ClearBridge Growth Strategy marginally underperformed the benchmark in the first quarter. While we do not manage the Strategy for a specific investment environment, we expect it to hold up well relative to our benchmark through turbulent periods. We believe such resilience is developed from a focus on quality, balance sheet strength, durability of profitable growth and free cash flow generation. Our balanced, pyramid of growth approach to portfolio construction also contributes to risk management.

This balance was on display in the first three months of the year as weakness among our information technology (IT) and consumer staples holdings was counteracted by solid performance from a cohort of durable compounders with defensive characteristics led by longtime health care holdings Vertex Pharmaceuticals and UnitedHealth Group. Two newer positions also held up well: uniform and workplace products provider, Cintas, and off-price apparel retailer, TJX. Cintas delivered strong quarterly results with organic growth and margin improvement ahead of expectations. The company cited several new business wins driven by cost savings, a value proposition that is particularly salient in today’s more uncertain macro environment. TJX also put up a high-quality beat and has become a relative safe haven for investors amid elevated recession fears. The company has historically benefited from trade-down and inventory availability during periods of weaker consumer spending.

A handful of holdings indexed to AI and/or federal government contracts, including semiconductor maker Broadcom, software developer ServiceNow as well as Vertiv, a provider of HVAC services to data centers, endured losses. While we continue to believe that the arms race and value unlock from AI will provide a multiyear tailwind to a number of companies in our coverage, we remain disciplined in our approach to managing this as well as other thematic exposures in the portfolio to ensure we are not overly exposed to any one trend.

As active managers, we can take advantage of market dislocations to buy quality names at attractive levels. During the quarter, we opportunistically scaled up newer positions such as Palantir Technologies and Robinhood Markets. Volatility also created entry points to motivate our first purchase in the utility sector, Vistra, as well as reduce our underweight to the consumer discretionary sector with the addition of CAVA Group.

Vistra is the largest competitive power generator in the U.S. with a 41 GW fleet of power plants diversified by geography and fuel sources. Long-term fundamentals of the deregulated power markets remain constructive with Vistra well positioned to benefit from continued tightening in its primary PJM (Pennsylvania, New Jersey, Maryland Interconnection) and ERCOT (Texas) markets. Pending regulatory clarity could also pave the way for additional power purchase agreements with hyperscalers and act as a positive catalyst for independent power producer stocks. These agreements, in combination with federal subsidies for nuclear plants, have the potential to improve visibility and lower earnings variability across the industry.

CAVA is a domestic fast casual restaurant chain focused on Mediterranean-inspired cuisine. Its unit economics and strong same-store sales growth are reminiscent of Chipotle when it was of similar size. We believe the company is still in the early stages of achieving its unit growth potential and see opportunity for continued same store sales growth as brand awareness rises and new stores ramp productivity.

The sales of AbbVie and Ionis Pharmaceuticals consolidate our exposures within health care toward companies with more attractive and predictable long-term growth prospects. Both companies face slowing growth — AbbVie due to the loss of exclusivity of Humira and the maturing of several of their existing franchises and Ionis due to waning sales for its drug for spinal muscular atrophy, Spinraza. We took advantage of the recent rally in AbbVie to exit as increasing reliance on pipeline and new product execution to support share appreciation make the risk/reward less attractive from here. Similarly, we sold out of Ionis as management’s capital allocation decisions reduced our conviction in the company’s ability to sustain profitable growth.

We dialed back our cyclical IT exposure with the sales of Seagate Technology and Western Digital. While still leaders in data storage, we sold both names in favor of opportunities with more durable growth and sustainable competitive advantages. We also exited Dolby Laboratories, a leader in audio and visual technology, as we see a challenging environment for consumer electronics constraining organic growth.

In a period of increased macro uncertainty, we regularly evaluate our existing positions and portfolio construction to ensure the Strategy is positioned well for various economic scenarios. We seek a balanced approach to growth to offer clients the right mix of offense and defense, which should serve them well through the course of a market cycle.

We believe the market correction that picked up speed to start the second quarter will lead to a reprioritization among investors toward growth stocks built on sound, profitable business models. This is the way we have managed shareholder capital in our Strategy for more than four decades, by owning cash-flow-generating businesses run by experienced management teams. Those businesses that can continue to invest through downturns and improve productivity and returns for their clients and customers can deepen and even extend their competitive moats during uncertain macro environments. As longer-term investors, we can similarly use dislocations created by broad market selloffs to better position the portfolio for the next upcycle of growth.

The ClearBridge Growth Strategy underperformed its Russell Midcap Growth Index benchmark in the first quarter. On an absolute basis, the Strategy experienced losses across eight of the nine sectors in which it was invested (out of 11 sectors total). The lone contributor to performance was the health care sector while IT was the main detractor.

Relative to the benchmark, stock selection contributed to performance but was offset by negative sector allocation effects. In particular, stock selection in the communication services, health care and consumer discretionary sectors aided results while selection in IT and consumer staples detracted from performance. From an allocation standpoint, an overweight to communication services and lack of exposure to the energy sector were detrimental.

On an individual stock basis, the leading absolute contributors to performance were Vertex Pharmaceuticals, CrowdStrike, TKO Group, Cintas and UnitedHealth Group. The primary detractors were Broadcom, Vertiv, HubSpot, ServiceNow and e.l.f. Beauty.