Commentary: Large Cap Value ESG Strategy

• U.S. equities delivered solid gains in a quarter marked by a return to AI market leadership, benefiting Strategy top contributors, while stock-specific headwinds in health care and industrials challenged relative results.
• Value has historically recovered following periods of sizeable underperformance versus growth such as during the first quarter of 2025; we view the current market opportunity to be particularly favorable for disciplined long-term-focused stock pickers with a focus on value stocks.
• Company engagements are a key pillar in ClearBridge’s climate strategy as we seek to understand and manage company-specific climate-related risks and opportunities.

U.S. equities bounced back from a first-quarter correction and survived tariff and growth scares as well as geopolitical concerns to deliver solid gains in the second quarter of 2025. The rebound following April’s tariff-induced Liberation Day selloff was marked by a return to AI market leadership, with hyperscalers showing their commitment to high levels of AI-driven capex. Semiconductor companies also benefited amid solid earnings and renewed expectations of widespread adoption of AI.

This trend was positive for our main contributors in the quarter such as Broadcom. Renewed enthusiasm for AI buildouts has benefited Broadcom tremendously as its custom-designed chips have continued to gain broader adoption with hyperscalers as an alternative to Nvidia’s dominant graphics processing units in AI applications. Broadcom shares also rallied with the reduction of retaliatory tariffs between the U.S. and China, which had weighed on semiconductor manufacturers.

Elsewhere within IT, the portfolio benefited from the strong financial results of Microchip Technology, a leading manufacturer of analog semiconductors and microcontrollers used for automotive, industrial, consumer electronics and aerospace and defense applications. After the recent return of long-tenured CEO Steve Sanghi, Microchip has gained momentum in its early turnaround efforts while also benefiting from a long-overdue cyclical rebound.

Also buoyed by its AI leadership position, Meta Platforms shares rose as its latest earnings showed continued secular digital advertising share gains across its leading social media networks, with AI benefiting both engagement and monetization across its platforms.

"We continue to position the portfolio for all macro environments, prioritizing stock-level decisions." 

Stock-specific headwinds led to overall underperformance in the quarter, however, especially within health care and industrials. UnitedHealth Group continued to underperform as higher utilization rates, primarily among its Medicare Advantage business, weighed on its insurance and provider network businesses. Concerns of poor execution were exacerbated by the resignation of its CEO and federal lawsuits against pharmacy benefit managers such as UnitedHealth’s OptumRx. Medical devices, laboratory equipment and diagnostic products maker Becton Dickinson reported marginally slower than expected organic sales growth across its portfolio, in part driven by headwinds from its China operations and by a lower global research funding environment for its biosciences division; a slight reduction in expected earnings resulted in a dramatic multiple contraction. Thermo Fisher Scientific, which provides life sciences solutions, analytical instruments, specialty diagnostics and laboratory products and biopharma services, lagged due to concerns around spending cuts in the academic/government and biopharma segments due to regulatory fears from tariffs and most-favored nation drug pricing. Conversely, drug distributor McKesson was a strong contributor, as it continued to benefit from strong U.S. pharma and specialty distribution fundamentals, including prescription volumes and stable pricing.

In industrials, we do not hold any aerospace and defense stocks, which performed well, and we are underweight a narrow group of higher-momentum stocks benefiting from AI demand for power (with the exception of electrification enabler Eaton). This more conservative positioning was a relative headwind in the quarter. Strong performance of Eaton, less-than-truckload freight company XPO, diversified industrial and aerospace company Parker Hannifin and agricultural equipment maker Deere failed to make up for the portfolio’s defense and AI underweight in the sector.

Positioning moves were minimal in the quarter, with larger moves concentrated in the consumer staples sector. We bought Procter & Gamble, which has traded down with consumer staples stocks amid fears of inflation, tariffs, pricing weakness and a recession. Procter & Gamble is a higher-quality name, however, and with guidance and estimates recently reset and the stock trading at a valuation discount rather than its usual premium, it should serve as ballast to the portfolio in a choppier environment and support steady growth as conditions improve. We funded the purchase by trimming PepsiCo, where we sought to reduce exposure given structural concerns in its U.S. business and a needed turnaround in its Frito Lay division.

We recognize we are in period of elevated geopolitical and policy uncertainty, and during such periods raised perceptions of risk can shorten the time horizon over which investors make decisions. We caution against doing this, however, and stick to our process of finding best-in-class franchises trading at attractive valuations that can offer compelling, risk-adjusted returns over the long haul. We continue to position the portfolio for all macro environments, prioritizing stock-level decisions as opposed to those based on factor bets or macroeconomic predictions.

The strong recovery, in particular for momentum stocks, following the “Liberation Day” tariff selloff has widened the valuation disparity not only between growth and value stocks but also between the “sainted few” and the rest of the value universe to levels not seeing in decades. We believe such valuation gaps are unlikely to persist over the long term. Value has historically recovered following periods of sizeable (-25%) underperformance versus growth; this threshold was triggered during the first quarter of 2025 (Exhibit 1).

Exhibit 1: Value Down but Not Out

Thus, we view the current market opportunity to be particularly favorable for disciplined long-term-focused stock pickers with a focus on value stocks, and we continue to use the opportunity to recycle capital from stocks that have benefited from recent factor-based trends into high-quality companies that we expect to do well over the coming years.

The ClearBridge Large Cap Value ESG Strategy modestly underperformed its Russell 1000 Value Index benchmark during the second quarter. On an absolute basis, the Strategy had positive contributions from seven of the 11 sectors in which it was invested for the quarter. The IT and financials sectors made the main positive contributions, while the health care sector was the main detractor.

On a relative basis, overall stock selection detracted from performance, while sector allocation was positive. In particular, stock selection in the industrials, health care, consumer staples and consumer discretionary sectors and a health care overweight weighed on relative returns. Conversely, stock selection in the IT, energy and communication services sectors and an energy underweight proved beneficial.

On an individual stock basis, the largest relative contributors were Broadcom, Microchip Technology, Eaton, JPMorgan Chase and Meta Platforms. Positions in Becton Dickinson, UnitedHealth Group, Air Products and Chemicals, PepsiCo and Edison International were the main relative detractors.

For almost 40 years ClearBridge has been incorporating climate risks and opportunities into our fundamental investment strategy. As climate has become more and more relevant in our portfolios, we have taken steps to enhance our process and ensure material climate metrics are appropriately captured.

Company engagements are a key pillar in ClearBridge’s climate strategy as we seek to understand and manage company-specific climate-related risks and opportunities. ClearBridge engagements on environmental, social and governance (ESG) topics generally have two overlapping objectives:

1. Research: Gaining a better understanding of ESG issues that could impact our investment thesis.

2. Impact: Encouraging specific changes at the company to better align its operations with sustainability best practices.

Across these two objectives, our engagements span many different climate-related topics (Exhibit 6), with engagements primarily focused on higher-emitting sectors.

Exhibit 2: Top Environmental Factors Engaged Upon in 2024

ClearBridge’s model for ESG integration, which includes ESG discussions as part of fundamental company research led by our investment teams, allows climate-related engagements to be thoughtful and well-rounded discussions on climate topics. As the following examples show, our analysts and portfolio managers cover very different topics in discussions with companies in very different sectors while still focusing both on companies’ climate strategies and the connection of these strategies to the companies’ business case.

Microsoft: Powering AI Responsibly

In November 2024, ClearBridge held a call with Microsoft’s sustainability investor liaison to discuss shareholder concerns on energy efficiency, as with the huge growth of AI has come a massive demand in energy as well. We discussed Microsoft’s AI energy needs and its goals to become carbon negative. Microsoft reconfirmed its commitment to achieving its climate goals with its recently announced power purchase agreement for nuclear power with Constellation Energy, which involves restarting Three Mile Island. Microsoft clarified it won’t own or operate this facility, but will be a customer of Constellation, with which Microsoft has maintained strong supplier conduct statements. When asked about safety concerns, Microsoft explained the reactor slated to be restarted was functioning safely and effectively for decades before being turned off for economic reasons in 2018. This represents a significant part of Microsoft’s commitment to nuclear power. The company sees this agreement as part of achieving its 2030 and 2050 carbon emissions targets (for net negative emissions).

As it relates to renewables, Microsoft continues to encounter the issue of intermittency (as do peers). It is conducting research on power battery storage and other mechanisms to solve this issue and includes deals for wind and solar in its portfolio approach to its power generation needs.

We were encouraged to hear Microsoft is still committed to bringing carbon emissions back down as energy needs increase. Since this engagement, Microsoft has also announced many agreements to purchase offsets, as the energy efficiency of AI, particularly in data centers, is still a challenge. We continue to see Microsoft’s climate strategy as leading among peers and will continue to engage with the company on this topic.

Amazon.com: A Fully Integrated Approach to Climate

In September 2024, ClearBridge joined Amazon for a group discussion with the company’s ESG and Energy Sustainability teams as part of Climate Week to discuss Amazon’s environmental strategy. Amazon went into the many components of its company-wide initiative to achieve net zero by 2040. Each business unit — grocery, studios, AWS — has dedicated sustainability leads, with a team led by Head of Energy and Sustainable Operations Chris Roe ensuring carbon goals are embedded in annual plans and reviewed by leadership. In setting its strategy, Amazon focuses on metrics specific to different business units like carbon per dollar of gross merchandise value (GMV) in retail and per unit of compute in AWS. Amazon has also launched a $2 billion fund to accelerate decarbonization technologies into commercial products.

Cost and carbon are highly correlated in Amazon’s climate strategy as retail operations get more efficient. Major challenges include reducing Scope 1 emissions from middle-mile logistics, where diesel trucks remain a bottleneck. However, progress is evident in last-mile delivery: 680 million packages were delivered by EVs in the previous year. Efficiency gains in packaging have also led to a 40% reduction in packaging waste over nine years.

Internally, Amazon uses climate risk models to anticipate energy usage and drive real estate design. Factors in the models include generative AI’s future energy needs, growth of Amazon’s fleet, locations of logistics facilities and water availability for different sites.

While ClearBridge encourages emissions reduction targets aligned with the Science-Based Targets initiative (SBTi), Amazon appears to have a responsible approach of setting internal science-based targets per business unit, although these are not formally verified by the SBTi. Amazon does, however, work with both SBTi and academics to align with International Energy Agency pathways. The company avoids offsets for interim targets, reserving removals like direct air capture for residual emissions — which are expected to be mostly Scope 3 by 2040.

This discussion provided us with a better understanding of Amazon’s climate strategy and we remain positive about its climate efforts. Our biggest takeaway was how well resourced and data driven Amazon’s climate efforts are from an organizational standpoint, driving down the cost/carbon impact per dollar of value with the value metrics being defined at a segment level: e.g., carbon footprint per unit of compute for AWS or per dollar of GMV in Retail.