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Commentary

SMID Cap Growth Strategy

Second Quarter 2019

Key Takeaways
  • SMID cap growth stocks were among the best performers in the market as investors expressed a strong preference for companies able to generate organic growth.
  • The portfolio’s health care and industrials exposure drove results during the period.
  • The attractive growth characteristics of the companies we target led to acquisition bids for three portfolio holdings.
Market Overview and Outlook

Second-quarter equity market dynamics could best be described as furious, with a myriad of factors driving volatility:

  • Early May reports of a China trade deal were dashed. Acrimony broke out with sanctions on both
    sides (Huawei, rare earths, etc.). At quarter end, negotiators and Presidents Trump and Xi gathered at the Osaka G-20 meeting to work on key differences. Trade anxieties were compounded by the Trump administration’s promise of unilateral tariffs on Mexico as a cudgel to slow the flow of Latino immigrants to the U.S.; the Mexican agreement in early June blunted that suggestion.
  • Real-time economic statistics in a variety of areas and regions showed deceleration or deterioration while interest rates collapsed (the 10-year U.S. Treasury ended the second quarter at 2.0%) and the U.S. yield curve inverted.
  • Overhangs from the Department of Justice and the Federal Trade Commission, as well as Congressional hearings on the big Internet platforms, caused a swoon in the higher growth Internet/software sector.

As one market commentator aptly noted, “Investors are getting chopped up between covering underweights/shorts and flocking back into old favorites.” The stock market continues to be whipped around by factors and baskets; we continue to take advantage of that as active long-term investors focused on business development and crucial portfolio company fundamentals. 

Amidst the volatility, investors continued to express a strong preference for the fastest growing stocks in the market. The benchmark Russell 2500 Growth Index gained 4.14% in the second quarter and was one of the best performing segments of the U.S. equity market year-to-date (+23.92%). The benchmark handily outperformed its value counterpart over each period. Strong performing growth stocks have benefited from multiple expansion on top of upward earnings revisions. As interest rates decline - the 10-Year U.S. Treasury yield fell 40 basis points in the second quarter - the present value of a company’s future earnings and cash flows rise.

Growth stocks could remain at a premium through a period of slowing profit growth expectations (which we expect to be reaffirmed during second-quarter earnings season).

 

"Capital market activity has provided further confirmation of the desire for growth."

 

Capital market activity has provided further confirmation of the desire for growth. Strategic acquirers
seeking sources of above-average growth led to the proposed takeout of three portfolio companies: cloud-based biopharmaceutical data and analytics software maker Medidata Solutions by French technology conglomerate Dassault Systemes; data analytics provider Tableau Software by Salesforce.com; and WABCO Holdings, a supplier of electronic truck parts, brakes and safety systems, by German truck parts maker ZF in an all cash transaction.

The current market environment is a tricky one to navigate with many cross currents. We are clearly closer to the end than the beginning of an economic cycle; however, most market indicators remain in positive or neutral territory despite signs of slowing down. Manufacturing activity is an area we are watching closely, as well as trade developments between the U.S. and China and credit conditions. Consumer health, on the other hand, remains fairly robust and consumer spending is the largest driver of the U.S. economy. As always, we will strive to outperform our benchmark and peer group by holding high-quality growth companies that should be able to thrive, even in a slower economic environment, while maintaining a long-term investment horizon.

Portfolio Highlights

The ClearBridge SMID Cap Growth Strategy outperformed its Russell 2500 Growth Index benchmark during the second quarter. On an absolute basis, the Strategy had gains across seven of the 10 sectors in which it was invested during the quarter (out of 11 sectors total). The primary contributors to performance were the industrials and health care sectors.

In relative terms, the Strategy’s outperformance was driven by stock selection. Specifically, stock selection in the health care and industrials sectors drove results. Stock selection in the materials and consumer staples sectors also helped. Meanwhile, stock selection in the IT, financials and communication services sectors and an underweight to financials had negative impacts on relative performance.

The biggest contributors to absolute returns during the second quarter included Copart, Tableau Software, MercadoLibre, Medidata Solutions and Insulet. Positions in New Relic, Fortinet, Cardtronics, Apergy and Jones Lang LaSalle were the greatest detractors from absolute returns.

During the second quarter, we initiated positions in CoreSite Realty in the real estate sector and Farfetch in the consumer discretionary sector and closed positions in WABCO Holdings in the industrials sector and Alliance Data Systems in the IT sector.

Brian Angerame

Portfolio Manager
26 Years experience
20 Years at ClearBridge

Derek Deutsch, CFA

Portfolio Manager
21 Years experience
21 Years at ClearBridge

Aram Green

Portfolio Manager
19 Years experience
14 Years at ClearBridge

Jeffrey Russell, CFA

Portfolio Manager
39 Years experience
30 Years at ClearBridge

Related Perspectives

  • SMID Cap Growth Strategy
    2Q20 Commentary: We continue to closely evaluate existing holdings and source new ideas, using volatility to add companies participating in secular growth trends.
  • SMID Cap Growth Strategy
    1Q20 Commentary: Companies with financial flexibility, pricing power and enduring business models should be in the best shape in the recovery from this unprecedented slowdown.
  • SMID Cap Growth Strategy
    4Q19 Commentary: Strong investor flows and a relaxing of a multitude of market risks sparked a vigorous finish to the year for equities.
  • Growth Opportunities in Digital Transformation
    PM Aram Green and Analyst Hilary Frisch discuss how software is transforming the way businesses compete.
  • SMID Cap Growth Strategy
    3Q19 Commentary: We remained active in repositioning the portfolio, adding several innovative companies in the health care and technology sectors.
  • Past performance is no guarantee of future results.

  • All opinions and data included in this commentary are as of the publication date and are subject to change. The opinions and views expressed herein are of the author and may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC  nor its information providers are responsible for any damages or losses arising from any use of this information. 

  • Performance source: Internal. Benchmark source: Russell Investments. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and/or Russell ratings or underlying data and no party may rely on any Russell Indexes and/or Russell ratings and/or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication.