Markets Review

When capital is rushing away from resilient, predictable franchises to crowd into unpredictable, uncertain and yet-to-be-proven themes, it may create a headwind for our strategy. As speculative enthusiasm intensifies and capital becomes increasingly concentrated, those headwinds can grow considerably. And the more indiscriminate the inflows into those speculative areas, the more pronounced those headwinds become.

But we are not standing still. We are eagerly accumulating what in our view are durable quality companies at valuations we believe to be attractive.  

The Scale of the Spending Firehose – From Processing Units to Memory Chips

A big part of recent underperformance is underexposure to spending on the data center ecosystem:

K Shaped: Wall Street Asset Owners and Main Street Consumers

But most businesses sit outside the AI data center ecosystem, and many are struggling:

• The broader construction industry is facing its toughest environment since the Global Financial Crisis.
• High rates have frozen housing activity, with turnover at its lowest level since the early 1990s.
• The average U.S. home age is now a record 44 years old.
• The average first-time homebuyer age is now 40, up from 32 in 2016.
• In short, AI infrastructure is booming, but much of the real economy is not (sidenote: social and political consequences may follow).

Quality: Three Archetypes

We remain focused on Quality fundamentals, Valuations we believe are attractive, and Catalysts controlled by management teams with a long-term strategic plan (“QVC”).

When we explain that our investment process starts with “quality,” clients often balk. After all, what active manager doesn’t “seek high quality?” Fair point. But like beauty, quality is in the eye of the beholder, and we see three kinds: Transient, Conventional and Durable.

• Transient Quality looks exceptional at the peak, with scarcity-driven pricing power, margin expansion, and high returns on capital that Wall Street often mistakes for permanent economics. But there is no cartel; supply eventually catches up, prices normalize and, once investors realize what has happened, significant valuation resets can occur. Consider memory technology companies today.
• Conventional Quality still has powerful brands, customer loyalty, incumbency advantages, and ecosystem lock-in – but the old moats are eroding. Digital advertising, ecommerce, private label, low barriers to entry, and AI disruption have made many of these franchises less structurally resilient than they once were.
• Durable Quality is where we are most energized, because scarcity is permanent rather than cyclical (or at least less so). These businesses can raise prices ahead of inflation for years without impairing volume, protected by natural monopolies, geology, irreplaceable infrastructure, essentiality, regulation, or deliberate scarcity. Consider businesses like luxury goods, regulated utilities, and mission-critical technology solutions, or specialty data providers, unique ingredient producers, and transportation platforms.

Performance and Attribution Summary

For the second quarter of 2026, Aristotle Capital’s Value Equity WM Composite posted a total return of 4.36% pure gross of fees (3.85% net of fees), underperforming the 13.84% return of the Russell 1000 Value Index and the 15.20% return of the S&P 500 Index. Please refer to the table for detailed performance.

Performance (%)	2Q26	YTD	1 Years	3 Years	5 Years	10 Years
Value Equity WM Composite (pure gross)	4.36	2.34	8.32	11.03	6.40	11.82
Value Equity WM Composite (net)	3.85	1.33	6.20	8.86	4.28	9.60
Russell 1000 Value Index	13.84	16.23	27.09	17.78	11.17	11.52
S&P 500 Index	15.20	10.21	22.33	20.61	13.41	15.51

Corteva, the seed and crop protection company, was one of the largest detractors during the period. While fundamentals remained healthy, with first-quarter FREE cash flow supported by strength in both Seed and Crop Protection, the stock lagged a sharply rising market as investors focused on Corteva’s more tempered outlook for the balance of the year. The management team cited potential second-half headwinds from tariffs, higher oil-related input costs, farmer fuel expenses, and competitive crop protection pricing in Latin America and Asia. We believe the market also weighed the near-term complexity of Corteva’s planned fourth-quarter separation into New Corteva and Vylor, including potential dis-synergies from operating two public companies. Nevertheless, our investment thesis remains intact. Farmers continue to adopt Corteva’s latest hybrids, varieties, and premium crop protection technologies, supporting Corteva’s margin expansion. Meanwhile, the company’s R&D-led innovation, disciplined cost management, and path toward net royalty income should enhance its long-term competitive position. Management has remained steadfast in returning shareholder value, with $500 million of share repurchases in the first half of the year. Finally, Corteva remains opportunistic as exemplified by its partnership with FMC Corporation to expand its product and technology portfolio.

Motorola Solutions, the provider of mission-critical communications and security systems, was one of the largest detractors during the quarter. Shares declined as higher memory and supply chain costs weighed on near-term margin expectations. While these factors affected near-term results, they do not change our long-term thesis. At the core of the company is its land mobile radio business, which provides the communication backbone used by police, fire, and emergency responders – particularly during natural disasters or other high-stress situations when commercial networks may become congested or unavailable. These systems are deeply embedded in public safety agencies, where reliability, control, and resiliency are non-negotiable, and customer relationships are often supported by long-term service agreements, predictable equipment refresh cycles, and decades of trust. Importantly, Motorola is using this installed base to broaden its platform, integrating radios with video security, body-worn cameras, and command center software to help agencies unify voice, video, and data across public safety workflows. The company is also expanding its capabilities through acquisitions such as Silvus Technologies, which adds secure wireless communications technology used in defense, unmanned systems, and other demanding environments. We believe these opportunities, together with a continued shift toward higher-margin software and recurring services, should support improved profitability and FREE cash flow generation over our three- to five-year investment horizon.

Qualcomm, a leading semiconductor and communications technology company, was the largest contributor for the quarter. Shares recovered as management indicated that the inventory adjustments and production constraints resulting from higher memory costs were progressing largely as expected and that handset revenues from Chinese customers were expected to reach a bottom. As we noted last quarter, we believed these headwinds to be cyclical rather than structural and did not alter our long-term investment thesis. The company also continued to make progress on its long-term strategy of evolving from a handset-centric company into a broader provider of connected computing technologies. Automotive revenue reached another record high, while Internet of Things (IoT) and newer businesses such as AI-enabled PCs, industrial applications, and data center computing continue to represent a growing portion of the company and remain central to its long-term diversification strategy. We believe Qualcomm’s technologies will continue to benefit as connectivity expands across devices and AI workloads increasingly extend from the cloud to the edge, supporting Qualcomm’s ability to generate strong levels of FREE cash flow in the long run.

Alphabet, the parent company of Google and YouTube, was a primary contributor during the period. We initiated our position in the first quarter of 2025, when investors were concerned that generative AI tools would fundamentally alter search behavior and erode Google’s advertising franchise. Since then, Alphabet has continued to demonstrate the strength of its ecosystem and the resilience of its core businesses. Google Search has remained strong, with AI-powered features increasing user engagement while supporting advertising growth, and Google Cloud has continued to benefit from robust enterprise demand for AI infrastructure and services. Importantly, Alphabet appears increasingly capable of monetizing these new experiences in a manner consistent with its historical strengths, through advertising, distribution, and integration across a broad user base rather than relying solely on paid subscriptions. YouTube also remains well-positioned to benefit from continued growth in advertising and subscription revenues, including YouTube TV, as consumers continue to shift away from traditional cable. In addition, while we continue to monitor regulatory risk, capital intensity, and changes in search behavior, recent execution reinforces our view that Alphabet remains a high-quality business with durable competitive advantages and multiple avenues for long-term value creation.

Recent Portfolio Activity

During the quarter, we sold our positions in Atmos Energy and Danaher and purchased Autodesk and Edwards Lifesciences.

We first invested in Atmos Energy, the largest fully regulated natural gas-only utility in the U.S., in the first quarter of 2022. We were attracted to the company’s strong balance sheet, constructive regulatory environment across its service territories, and significant opportunity to invest in infrastructure modernization projects. During our holding period, Atmos benefited from ongoing system replacement programs, population growth in its key markets, and supportive rate mechanisms that allowed it to earn attractive returns on invested capital. While we continue to view Atmos as a high-quality business, we believe many of the catalysts identified at purchase have either been realized or are well underway. Looking ahead, we expect the company’s growth plan to require a significantly higher level of equity capital than in prior investment cycles. As a result, we elected to exit our position and redeploy the proceeds into Autodesk, which we believe offers a more compelling investment opportunity.

We first invested in Danaher, a company focused on biotechnology, life sciences and diagnostics, in the second quarter of 2016, attracted by its disciplined capital allocation, differentiated operating culture, and consistent FREE cash flow generation. The business is distinguished by a portfolio of market-leading franchises and a high mix of recurring consumables revenue tied to a large installed base. Its differentiated operating culture, anchored by the Danaher Business System (DBS), has historically enabled the company to be a highly effective acquirer, consistently integrating new businesses, expanding margins, and driving strong FREE cash flow generation. Over our decade-long holding period, Danaher successfully transformed itself from a diversified industrial company into a more focused healthcare business. This evolution included the spinoffs of Fortive, Envista, and Veralto, as well as the acquisition and integration of key assets such as Pall, Cepheid, and Cytiva. The company also increased the contribution from recurring revenue and workflow-based solutions embedded in customer operations, which contributed to the durability and predictability of the business.

More recently, as Danaher has shifted further into more complex, innovation-driven end markets, the application of DBS appears to be less differentiated than it was in Danaher’s traditional manufacturing-oriented businesses. Success in these new end markets is increasingly driven by scientific innovation, faster product cycles, and more specialized customer requirements. At the same time, increased scale and a more centralized organizational structure appear to be limiting flexibility at the business unit level, reducing the speed and effectiveness with which opportunities can be pursued. While we continue to view Danaher as a high-quality business, we believe much of our original investment thesis has now been realized, with fewer company-specific catalysts ahead. Accordingly, we elected to exit the position and redeploy the proceeds into what we view as a more attractive opportunity in Edwards Lifesciences.

Autodesk, Inc.

Headquartered in Northern California and founded in 1982, Autodesk produces software that allows companies to design and model their products and/or projects. The company is the global industry standard for computer-aided design in the architecture, engineering, and construction industry (AEC). Autodesk’s millions of subscribers rely on its software to design and model buildings, manufactured products, animated films, and video games. The company’s four segments are AEC (~48% of net sales), its iconic software AutoCAD (~27%), Manufacturing (~20%), and Media and Entertainment (M&E) (~5%).

Autodesk primarily sells its software on a subscription basis, having discontinued perpetual license sales of most standalone products in 2016. As part of the move to subscription licensing, Autodesk replaced its product suite with three streamlined “Industry Collections” focused on AEC, Manufacturing and M&E.

In recent years, the AEC industry has increasingly sought to resolve the inefficiencies that arise when many parties are needed to complete a building project. Autodesk has been at the cutting edge of enabling improvement through innovation and promoting the use of open standards, or open building information modeling (BIM), which allows for all relevant building data to be processed virtually in a 3D model and shared across stakeholders. Importantly, Autodesk’s leadership in ensuring the interoperability of its software with that of competitors increases collaboration and productivity among architects, engineers and contractors—an attractive value proposition for its customers.

High-Quality Business

Some of the quality characteristics we have identified for Autodesk include:

• Brand power, as AutoCAD is one of the most recognizable products in the industry;
• Leading market share in AEC software, where Autodesk’s BIM platform has reinforced its position as the industry standard;
• Large and loyal installed base of over six million users across more than 180 countries;
• Stable business model with a high degree of recurring revenue (97% of total) and significant FREE cash flow generation; and
• Substantial switching costs and pricing power that stem from its advanced solutions, network effects and the time (often many years) it requires for a professional to master Autodesk software.

Attractive Valuation

We believe shares of Autodesk are attractively valued given our estimates of normalized earnings. In our view, the market underappreciates Autodesk’s ability to sustain double-digit revenue growth while maintaining high levels of profitability, with operating margins of approximately 40%. Supported by pricing initiatives, strong customer retention and a highly recurring revenue model, we believe the shares do not fully reflect the company’s long-term earnings power and ability to generate FREE cash flow.

Compelling Catalysts   

Catalysts we have identified for Autodesk, which we believe will cause its stock price to appreciate over our three- to five-year investment horizon, include:

• Expanding adoption of BIM, 3D modeling and construction coordination tools as customers increasingly seek to improve collaboration and productivity across complex projects, driving greater utilization of Autodesk’s software portfolio;
• Benefits from its multi-year go-to-market modernization initiative, including greater automation of renewals through direct billing and auto-renew capabilities, allowing sales resources to focus on growth opportunities rather than maintenance activities;
• Increased monetization through tiered offerings and consumption-based pricing initiatives, which should support higher average selling prices over time; and
• Continued market share gains across its core AEC and Manufacturing software businesses.

Edwards Lifesciences Corporation

Headquartered in Irvine, California, Edwards Lifesciences is a global leader in structural heart disease therapies, developing and commercializing medical devices used to treat advanced cardiovascular conditions. The company is best known for its leadership in transcatheter aortic valve replacement (TAVR), a minimally invasive procedure that allows physicians to replace diseased heart valves without open-heart surgery. By reducing the invasiveness, recovery time and risk associated with traditional surgical valve replacement, TAVR has significantly expanded the number of patients eligible for treatment and accelerated adoption across the structural heart market.

We have followed Edwards for many years as both a leading structural heart company and a competitor to Medtronic’s CoreValve platform. Over the last decade, Edwards effectively “bet the company” on TAVR technology and successfully established its Sapien platform as one of the leading transcatheter heart valve systems globally while maintaining a meaningful presence in surgical aortic valve replacement (SAVR). Today, TAVR represents the core of Edwards’ business and is supported by a large global installed base, extensive physician training and extensive long-term clinical evidence, reinforcing its position as a standard of care for aortic stenosis.

Beyond TAVR, Edwards is expanding into transcatheter mitral and tricuspid therapies (TMTT), which represent a significantly larger but more underpenetrated market opportunity. The company is also investing in adjacent cardiovascular technologies, supported by continued investment in research and development, targeted acquisitions, and substantial FREE cash
flow generation.

High-Quality Business

Some of the quality characteristics we have identified for Edwards Lifesciences include:

• Leadership in transcatheter heart valve technologies, particularly TAVR, where the company’s Sapien platform is widely regarded as a gold standard among physicians;
• High barriers to entry, driven by clinical data, physician training requirements and regulatory approvals, which create meaningful switching costs once devices are adopted in practice;
• A strong innovation-driven culture, supported by consistent investment in R&D and a track record of developing next-generation cardiovascular therapies; and
• A focused strategy centered on structural heart disease, allowing for deep expertise and a comprehensive product portfolio across aortic, mitral and tricuspid valve therapies.

Attractive Valuation

While the TAVR market is more developed, we believe both the continued expansion of this franchise and the scaling contribution from newer mitral and tricuspid therapies are not fully reflected in the current stock price. As these businesses continue to scale and adoption broadens, we expect continued improvement in operating performance and FREE cash flow generation over our investment horizon.

Compelling Catalysts   

Catalysts we have identified for Edwards Lifesciences, which we believe will cause its stock price to appreciate over our three- to five-year investment horizon, include:

• Higher TAVR procedure volumes, driven by increasing penetration across symptomatic and asymptomatic patient populations, ongoing clinical data supporting use in additional indications, expanding physician adoption, and continued share gains relative to surgical valve replacement surgery (SAVR);
• Broader adoption of TMTT valve therapies, which we believe represent a market opportunity significantly larger than TAVR over time;
• Expansion into adjacent cardiovascular technologies, including heart failure monitoring and treatment, supported by internal development and targeted acquisitions; and
• Continued deployment of substantial FREE cash flow into internal innovation, targeted acquisitions and shareholder returns, supported by a strong balance sheet and meaningful net cash position.

Conclusion

We believe markets are extrapolating the earnings of today’s AI infrastructure beneficiaries far into the future and treating Transient Quality as though it were durable. While artificial intelligence and its enabling technologies are undoubtedly important, history suggests that no investment theme enjoys an uninterrupted run forever. Capital eventually chases diminishing returns, valuations become overly extended, and investors begin to rediscover quality businesses outside the market’s narrow focus. Cycles don’t end because the underlying technology disappears—they end because expectations and prices become disconnected from what is normal.

We are not dismissing AI, nor are we waiting passively for the market to change. We are using this dislocation to upgrade the portfolio toward what we believe to be Durable Quality businesses, purchased at valuations that better reflect normalized fundamentals. In periods like this, discipline can feel uncomfortable, but history suggests that prices and fundamentals eventually reconnect. Our objective is to ensure that when they do, our clients own businesses with the durability, pricing power, and compounding potential to create value well beyond the current cycle.