Commentary
Large Cap Growth 4Q 2021
Markets Review
Markets (total return) performed as follows:
Sources: SS&C Advent, Bloomberg
Past performance is not indicative of future results. Aristotle Large Cap Growth Composite returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Aristotle Atlantic Composite returns are preliminary pending final account reconciliation. Please see important disclosures at the end of this document.
The U.S. equity market finished the year strong, recording its seventh consecutive quarter of positive performance. Overall, the S&P 500 Index gained 11.03% during the period, which brings its full-year return to 28.71%. Concurrently, the Bloomberg U.S. Aggregate Bond Index finished flat for the quarter, which gives the Index a calendar-year return of -1.54%. In terms of style, the Russell 1000 Value Index underperformed its growth counterpart by 3.87% during the quarter, resulting in its full-year underperformance of 2.44%.
On a sector basis, all eleven sectors within the Russell 1000 Growth Index finished higher for the quarter, led by Materials, Information Technology and Consumer Staples. The worst performers were Communication Services, Utilities and Financials.
Economic data points were mixed during the period. Although the unemployment rate fell to 4.2%, inching to levels not seen since 2019, the U.S. economy created fewer jobs than expected, as November nonfarm payrolls increased just 210,000. Nonetheless, inflation garnered the most attention as the CPI, driven by energy, food, and used car and truck prices, rose 6.8% on a year-over-year basis—the fastest rate since 1982. Correspondingly, the Federal Reserve (Fed) ceased the use of “transitory” in reference to inflation and subsequently accelerated the tapering of its asset purchase program. Furthermore, new projections based on the median forecast by Fed officials signaled the possibility of three interest rate increases in the new year.
Meanwhile, fiscal policy also made headlines as the $1 trillion bipartisan infrastructure bill was signed into law. However, momentum for the now $1.7 trillion Build Back Better social spending and climate bill stalled, largely due to disagreements over the scope and size of the bill.
In terms of corporate earnings, labor shortages and supply-chain disruptions, specifically procurement issues and input price pressures, continued to impact businesses. Nevertheless, corporate earnings were robust, with year-over-year earnings per share (EPS) growth for S&P 500 constituents reaching nearly 40%, the third-highest figure since 2010, and 82% of S&P 500 companies beating EPS estimates. Additionally, nearly two out of three S&P 500 companies reported improving profitability since the start of the pandemic, citing pricing power and strong demand.
On the COVID front, the Omicron variant became the dominant strain in the U.S., with the number of new daily cases rising to upwards of 500,000, the highest reported figure during the pandemic.
Annual Markets Review
In a year filled with uncertainty, the U.S. economy proved resilient. Even in the face of inflation, supply-chain disruptions, labor shortages and COVID-19 variants, many businesses reported strong earnings growth and stable, if not improving, margins. Themes from 2020, such as fiscal and monetary policy actions, vaccine (and now booster) developments, and economic recovery persisted.
Although we are happy to report another strong year, the constant twists, turns and pivots of this past year are a reminder of the fragility of the short term. Factors such as the possibility of new variants, the timing of a full recovery, fiscal and monetary policy decisions, and market sentiment are topics better left for reporters. We believe investment managers (and their clients) are best positioned to create lasting value by minimizing distractions and focusing on the long term.
Performance and Attribution Summary
For the fourth quarter of 2021, Aristotle Atlantic’s Large Cap Growth Composite posted a total return of 8.30% gross of fees (8.21% net of fees), underperforming the 11.64% total return of the Russell 1000 Growth Index. Since its inception on November 1, 2016, the Large Cap Growth Composite has posted a total return of 25.11% gross of fees (24.62% net of fees), while the Russell 1000 Growth Index has reported a total return of 25.21%.
| 4Q21 | 1 Year | 3 Years | 5 Years | Since Inception* | |
|---|---|---|---|---|---|
| Large Cap Growth Composite (gross) | 8.30 | 22.13 | 33.80 | 25.18 | 25.11 |
| Large Cap Growth Composite (net) | 8.21 | 21.67 | 33.27 | 24.68 | 24.62 |
| Russell 1000 Growth Index | 11.64 | 27.60 | 34.04 | 25.30 | 25.21 |
During the fourth quarter, the portfolio’s underperformance relative to the Russell 1000 Growth Index can be attributed to security selection and allocation effects. Security selection in Information Technology and Health Care, as well as an overweight in Health Care, detracted the most from relative performance. Conversely, security selection in Communication Services, Industrials and Real Estate contributed the most to relative returns.
| Relative Contributors | Relative Detractors |
|---|---|
| NVIDIA | Guardant Health |
| Norfolk Southern | Twilio |
| Prologis | PayPal Holdings |
| Home Depot | Adaptive Biotechnologies |
| Costco Wholesale | Global Payments |
Top Contributors
NVIDIA Corporation
NVIDIA contributed to relative performance in the fourth quarter due to stronger-than-expected quarterly results and positive spending announcements by hyperscale customers supporting an improving 2022-2023 outlook. The quarterly results benefited from record Data Center revenues, driven by hyperscale and enterprise spending, as anti-money laundering continues to be an investment priority. The Gaming segment also posted strong growth, driven by the continuing Ampere upgrade cycle and strong ASPs, as inventories remain very lean. The fourth quarter also saw investors embrace the market’s enthusiasm for future spending on the metaverse and the perceived growth in demand for NVIDIA GPUs that will be required to support the buildout of this 3D universe. Company guidance for the next quarter was also ahead of consensus, with sequential growth still being driven by the Data Center and Gaming segments.
Norfolk Southern Corporation
Norfolk Southern outperformed in the fourth quarter following a report of better-than-expected revenue and earnings growth for its fiscal third quarter. Consensus earnings estimates are being increased for fiscal year 2021 and fiscal year 2022. The company is making progress on its operating efficiency initiatives. Pricing remains strong for the railroad industry as shipping capacity remains tight.
Bottom Detractors
Guardant Health, Inc.
Guardant shares were down in the fourth quarter, despite the company reporting better-than-expected results in November. Testing volumes rebounded, and Guardant has a full pipeline of events for 2022. Its pivotal Eclipse study in colorectal cancer screening is expected to readout mid-year and could be an attractive catalyst for the stock. High-valuation growth companies in health care continued to be pressured during the quarter as investors weighed the risk of inflation and rising Treasury yields.
Twilio, Inc.
Twilio detracted from performance in the fourth quarter, as investors were disappointed by third quarter earnings and the fourth quarter outlook, with organic growth rates lower than expected. On the third quarter earnings call, management continued to reiterate the 30% organic growth rate over the next three years but did not provide further details on why the current environment is seeing a deceleration in growth trends from the prior three quarters. Twilio’s underperformance during the quarter was also due to multiple compression amid the sell-off in high-growth technology names as concerns around rising inflation trends led to a sharp increase in 10-year yields.
Sources: FactSet
Past performance is not indicative of future results. Attribution results are based on sector returns, which are gross of investment advisory fees and include the reinvestment of all income. Please see important disclosures at the end of this document.
Recent Portfolio Activity
The following table shows all buys and sells completed during the quarter, followed by a brief rationale.
| Buys | Sells |
|---|---|
| Dynatrace | Qorvo |
| Iovance Biotherapeutics | Teleflex |
| Synopsys |
Buys
Dynatrace, Inc.
Dynatrace offers a market-leading software intelligence platform, purpose-built for dynamic multi-cloud environments. As enterprises embrace the cloud to effect their digital transformation, the company’s all-in-one intelligence platform is designed to address the growing complexity faced by technology and digital business teams. With automatic and intelligent observability, we believe its all-in-one platform delivers precise answers about the performance and security of applications, the underlying infrastructure and the experience of all users to enable organizations to innovate faster, simplify cloud complexity, collaborate more efficiently and secure cloud-native applications.
We are adding Dynatrace, as we see the company as being a key beneficiary of the acceleration of digital transformation strategies and the need for companies to monitor application performance and develop metrics across multiple and hybrid cloud environments. We believe the Dynatrace software intelligence platform is a key competitive advantage that provides all-in-one performance capabilities with multiple modules, including the Davis AI engine which provides continuous automatic actionable insights. The Dynatrace land and expand model, which focuses on the largest global companies, supports a long runway for top-line growth, with initial land of $100,000 annual recurring revenue (ARR) increasing to an average of $280,000 ARR per customer through a 120%+ net expansion rate. The multiple module business model can provide attractive leverage, with customers of three or more modules generating $500,000 ARR and overall free cash flow margins of 30%+. As the company continues to increase its market presence across both application performance monitoring and infrastructure monitoring, we believe Dynatrace will gain market share of the estimated $50 billion total addressable market.
Iovance Biotherapeutics, Inc.
Iovance Biotherapeutics is a late-stage oncology company with the potential to bring the first novel autologous T-cell therapy to the market for solid tumors in patients with significant unmet needs. The company is focused on the development, manufacturing and commercialization of novel cancer immunotherapies based on tumor infiltrating lymphocytes (TIL).
We believe that TIL therapy offers a sound approach to enhancing efficacy with current immuno-oncology approaches. The approach is highly personalized, using a patient’s own T-cells extracted from a tumor sample, then expanded and rejuvenated, then reinfused. This will be a one-time therapy. The company has strong intellectual property (IP), with over 30 granted or allowed U.S. and international patents, as well as pivotal programs in late-stage advanced metastatic melanoma and advanced cervical cancers. Iovance is in advanced negotiations with the FDA over a potency assay for the product, and we believe resolution of this issue could be a positive catalyst for the company. We believe that Iovance is attractively valued based on our view that peak sales in melanoma and cervical alone could reach $1.5 billion.
Synopsys, Inc.
Synopsys provides products and services used across the entire Silicon to Software spectrum to bring Smart Everything to life. Synopsys is a global leader in supplying the electronic design automation (EDA) software that engineers use to design and test integrated circuits (ICs), also known as chips. The company also offers semiconductor intellectual property (IP) products, which are pre-designed circuits that engineers use as components of larger chip designs rather than designing those circuits themselves. Synopsys provides software and hardware used to validate the electronic systems that incorporate chips and the software that runs on them. Synopsys is also a leading provider of software tools and services that can improve the security, quality and compliance of software in a wide variety of industries, including electronics, financial services, automotive, medical, energy and industrials.
We believe that Synopsys will be a key beneficiary of both the growth in end-market demand for semiconductors over the next few years, as well as the accelerating shift in semiconductor design to internal design groups at OEM technology companies and hyperscalers. The shift in internal development of semiconductor technology versus procurement from merchant semiconductor companies has accelerated over the past few years. This trend is benefiting the EDA and IP industry, which has seen industry growth accelerate from the high single digits to the low double digits. We expect this strong growth to continue companies in the semi-manufacturing process focus on leveraging EDA tools and IP technology from Synopsys to produce more efficient and powerful circuit and packaging designs. Synopsys can also benefit from the nationalization of the global semiconductor industry, with China seeking to develop its own national semiconductor companies. These companies will need to license both technology and tools as they build their own design and manufacturing capacity. We view this trend of fragmentation in the semiconductor design and development process as benefiting Synopsys and view the growing backlog at the company as a leading indicator of a multi-year growth trajectory for the company. As Synopsys continues to leverage its cloud and AI footprint for new technology and design capabilities, we believe margins will continue to expand, supporting high-teens earnings growth over the next few years.
Sells
Qorvo, Inc.
We sold Qovro to reduce our exposure to the mobile handset market, where we believe recent data points indicate slowing momentum for Android-based 5G handsets in China due to both slowing economic growth, as well as a slower-than-expected rollout of 5G consumer apps. We believe that this slower-than-expected growth of 5G penetration will continue in 2022, especially for Android handset makers, and are reducing our bullish outlook on mobile handset component makers. We are using the funds to initiate a position in Dynatrace, which we view as an industry leader in application and IT performance monitoring and observability, a key beneficiary of the acceleration of digital transformation initiatives by global enterprises.
Teleflex, Inc.
We sold Teleflex based on our concerns about the Omicron variant and the potential for additional disruption to hospital-based procedures, including elective procedures such as Teleflex’s Urolift to treat benign prostatic hyperplasia. Furthermore, recent actions by Centers for Medicare and Medicaid Services (CMS) to reduce reimbursement around office-based Urolift procedures have caused some uncertainty around the potential growth of this important part of the Teleflex growth story.
Outlook
The outlook for the U.S. large cap equity market in 2022 will likely be influenced by the tightening cycle by the Federal Reserve. We would agree with the consensus view that, in addition to tapering, we will most likely face two to three rate hikes by the Federal Reserve in 2022. Markets tend to rally at the start of Federal Reserve tightening cycles, and we would expect this to hold true in 2022. Price-to-earnings multiple compressions started this past year in anticipation of the tightening cycle. This will likely be less of an issue in 2022, as the market has already discounted multiple rate hikes. Inflation should start to peak, as many companies have commented on earnings calls that inflation and supply-chain issues have stabilized. We believe the opportunities within the equity market will be with companies that are able to price to offset inflationary pressures. As inflation abates, the companies that can maintain these price increases should have the added benefit of margin expansion. The risk for equities is a mistake by the Federal Reserve in when and how much to tighten. Also, as we have seen in the past two years, COVID variants can impact economic activity and the supply chain. With growing geopolitical issues across the globe, any one of them could result in a quick drop in equity prices if military escalation becomes an outcome. Our focus will continue to be at the company level, with an emphasis on companies with secular tailwinds or strong product-driven cycles.
The opinions expressed herein are those of Aristotle Atlantic Partners, LLC (Aristotle Atlantic) and are subject to change without notice. Past performance is not a guarantee or indicator of future results. This material is not financial advice or an offer to purchase or sell any product. You should not assume that any of the securities transactions, sectors or holdings discussed in this report were or will be profitable, or that recommendations Aristotle Atlantic makes in the future will be profitable or equal the performance of the securities listed in this report. The portfolio characteristics shown relate to the Aristotle Atlantic Large Cap Growth strategy. Not every client’s account will have these characteristics. Aristotle Atlantic reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account’s entire portfolio and, in the aggregate, may represent only a small percentage of an account’s portfolio holdings. The performance attribution presented is of a representative account from Aristotle Atlantic’s Large Cap Growth Composite. The representative account is a discretionary client account which was chosen to most closely reflect the investment style of the strategy. The criteria used for representative account selection is based on the account’s period of time under management and its similarity of holdings in relation to the strategy. Recommendations made in the last 12 months are available upon request.
Returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. For example, a 0.5% annual fee deducted quarterly (0.125%) from an account with a ten-year annualized growth rate of 5.0% will produce a net result of 4.4%. Actual performance results will vary from this example. Please see important disclosures enclosed within this document.
The Russell 1000® Growth Index measures the performance of the large cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. This index has been selected as the benchmark and is used for comparison purposes only. The Russell 1000® Value Index measures the performance of the large cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. The S&P 500® Index is the Standard & Poor’s Composite Index of 500 stocks and is a widely recognized, unmanaged index of common stock prices. The Russell 2000® Index measures the performance of the small cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. The Dow Jones Industrial Average® is a price-weighted measure of 30 U.S. blue-chip companies. The Index covers all industries except transportation and utilities. The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The NASDAQ Composite includes over 3,000 companies, more than most other stock market indices. The Bloomberg U.S. Aggregate Bond Index is an unmanaged index of domestic investment grade bonds, including corporate, government and mortgage-backed securities. The WTI Crude Oil Index is a major trading classification of sweet light crude oil that serves as a major benchmark price for oil consumed in the United States. The 3-Month U.S. Treasury Bill is a short-term debt obligation backed by the U.S. Treasury Department with a maturity of three months. While stock selection is not governed by quantitative rules, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors. The volatility (beta) of the Composite may be greater or less than its respective benchmarks. It is not possible to invest directly in these indices.
Aristotle Atlantic Partners, LLC is an independent registered investment adviser under the Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Aristotle Atlantic, including our investment strategies, fees and objectives, can be found in our Form ADV Part 2, which is available upon request. AAP-2201-11
Composite returns for all periods ended December 31, 2021 are preliminary pending fi nal account reconciliation.
Past performance is not indicative of future results. Performance results for periods greater than one year have been annualized. Returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. For example, a 0.5% annual fee deducted quarterly (0.125%) from an account with a ten-year annualized growth rate of 5.0% will produce a net result of 4.4%. Actual performance results will vary from this example. Please see important disclosures enclosed within this document.
