Commentary
Value Equity 2Q 2021
Markets Review
Markets (total return) performed as follows:
Sources: SS&C Advent, Bloomberg
Past performance is not indicative of future results. Aristotle Value Equity Composite returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Aristotle Capital Composite returns are preliminary pending final account reconciliation. Please see important disclosures at the end of this document.
The U.S. equity market continued to trend upwards for the fifth consecutive quarter. Overall, the S&P 500 Index gained 8.55% during the period. Concurrently, the Bloomberg Barclays U.S. Aggregate Bond Index increased 1.83%. In terms of style, the Russell 1000 Value Index underperformed its growth counterpart by 6.72% during the quarter.
On a sector basis, ten out of eleven sectors within the Russell 1000 Value Index finished higher for the period, led by Energy, Real Estate and Financials. The worst performers were Utilities (the only sector to post a negative return), Information Technology and Industrials.
Positive momentum in the U.S. regarding the receding spread of COVID-19, vaccination uptake and relaxation of quarantine mandates continued to build during the quarter. According to CDC reports, more than 50% of the country (more than 65% for those 18 and over) has received at least one dose of the vaccine, and the number of new daily cases in the U.S. has fallen to levels unseen since the onset of the pandemic. As a result, various state governments have dropped travel restrictions, capacity limitations, curfews and mask requirements for fully vaccinated individuals, leading to increased economic activity, such as traveler throughput at U.S. airports, which as of June 2021 is approaching pre-COVID levels.
In line with the improving conditions, economic data points were also strong, as May retail sales were up 28.1% year-over-year, the ISM manufacturing index came in above 60 for a fourth consecutive month and the ISM services index hit a record high. Unemployment also continued to decline to 5.8%, the lowest level over the past year.
Additionally, the narrative surrounding inflation continued to capture headlines as the Bureau of Labor Statistics reported a 5% year-over year increase in the Consumer Price Index, the largest gain since August 2008. While the year-over-year increase was abnormally high, it is important to note that prior year percentage changes were abnormally low. As such, the Federal Reserve reiterated its stance that the near-term price pressures are largely transitory in nature and made no changes to the current rate policy or asset purchase plan.
Lastly, Senate members have been in negotiations with President Biden for a $1.2 trillion, eight-year spending package that would be used to rebuild the nation’s infrastructure. The deal, which currently has bipartisan support, could pass the Senate as early as July.
Performance and Attribution Summary
For the second quarter of 2021, Aristotle Capital’s Value Equity Composite posted a total return of 6.37% gross of fees (6.31% net of fees), outperforming the 5.21% return of the Russell 1000 Value Index and underperforming the 8.55% return of the S&P 500 Index. Please refer to the table for detailed performance.
| Performance (%) | 2Q21 | YTD | 3 Years | 5 Years | 10 Years |
|---|---|---|---|---|---|
| Value Equity Composite (gross) | 6.37 | 17.04 | 17.87 | 17.60 | 14.95 |
| Value Equity Composite (net) | 6.31 | 16.88 | 17.51 | 17.23 | 14.54 |
| Russell 1000 Value Index | 5.21 | 17.05 | 12.41 | 11.87 | 11.60 |
| S&P 500 Index | 8.55 | 15.25 | 18.65 | 17.64 | 14.83 |
The portfolio’s outperformance relative to the Russell 1000 Value Index this quarter can be entirely attributed to security selection, while allocation effects had a negative impact. Security selection in the Information Technology, Industrials and Health Care sectors contributed the most to relative performance. Conversely, security selection in Consumer Discretionary and Materials and an overweight in Information Technology detracted. (Relative weights are the result of bottom-up security selection.)
Source: 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.
Leading credit card issuer and lender Capital One Financial was a primary contributor for the quarter.
Shares of Capital One advanced as the company posted record earnings for the most recent period, driven by strong credit results and rebounding spending volumes in the Credit Card segment. Furthermore, Capital One reported a significant improvement in its results from the Federal Reserve’s simulated nine-quarter stress test that determines required levels of capital. As a result, the company can substantially reduce its capital requirements and deploy the excess capital in shareholder-friendly manners. Lastly, Capital One announced a data-sharing agreement with Plaid and established itself as the exclusive long-term issuing partner for Williams-Sonoma’s new credit cards. We believe these types of partnerships will enhance the company’s platform and can allow Capital One to gain market share in the long run.
Diversified healthcare-oriented company Danaher was one of the main contributors for the period.
Shares rose as the company reported robust revenue, earnings and cash flow growth. The strength was broad-based, although COVID-related tailwinds continued to benefit its Life Sciences (vaccines) and Diagnostics (testing) segments. The company also announced a $9.6 billion agreement to acquire Aldevron, a high-quality plasmid DNA, mRNA and proteins manufacturer serving biotechnology and pharmaceutical customers. This acquisition is in line with Danaher’s efforts over the past years to broaden its Life Sciences portfolio. We believe the company has demonstrated an ability to identify attractive acquisition targets, successfully integrate them into the Danaher Business System and bring them to new heights.
Conglomerate Sony, maker of the PlayStation videogame console, was the quarter’s largest detractor.
Shares pulled back after the company’s full-year 2021 guidance indicated a year-over-year decline in operating profit, heightening concerns surrounding the company’s Gaming and Imaging & Sensing segments. Nevertheless, management remained optimistic, as it stated that it still expects to exceed the 14.8 million PlayStation 4 sold in the second year after the product’s launch. Additionally, the company continued to invest in the customer experience and offering of its Gaming segment by partnering with Discord, an instant messaging and digital distribution platform popular with gamers, and funding Epic Games, a videogame and software developer. While the company continues to enjoy success in the Gaming segment after its launch of the PlayStation 5, the Pictures segment has dragged due to the restrictions related to the pandemic. However, management has remained active and forward thinking in the space by signing deals with both Netflix and Disney to bring their titles to the streaming platforms. We believe these deals will continue to strengthen Sony’s brand and can improve profitability of the business unit. The company believes these investments and partnerships across various business segments will allow Sony to accomplish its long-term goal of integrating technology, entertainment and content to enhance collaboration and synergies across its diverse business units.
Natural gas producer Cabot Oil & Gas was one of the largest detractors for the period.
During the quarter, the company reported robust FREE cash flow and net income growth of over 175% year-over year and announced it would increase its quarterly dividend by 10%. Despite the strong results, shares seemed to have been impacted by macroeconomic factors, specifically the ebbs and flows of oil and natural gas prices, as well as the company’s announcement that it plans to merge with Cimarex Energy, an exploration and production company focused on the Permian and Anadarko basins. The combined entity has, in our opinion, a healthy balance sheet and should begin returning cash flow immediately. While a disparate acreage position (Marcellus versus Permian/Anadarko) provides little in the way of operating synergies, the combined entity is targeting $100 million of G&A synergies within a two-year time frame, and management expects to generate $4.7 billion of FREE cash flow from 2022-2024. We will continue to diligently study the merger and the direction of the new company and any impact it may have on our investment thesis.
Contributors and Detractors for 2Q 2021
| Relative Contributors | Relative Detractors |
|---|---|
| Adobe | Sony |
| Capital One Financial | Corteva Agriscience |
| Danaher | Microchip Technology |
| Microsoft | Parker Hannifin |
| PayPal Holdings | Cabot Oil & Gas |
Recent Portfolio Activity
| Buys | Sells |
|---|---|
| None | None |
Consistent with our long-term horizon and low turnover, there were no new purchases or sales completed during the period.
Conclusion
As conditions begin to normalize in the U.S., we have seen a plethora of headlines, such as improving economic figures, inflation and potential policy decisions, capture the market’s attention. Although broad economic factors are taken into consideration as part of our analysis, we spend the vast majority of our eff orts focusing on individual companies that, in our opinion, possess a combination of qualities which are both sustainable and difficult to reproduce. We will persist in our quest of identifying what we perceive to be high-quality businesses, trading at discounts to our estimate of their intrinsic value, that possess catalysts for appreciation which are within management’s control. It is our belief that a diversified portfolio of investments in these companies will hold up best regardless of the environment and can optimize risk-adjusted performance for our clients.
The opinions expressed herein are those of Aristotle Capital Management, LLC (Aristotle Capital) 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 Capital 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 Value Equity strategy. Not every client’s account will have these characteristics. Aristotle Capital 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 Capital’s Value Equity 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.
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 Index 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 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. 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 indexes. The Bloomberg Barclays 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. 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 Capital Management, 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 Capital, including our investment strategies, fees and objectives, can be found in our ADV Part 2, which is available upon request. ACM-2107-19
