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US Equity Concentrated Fund Review

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US Equity Concentrated Fund Review Lazard 2Q21 Fund US Equity Concentrated Review Market Review Shares fell in the second quarter after the company reported quarterly results below expectations, with management issu- The S&P 500 Index rose 8.6% in the second quarter, ing cautious guidance owing to higher labor and freight costs. bring ing its year-to date gain to 15.3%, as investors gained While we expected to hear comments on labor and freight confidence in a domestic economic recovery amid dissipating inflation, we are surprised at the magnitude of the latter. COVID-19 risks. While other retailers have noted these costs as a factor, we As evidence of the brightening economic outlook, the first- have not seen them impacting competitors to the same extent quarter corporate earnings season was exceptionally strong, as they have Dollar Tree. While we do believe these issues with 86% of the companies in the S&P 500 Index reporting will be manageable over time as supply chains normalize post earnings that exceeded consensus estimates, the highest such COVID, we are also mindful that there is execution risk in percentage since 2008. In the aggregate, the index’s year-over- the face of the current headwinds. We are maintaining our year earnings growth was 52%, the highest figure since the current position due to the structural advantages Dollar Tree first quarter of 2010. maintains, coupled with its continued revenue performance. However, we will be monitoring the inflationary topics dis- The specter of inflation was top of mind for some investors cussed above and will adjust our position accordingly if they due to ongoing supply chain bottlenecks, a surge in commod- become untenable. ity prices, and a tight domestic labor market. However, the Federal Reserve’s narrative helped assure investors that the Fiserv recent spike in inflation will be transitory, and occurring pri- We initiated our investment in payments processor Fiserv marily as a consequence of an economy that is strengthening in January 2019, after the company announced its planned in the wake of last year’s slowdown. merger with rival First Data. We believed the deal would drive nearly $1 billion in cost synergies (comprising 9% Performance Recap and of combined costs) and provide a broader set of solutions Positioning to Fiserv’s clients, as both companies could cross-sell card- issuing services. After initially classifying Fiserv as Mispriced Lazard US Equity Concentrated Fund (6.4%, net of fees) given deal integration risk and debt load, we subsequently underperformed the S&P 500 Net Total Return Index reclassified it as a Compounder after seeing merger synergies (8.4%) by 207 basis points (bps) during the quarter as stock- play out and watching the company quickly and efficiently specific factors impacted performance. Year to date, the Fund reduce its debt. Our initial thesis remains intact: Fiserv has (15.2%, net of fees) has outperformed the index (15.0%) by executed on both cost and revenue synergies, while earnings 24 bps in a very strong up market. Exhibit 1 provides details continue to compound higher. on the strategy’s largest second-quarter contributors and detractors, while year-to-date attribution is detailed in the During the quarter, shares lagged along with those of Appendix. payment-processing peers as the anticipated ramp-up in consumer spending was hampered by concerns related to The Fund's largest detractors—Dollar Tree and Fiserv— COVID-19 flare-ups, particularly in Europe. Despite this, accounted for more than 100 bps of combined negative the company reported solid quarterly results, reflecting a performance. Below, we discuss what drove their performance recovery in broader card spending. We took advantage of during the quarter and why we continue to hold them. We the recent sell-off to increase our position size, as we believe note that, of the 29 companies currently held in the Fund, Fiserv is well positioned to compound returns as consumer only Dollar Tree’s opera tional results disappointed during the spending accelerates and the payments industry fundamen- quarter. tally shifts toward automated transaction services. Dollar Tree Portfolio Composition We initiated a position in Dollar Tree in June 2020, as we believed that the secular trend of serving price-sensitive shop- We continue to be confident in our existing holdings’ poten- pers coupled with Dollar Tree’s scale advantages created a tial to outperform as they benefit from a normalizing market durable business model that has yet to be fully optimized environment. We remain overweight recovery-exposed, from a margin standpoint. Despite integration issues from its long-term-disruptive names. While we have added positions acquisition of Family Dollar several years ago, the company that we believe further enhance the portfolio’s return profile, has continually generated significant—and growing—free our sustained conviction has resulted in little selling activity cash flow, which we believe is not recognized by the market. since the market began to recover from its March 2020 low. Exhibit 2 displays our current portfolio composition. MF27895 For Financial Professional Use Only. Not for Public Distribution. 2 Exhibit 2 2Q 2021 Contributors and Detractors Contributors Security Classification Name Impact (bps) Drivers of Performance Compounder Public Storage 67 Announced the acquisition of East Coast competitor ezStorage for $1.8 billion. We were encouraged by the deal, as it shows the company is executing on its M&A strategy by acquiring a high-quality set of assets at a reasonable valuation. The company also reported quarterly results above expectations, with strong performance across all metrics. We believe Public Storage's technology, data, and machine learning operations will widen the company’s advantage over smaller operators, who control 80% of current supply, providing a large consolidation opportunity. Compounder Alphabet 42 Reported impressive performance in the first quarter driven by its core search/YouTube business and strong cost management. We continue to own Alphabet as the company is innovating at a scale that is driving growth, build- ing competitive barriers, and creating new adjacent opportunities. Mispriced Armstrong 30 Shares rose as commercial construction indicators gradually improved and the US economy continues to reopen. Armstrong has undergone many positive improvements, including accelerating pricing, daily ship rates above 2019 levels, and Architectural Series order rates at record levels. Mispriced S&P Global 26 Reported strong revenues driven by the Ratings segment, as bond issues were robust during the period. We think the company will continue to consolidate its position as a leading data and analytics provider and further diversify revenues, with its deal to acquire competitor IHS Markit serving as a prime example. Mispriced Crown Castle 20 Reported strong quarterly results, driven by revenues from customer Verizon, and management raised its guid- ance for the year. We continue to like the company's significant pricing power and sticky, compounding business model, and see further tailwinds from 5G buildout. Detractors Security Classification Name Impact (bps) Drivers of Performance Compounder Fiserv -119 Shares lagged in response to consumer spending concerns. Please see our discussion in the Performance Recap and Positioning section. Mispriced Dollar Tree -68 Higher freight and labor costs led to disappointing results. Please see our discussion in the Performance Recap and Positioning section. Compounder Baxter -47 Management issued conservative guidance, while supply chain and inflation concerns weighed on the stock. However, we believe Baxter is positioned to capitalize on structural long-term tailwinds in its largest business seg- ment (renal care) given the company’s strong balance sheet and expected margin recovery in the second half of the year, and amid anticipation of management’s new long-range plan to be presented in September. Compounder Sysco -28 Revenues continue to grow in the United States, but reopening internationally has weighed on the business. We believe the company's guidance is conservative and think management's multi-year initiatives should lead to higher growth and profitability. Compounder Sotera Health -22 Shares of the sterilization and lab testing company lagged as certain pre-IPO investors sold some of their holdings. Please see our Stock in Focus section for more details about Sotera’s business. For the three months ended 30 June 2021. The allocations and specific securities mentioned are based upon the Lazard US Equity Concentrated Fund. Allocations are subject to change. Attribution is based upon a representa- tive portfolio and is versus the S&P 500 Index. Attribution analysis is provided for illustrative purposes only, as values are calculated based on returns gross of fees. Performance would be lower if fees and expenses were included. Past performance is not a reliable indicator of future results. Source: Lazard, Standard & Poor’s During the quarter we purchased Verisk (Compounder) and statistical models, and robust software platforms. Verisk was a first LiveRamp (Tactical) and sold Brunswick (Tactical). We note that the mover in the property and casualty insurance analytics industry, strategy's cash position has averaged just above 1% over the last 12 giving it a library of non-replicable historical data and proprietary months, its lowest level in our 18-year history. This, along with our relationships with clients. The company has deep expertise in historically high name count at 29, is a testament to the attractive— analytics and forecasting as a pioneer in the field of probabilistic and attractively priced—companies we continue to see coming onto catastrophe modeling. It has since expanded its business to offer our radar screen. We describe our trade rationales below: solutions in the energy and financial services industries. The com- pany’s revenue is largely recurring, as most customers have annual Verisk subscriptions or long-term contracts that are paid up-front. This Cash flow driver: Growing complexity in risk assessment high revenue visibility and attractive returns on capital give Verisk characteristics of a Compounder.
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