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Quarterly Commentary—Artisan U.S. Mid-Cap Growth Strategy

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Quarterly Commentary—Artisan U.S. Mid-Cap Growth Strategy QUARTERLY Artisan U.S. Mid-Cap Growth Strategy FactCommentary Sheet As of 30 September 2020 Investment Process We seek to invest in companies that possess franchise characteristics, are benefiting from an accelerating profit cycle and are trading at a discount to our estimate of private market value. Our investment process focuses on two distinct elements—security selection and capital allocation. We overlay our investment process with broad knowledge of the global economy. Security Selection We seek to identify companies that have franchise characteristics (e.g., low-cost production capability, possession of a proprietary asset, dominant market share or a defensible brand name), are benefiting from an accelerating profit cycle and are trading at a discount to our estimate of private market value. We also assess key environmental, social and governance (ESG) issues that could impact future stock returns. We look for companies that are well positioned for long-term growth, which is driven by demand for their products and services, at an early enough stage in their profit cycle to benefit from the increased cash flows produced by the emerging profit cycle. Capital Allocation Based on our fundamental analysis of a company’s profit cycle, we divide the portfolio into three parts. GardenSM investments are small positions in the early part of their profit cycle that may warrant more sizeable allocations as their profit cycle accelerates. CropSM investments are positions that are being increased to a full weight because they are moving through the strongest part of their profit cycles. HarvestSM investments are positions that are being reduced as they near our estimates of full valuation or their profit cycles begin to decelerate. Broad Knowledge We overlay the security selection and capital allocation elements of our investment process with a desire to invest opportunistically across the entire global economy. We seek broad knowledge of the global economy in order to find growth wherever it occurs. Team Overview We believe deep industry expertise, broad investment knowledge, a highly collaborative decision-making process and individual accountability are a powerful combination. Since the inception of the team, we have been committed to building a team of growth investors that retains these attributes and is solely dedicated to our process and approach. Portfolio Management Matthew H. Kamm, CFA James D. Hamel, CFA Craigh A. Cepukenas, CFA Jason L. White, CFA Portfolio Manager (Lead) Portfolio Manager Portfolio Manager Portfolio Manager Investment Results (% USD) Average Annual Total Returns As of 30 September 2020 QTD YTD 1 Yr 3 Yr 5 Yr 10 Yr Inception1 Composite — Gross 12.12 36.31 46.50 24.15 18.88 16.91 16.20 Composite — Net 11.87 35.39 45.18 23.02 17.79 15.84 15.12 Russell Midcap® Growth Index 9.37 13.92 23.23 16.21 15.51 14.54 9.94 Russell Midcap® Index 7.46 -2.35 4.55 7.13 10.12 11.75 9.94 Annual Returns (% USD) 12 months ended 30 September 2016 2017 2018 2019 2020 Composite — Gross 9.34 13.52 22.75 6.47 46.50 Source: Artisan Partners/Russell. Returns for periods less than one year are not annualized. 1Composite inception: 1 April 1997. Past performance does not guarantee and is not a reliable indicator of future results. Current performance may be lower or higher than the performance shown. Composite performance has been presented in both gross and net of investment management fees. Investment Risks: Investments will rise and fall with market fluctuations and investor capital is at risk. Investors investing in strategies denominated in non-local currency should be aware of the risk of currency exchange fluctuations that may cause a loss of principal. These risks, among others, are further described near the back of this document, which should be read in conjunction with this material. Quarterly Commentary Artisan U.S. Mid-Cap Growth Strategy As of 30 September 2020 Investing Environment healthy balance sheets and where we have excellent visibility into The global equity market rally persisted through Q3, leaving the MSCI their profit cycles’ future paths. We look for stocks trading at discounts AC World Index flat for 2020 and near its all-time high. Markets rose to our estimate of a company’s private market value (PMV) and would alongside increasingly dovish global central bank rhetoric, additional note that a meaningful increase in our forward profit expectations and fiscal stimulus in major global economies, progress toward a vaccine lower interest rates have generally increased our PMVs in line with our and Q2 corporate earnings well ahead of consensus expectations. technology holdings’ stock prices over the course of the year. It is Strength was broad-based at the sector level, with consumer certainly possible investors will rotate out of technology stocks in the discretionary and information technology leading. Energy was the coming months after such a strong YTD run. If so, we would look to only sector to deliver a negative total return. Growth handily take advantage of any significant pullback, assuming our underlying outperformed value. profit forecasts are unchanged. Global central banks have shown they are willing to indefinitely Turning to individual securities, among our top contributors in Q3 support financial markets until their economies are well on their way were Zoom Video Communications, Peloton and Advanced Micro to a full recovery. The US Federal Reserve recently indicated a rate hike Devices. Zoom’s enormous growth so far this year was on full display isn’t on the table until 2023 and adopted a “flexible average inflation” in Q2: 458% YoY growth in new customers (companies with >10 targeting framework. On the surface, this new policy appears more employees), 355% YoY revenue growth and a more than doubling in dovish, is a clear departure from the central bank’s prior 2% target and operating margins to 42%. Notable new customers included Exxon is seemingly an attempt to make up ground for undershooting Mobil, Activision Blizzard and Service Now. While Zoom will not inflation for most of the past decade. sustain this extreme rate of growth much longer—we and the company expect elevated customer churn on the other side of the As of this writing, the US Congress is debating another $2 trillion US pandemic—there are many potential long-lasting behavioral changes fiscal stimulus bill—the “HEROES Act.” The bill seems unlikely to make from this crisis that rely on videoconferencing (telehealth, less it to law before the November 3 election. This delay comes despite business travel, online education, etc.). Furthermore, Zoom’s customer Fed Chairman Powell’s recently highlighting the potentially dire base (15 million) still represents a small fraction of the total economic consequences absent swift legislative action, particularly addressable market for video conferencing (400 million), and the for the 11 million people who remain unemployed. company is in the early days of cross-selling additional products and services (Zoom Phone, Zoom Chat, Zoom Rooms) into its large Looking toward the year’s final months, there is still a healthy customer base. However, with a market cap north of $100 billion, collection of near-term lingering uncertainties. A second wave of Zoom’s success represents a “good problem to have” for a mid-cap COVID-19 during flu season, a stalling US economic recovery, portfolio. We are balancing this reality against the stock’s still- uncertain US-China relations, a contested US election outcome, Brexit, attractive investment attributes by gradually harvesting the position rising government debt levels, an unclear timeline to developing herd into strength. For now, it remains a top-10 holding. immunity to COVID-19 and an inability for the US government to pass another coronavirus relief package. Depending on how these events Peloton is a connected fitness franchise known for its stationary materialize, further volatility in the equity markets seems probable exercise bikes that provide live and on-demand cycling classes. The before 2020 concludes. company’s growth has accelerated during the pandemic as consumers replace in-person gym workouts—its subscriber count Performance Discussion rose 113% YoY in the second quarter, and customer engagement We have been pleased with our portfolio’s performance so far this (number of workouts per month) doubled. The company also year, which has in large part been led by stock selection among our announced the launch of a premium version of the Peloton bike— technology and health care holdings. The technology sector has allowing it to reduce the price of its standard bike—and a 2021 garnered increasing scrutiny as the year has progressed and introduction of a less expensive treadmill (the home treadmill market valuations have risen, and while we wouldn’t disagree there are is much larger than the bike market). We believe offering lower-priced pockets of frothiness—the IPO market in particular—we do not think bikes and treadmills will help make Peloton affordable for more we are in a dot-com era bubble. Margins and cash flow are consumers. Our conviction that Peloton is benefiting from network significantly better today, and many of the profit cycles seem and scale efficiencies has increased notably in recent quarters—it is sustainable for the rest of the decade. Big secular change can drive showing up in both revenue and profitability metrics—and we don’t massive and not fully appreciated value-creation, and we believe the think these trends will reverse post-pandemic. Given our high level of pandemic has been a meaningful accelerator of these changes. conviction in the profit cycle, we added to our position. Our holdings go through a highly selective process. While some of the Advanced Micro Devices (AMD) is a leading provider of high-flying technology stocks are not generating cash flow and are microprocessors for PCs and servers, graphics processors, and video trading on revenue metrics today, our focus is on businesses that are game consoles.
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