Value landscape shifts in a challenging quarter

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Q2 2022 Putnam Large Cap Value Fund Q&A

• The fund outperformed the benchmark Russell 1000 Value Index for the second quarter and for the 1-, 3-, 5-, and 10-year periods ended June 30, 2022.
• In 2022, we have seen many stocks typically classified as growth moving to the value space.
• We are closely monitoring market conditions and headwinds while remaining cognizant of where we are in the economic cycle.

In the first half of 2022, equities had their worst performance in decades. How did it affect the portfolio?

Darren: We’ve seen some important shifts in the market in 2022. While all stocks have struggled, growth stocks in particular have underperformed significantly. As a result, we’ve seen many stocks typically classified as growth moving to the value space. Once a year in June, to adjust to changing market conditions, Russell rebalances its indexes, including our benchmark, the Russell 1000 Value Index. As part of the rebalance, for example, technology giant Meta Platforms has moved to the value index.

Because of our investment process, we were already ahead of these changes in many cases. We do not wait for index rebalancing. Rather, we analyze and define the value universe every day — helping to uncover attractive stocks that may not yet be part of the benchmark.

How did the fund perform in this environment?

Lauren: In yet another difficult quarter for financial markets, the fund declined less than its Russell 1000 Value benchmark. The fund also outperformed the benchmark for the 1-, 3-, 5-, and 10-year periods ended June 30, 2022. In terms of sectors for the quarter, holdings in health care and information technology contributed most to performance.

What helped the fund outperform its benchmark?

Darren: We believe the outperformance was due to the portfolio’s positioning as we entered the period. A key component of our investment process has always been rigorous risk control. Another key strategy — which was very important for weathering this period — is portfolio construction. We had a balanced portfolio that was focused on the fundamentals of individual businesses rather than on macroeconomic or sector trends. This helped prepare the fund in advance for very difficult conditions in the equity market. To use an analogy, we want to have the house ready before the tornado arrives, because trying to fix it during the tornado is very difficult.

In many cases, the market disruption gave us an opportunity to trade into more attractively valued stocks. When the market sells off sharply due to short-term issues, investors tend to overlook improving fundamentals for many businesses. In health care, for example, late last year we identified a stock trading at a price-to-earnings multiple that didn’t reflect improvements in its underlying business. The stock was also cheap relative to its own history, as many investors were avoiding it due to litigation-related expenses for the company. We added it to the portfolio and exited a position in a health care stock that had become expensive relative to its own history and relative to its health care peers. In the time since this shift, the new holding has delivered strong performance and has outperformed the holding we sold.

Inflation has been a serious headwind for investors. How does it affect your investment process?

Lauren: We’ve clearly seen that inflation has broad implications for the global economy. As portfolio managers, we don’t try to predict the duration or magnitude of inflationary forces. However, we do focus on how it might impact the profitability of the companies we own. We aim to find companies that have pricing power — the ability to raise prices to cover their increased costs without negatively impacting demand. But we’re also mindful of instances where pricing power will be challenged.

Through careful portfolio construction and stress testing, we seek to manage the portfolio’s sensitivity to inflation as well as to interest-rate and bond-yield movements. With our risk management process, we work to keep the portfolio from meaningfully underperforming in a rising-rate environment. We also seek to manage interest-rate risk by maintaining a mix of holdings with varying interest-rate sensitivity.

We are closely monitoring market conditions and headwinds such as inflation and supply chain disruptions, while remaining cognizant of where we are in the economic cycle. Although sentiment has declined and stocks have sold off, we have yet to see the impact of current conditions on company earnings. As fundamental investors, we will analyze this upcoming earnings season to determine which companies are weathering the cycle and which are not.