Market overview

We entered calendar year 2026 with some degree of caution. The Index had just come off its third consecutive year of double-digit returns, while earnings and free cash flow per share growth were essentially flat over the multiyear period. Valuations were full and expectations for earnings growth were high, both on an absolute basis and relative to near- and longer-term history, while internal market structure was undergoing a period of dramatic change.

The bifurcation between momentum and fundamental metrics has never been more extreme. In today’s market environment, price momentum and positive revisions to sell-side analyst estimates are being rewarded, often without regard to valuation or the absolute fundamental performance of a company in respect of the drivers of true economic value creation. Performance measurement and its interpretation should be carefully contemplated given the rapidly changing market structure, and our general goal of transparency and its benefits are only heightened given the significant trade activity experienced of late and that is likely to continue in the near term as we reposition portfolios to achieve our multifaceted investment goals in the context of intense and evolving risks.

First quarter 2026 experienced a decline of 4%, with escalating geopolitical risk triggering an oil supply shock, fueling near-term inflation concerns. Energy (+38.3%) and Materials (+9.7%) were the best performing sectors, contributing ~122 basis points (bps)¹ to the market’s total return. In contrast, Financials (‑9.4%) and Consumer Discretionary (‑9.2%) were the worst performers for the quarter. Energy was the only sector in the index to generate double‑digit returns, driven by significant tailwinds from the war in Iran.

Portfolio commentary

The financial results of our portfolio companies were strong, with our recipe for economic value creation – reported returns on invested capital plus implied free cash flow per share growth – attractive on both an absolute and relative basis. Compared to the extreme uncertainty that accompanies the price other market participants are willing to pay for our portfolio companies and those we choose not to own, we feel more in control of the fundamental performance and superior valuation of our portfolio companies. Net earnings and free cash flow per share grew 11% and 10%, respectively, for the Strategy over the three-year trailing period vs. 7% and -2%, respectively, for the Index over the same time period.

To that end, our portfolio companies have executed well and have produced solid growth and fundamental economic performance while maintaining appropriately conservative capital structures. These achievements are evident at the aggregate portfolio level, where we have observed attractive growth in revenue, cash flow, and earnings; superior profit margins; returns on capital; and healthy balance sheets. While the Strategy is more fully valued than we have historically observed given the strong equity markets we experienced over the past several years, the valuation remains supportive on an absolute basis and is attractive relative to the Index. Compared to the extreme uncertainty that accompanies the price other market participants are willing to pay and those names we choose not to own, we feel more in control of the fundamentals and valuation of our portfolio companies.

For the quarter, the Fund’s two largest detractors to total return were Microsoft (MSFT) and Oracle (ORCL) respectively.

Microsoft (share price -23%) was the largest performance detractor, reducing the Strategy’s total return by ~163 bps during the quarter. The share price decline reflected growing market skepticism around the returns on AI‑related capital spending and the capital intensity required to support AI infrastructure delivery, alongside a market rotation favoring semiconductor companies over software and cloud infrastructure providers. Investor disappointment was compounded by management’s decision to prioritize internal workloads over external customer demand, which weighed on Azure growth. Management has emphasized that allocating scarce capacity toward internal workloads is intended to maximize long‑term value by leveraging Microsoft’s distribution advantages and capturing value higher in the software stack, an approach we believe supports durable strategic positioning despite near‑term share price pressure.

Oracle (share price -24%) detracted ~64 bps from the Strategy’s total return during the quarter as the company was exposed to the same skepticisms (i.e., AI infrastructure investment, market rotation away from software) as Microsoft. Investor attention also centered on Oracle’s financing mix for its AI data center expansion, which requires incremental debt and equity issuance and introduces additional financial leverage; however, we view this risk as mitigated by strong contractual commitments from customers that have subscribed to capacity coming online over the next several years. We were encouraged by management’s intention to include equity financing, which should reduce overall leverage and improve the company’s risk profile as investments scale. Oracle’s growing Remaining Performance Obligations provide attractive visibility into future revenue.

For the quarter, the Strategy’s two largest contributors to total return were Applied Materials (AMAT) and KLA Corp (KLAC) and respectively.

Applied Materials (share price +33%) was the largest contributor during the quarter, adding ~96 bps to the Strategy’s total return. Applied Materials develops, manufactures, and services semiconductor wafer fabrication equipment and spare parts for the global semiconductor industry. Share price performance during the period reflected increasing market recognition that demand for AI continues to exceed supply, with silicon availability emerging as a critical bottleneck. With market share in the high teens, Applied Materials is a direct beneficiary of incremental capital spending required to support higher production volumes at leading semiconductor manufacturers.

KLA (share price +21%) was a large contributor during the quarter, adding ~60 bps to the Strategy’s total return. KLA provides process‑control, inspection, and metrology solutions that are critical to semiconductor manufacturing, particularly as chip complexity increases in advanced logic and high‑performance computing. Share price performance reflected confidence that KLA’s leading market share in defect inspection and metrology positions it to benefit from next generation nodes, including 2‑ and 1‑nanometer technologies at leading foundries, as well as long‑term growth in advanced packaging and power semiconductors. During the period, KLA also exceeded earnings and revenue expectations and reinforced its shareholder return profile through a $7 billion share repurchase authorization and a 21% increase in its quarterly dividend.

Over any period, stock prices reflect the confluence of many factors as well as the perspectives of myriad other investors, both active and passive, that do not share our perspectives on risk, fundamental economic value creation, or how to properly measure it. Regardless of these other views, over the long term, we believe that it is a reasonable and an economically sound premise that the price of stocks should follow their growth in free cash flow per share and that attractive valuations support economic upside and mitigate risk. This will remain our focus as we seek to deliver both strong absolute and relative returns over the long term.

While this work will continue and is a constant focus of our analytical and portfolio management activities, we expect it to slow in the near term given the sharp recovery in market prices and still-elevated levels of policy-induced risk. While we remain focused on finding new investments that meet our investment criteria and are attractively valued, we do so in the context of a market environment we view as challenged, with risks evident on many fronts.

Portfolio activity

Negative stock price reactions have been driven by concerns about AI code generation tools lowering barriers to entry in software and agentic AI displacing labor and thus reducing the need for licensed application software seats. As we evaluated relative disruption risk within the software ecosystem, we took portfolio action intended to reduce AI-centric product and business model disruption and disintermediation risk. Our trading activity during the quarter balanced these risks with the significant fundamental and valuation support these stocks offer.

To that end, we were able to initiate positions in a number of high-quality companies: J.P. Morgan, Rockwell Automation, Intuitive Surgical, Palo Alto Networks, Hilton Worldwide, Broadcom, Home Depot, Parker Hannifin, and Graco.

During the quarter, we also executed several portfolio rebalancing trades reflective of relative valuation opportunities, risk, and fit with our investment criteria. Turnover during the quarter was 13.2%. While high relative to recent periods, this represents a period of market volatility and uncertainty, and where we have been acting with an aim to improving an already high-quality portfolio to one possessing higher expected levels of economic profit growth and better valuation support.

Outlook

At the end of first quarter 2026, we held positions in 46 companies, with the 10 largest holdings accounting for 45% of total assets. We ended the quarter with a cash position of 2.6%.

In our view, momentum and high beta continue to drive market performance at the expense of growth, quality, and positive fundamental factors. After making opportunistic adjustments, we remain focused on finding new investments and rebalancing existing portfolio companies in the context of a market environment we view as challenged.

With a backdrop of decelerating economic growth, extreme policy uncertainty and geopolitical risk, and still-high market expectations relative to history, we remain focused and committed to investing in companies that meet our qualitative criteria, have the fundamental financial characteristics in place that allow for durability in times of economic and market stress, and offer valuation support.

To conclude, our portfolio companies have executed well and produced solid growth and fundamental economic performance while maintaining appropriately conservative capital structures. Given the near- and longer-term outlooks provided by the companies in the Strategy, we are optimistic that these strong trends will continue and that the differentiated financial attributes will be better recognized by other investors in the future, improving the stock price performance of the Fund relative to the Index over time.

Thank you for your interest in the BBH Large Cap Core Select equity strategy. Please reach out if you have any questions.