BBH U.S. Large Cap Equity Quarterly Strategy Update – 3Q 2022

Portfolio Managers, Nicholas Haffenreffer & Michael Keller, discuss how the U.S. Large Cap Equity portfolio companies performed over the most recent quarter-end.

Market Overview

During the third quarter, markets remained focused on one thing – inflation. In his August 26th speech to the Jackson Hole Economic Symposium, Federal Reserve (Fed) Chairman Jerome Powell put ambiguity aside stating, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation.”1 Reflecting the increased likelihood of a recession due to tighter monetary policy, markets resumed their downward trajectory and closed the period at new lows. While the balance between economic growth and inflation remains fragile, and the impact of higher rates a source of volatility, we remain focused on assessing attractive opportunities to deliver strong returns through the full cycle.

Performance BBH U.S. Large Cap Equity Composite
As of September 30, 2022

  Total Returns Average Annual Total Returns
  3 Mo.* YTD* 1 Yr. 3 Yr. 5 Yr. 10 Yr. Since
Inception
Gross of Fees -6.77% -26.88% -17.70% 3.68% 6.58% 9.05% 9.15%
Net of Fees -7.01% -27.45% -18.53% 2.66% 5.53% 7.98% 8.07%
S&P 500 -4.88% -23.87% -15.47% 8.16% 9.24% 11.70% 8.67%

Portfolio Commentary

The BBH U.S. Large Cap Equity Strategy (“the Strategy”) declined -6.77% for the third quarter versus a decline of -4.88% for the benchmark S&P 500 Index. The primary sources of underperformance were stock-specific, including NIKE (NKE, -18%) on inventory concerns, Alcon (ALC, -17%) on currency headwinds, and Adobe (ADBE, -25%) on the proposed acquisition of design application competitor Figma. On the other hand, allocation was positive as the portfolio was generally overweight better performing sectors and underweight primary underperformers. At the sector level, Industrials, Financials, and Staples held up relatively well, while Health Care and Communication Services performed poorly. E-commerce giant Amazon.com (AMZN) and insurance broker A. J. Gallagher (AJG) were the top contributors, while Alphabet (GOOG) and Celanese (CE) were the largest detractors. At quarter-end, the portfolio held 30 securities, 1.8% cash, and valuation at a wide discount to our estimate of intrinsic value[1], in sharp contrast to a year ago. During the quarter we purchased shares of Texas Instruments (TXN) and exited our investment in Sherwin-Williams (SHW).

Our thesis on Texas Instruments is based on two factors: the long-term secular demand for analog semiconductors and the company’s industry-leading capital allocation discipline. Texas Instruments (TI) is a leading semiconductor manufacturer specializing in high-performance analog integrated circuits (“ICs”) and embedded processors. Analog semiconductors are increasingly ubiquitous and essential building blocks in almost all electronic systems – a point highlighted by recent supply chain disruptions and geopolitical conflicts. TI possesses several competitive advantages that differentiate it from more commoditized and cyclical competitors. These include customer diversity, captivity, longevity of product cycles, superior technology and manufacturing efficiencies, and critically, disciplined capital allocation. This combination of advantages is difficult to replicate and helps position TI in a unique class of companies capable of generating and returning significant amounts of cash to shareholders on a consistent and dependable basis.

TI’s high performance analog products are mission critical building blocks used in applications such as automation, instrumentation, aerospace, defense, communication infrastructure, and the automotive industry. Once the products are qualified and deployed, customers are reluctant to make

changes. The cost of analog ICs is small compared to that of the end system, leaving customers likely to make purchasing decisions based on performance and reliability over price. TI has over 100,000 customers, reducing its dependence on any single product, market, or customer. Industry leading scale allows TI to invest more than its competitors in research & development, manufacturing, and distribution. While the industry is fundamentally capital intensive and economically sensitive, CEO Rich Templeton has a strong record as a disciplined capital allocator, delivering tremendous shareholder value over the past 20 years.

Our decision to exit Sherwin-Williams was based on three points, a process first begun earlier this year. First, we wanted to reduce our portfolio exposure to the U.S. residential and commercial real estate markets given current and likely continuing near- and medium-term monetary policy. Reducing and ultimately exiting the company was the best way to achieve this portfolio objective as it is the leading supplier of architectural coatings to the U.S. residential and commercial real estate markets. Second, a recent earnings warning immediately followed a positive investor day at which a completely different fundamental message was delivered suggested a lack of visibility into end-market dynamics. Third, competition for capital in the context of our concentrated approach remains high and we believe there are more compelling long-term investment opportunities with fewer near-term fundamental headwinds.

Finally, Adobe’s proposed acquisition of cloud-based design company Figma deserves mention as it was a source of pressure for one of the portfolio’s more recent investments. On September 16th, Adobe simultaneously reported results for Q3 and announced its intention to purchase Figma for $20 billion in cash and stock, along with an additional $2 billion in restricted shares that vest over the four years following the close of the acquisition. While Adobe’s quarterly results were strong in the face of macroeconomic headwinds, the market’s reaction to the Figma announcement was negative. Shares of Adobe traded down nearly 20% in the two sessions following the announcement, a decline that represented a loss of approximately $35 billion in market capitalization.

Figma is a competitor to Adobe XD which is Adobe’s UI/UX (user interface and user experience) design tool within the Creative Suite. While the purchase price appears remarkably high to acquire a competitor to a single solution within the broader Creative Suite that includes more than 20 individual applications, Figma’s collaboration capabilities are superior to any application currently within the Creative Suite. We believe that collaboration functionality accounts for management’s generous valuation of Figma and the strategic rationale to acquire the competitor. Over time, we expect to see Figma’s collaboration tools and functionality leveraged across Adobe’s legacy applications to support growth, pricing power and customer retention. Based on these assumptions, our assessment of the deal’s strategic merit is positive

Outlook

With the Fed’s cards on the table, the market’s attention turns to fundamentals. While the U.S. economic backdrop remains reasonably strong, the challenges and level of uncertainty remain high. Household and corporate balance sheets are healthy, and employment is full, but consumer confidence and leading economic indicators have turned sharply lower. Supply chain disruptions have been largely resolved, but remain vulnerable and in some cases, have resulted in acute inventory imbalances. The strong dollar poses significant growth and margin headwinds for U.S. exporters. As higher interest rates have brought valuations back to historic long-term averages, we enter the next phase of the market cycle where valuation support will largely depend on the durability of economic profits. On this front, we believe our portfolio is well positioned. Our investments are not immune to inflationary pressures or economic cycles, but compare favorably to the broader market. As a whole, the portfolio’s earnings growth, cash flows, and balance sheet health are superior to that of the S&P 500, and we take comfort in view that the underlying economic profits of our clients’ portfolios are resilient and that value is far more durable than price.

Holdings
Representative Account
As of September 30, 2022

Alphabet Inc (Class C) 6.5%
Berkshire Hathaway Inc (Class A) 6.2%
Mastercard Inc 5.5%
Arthur J Gallagher & Co 4.6%
Linde PLC 4.5%
Microsoft Corp 4.5%
Progressive Corp 4.1%
Waste Management Inc 4.0%
Zoetis Inc 3.8%
Alcon Inc 3.8%
Costco Wholesale Corp 3.7%
Thermo Fisher Scientific Inc 3.6%
Dollar General Corp 3.2%
KLA Corp 3.0%
Amazon.com Inc 2.9%
Copart Inc 2.7%
Abbott Laboratories 2.6%
Graco Inc 2.6%
Nike Inc 2.5%
Celanese Corp 2.5%
S&P Global Inc 2.5%
Oracle Corp 2.4%
Texas Instruments Inc 2.3%
Diageo PLC ADR 2.2%
A O Smith Corp 2.1%
Pool Corp 2.1%
Booking Holdings Inc 2.1%
Adobe Inc 2.0%
Signature Bank 2.0%
Nestle SA ADR 1.8%
Cash & Cash Equivalents 1.8%
Holdings are subject to change.

Representative Account
Equity Weighting
As of September 30, 2022

Common Stock

98.2%

Cash and Cash Equivalents

1.8%

Total

100.0%

Representative Account
Sector Weighting
As of September 30, 2022

Communication Services 6.7%
Consumer Discretionary 13.0%
Consumer Staples 7.9%
Energy 0.0%
Financials 19.7%
Health Care 14.0%
Industrials 11.6%
Information Technology 20.0%
Materials 7.1%
Real Estate 0.0%
Utilities 0.0%
Total 100.0%
Reported as a percentage of portfolio securities, excluding Cash and Cash Equivalents.

Representative Account
Portfolio Characteristics
As of  September 30, 2022

Composite Assets (mil)

$762.5

Number of Securities Held

30

Average P/E

23.1

Average Market Cap (bil)

$249.1

Turnover (Rolling 12 Months)

24.63%

Exclude cash equivalents

Representative Account
Top 10 Companies
As of September 30, 2022

Alphabet Inc 6.5%
Berkshire Hathaway Inc 6.2%
Mastercard Inc 5.5%
Arthur J Gallagher & Co 4.6%
Linde PLC 4.5%
Microsoft Corp 4.5%
Progressive Corp 4.1%
Waste Management Inc 4.0%
Zoetis Inc 3.8%
Alcon Inc 3.8%
Total 47.5%


1 Federal Reserve, Monetary Policy and Price Stability: federalreserve.gov/newsevents/speech/powell20220826a.htm2 Stablecoins are cryptocurrencies whose value is pegged to that of another currency, commodity, or financial instrument.
2 BBH’s estimate of the present value of the cash that a business can generate over its remaining life.

* As of 10/4/2021, Nicholas Haffenreffer joined BBH as Portfolio Manager of BBH U.S. Large Cap Equity strategy.

Holdings are subject to change. Totals may not sum due to rounding.

Intrinsic value is an estimate of the present value of the cash that a business can generate and distribute to shareholders over its remaining life.

Price/Earnings (P/E) ratio is a company’s current share price divided by earnings per-share.

Turnover ratio is the rate of trading in a portfolio; higher values imply more frequent trading.

Contribution figures are presented gross of fees and do not include cash and cash equivalents.

Opinions, forecasts, and discussions about investment strategies represent the author’s views as of the date of this commentary and are subject to change without notice. References to specific securities, asset classes, and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations.

Purchase and sale information provided should not be considered as a recommendation to purchase or sell a particular security and that there is no assurance, as of the date of publication, that the securities purchased remain in a fund's portfolio or that securities sold have not been repurchased.

RISKS

Investors should be able to withstand short-term fluctuations in the equity markets in return for potentially higher returns over the long term. The value of portfolios changes every day and can be affected by changes in interest rates, general market conditions and other political, social and economic developments. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

The strategy may assume large positions in a small number of issuers which can increase the potential for greater price fluctuation.

Foreign investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.

The Representative Account is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the strategy.

Contribution to returns is of the Representative Account. The performance of the Representative Account is available upon request.

Brown Brothers Harriman Investment Management (“IM”), a division of Brown Brothers Harriman & Co (“BBH”), claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To receive additional information regarding IM, including a GIPS Composite Report for the strategy, contact Craig Schwalb at (212) 493-7217, or via email at craig.schwalb@bbh.com.

Gross of fee performance results for this composite do not reflect the deduction of investment advisory fees. Actual returns will be reduced by such fees. Net of fees performance results reflect the deduction of the maximum investment advisory fees. Returns include all dividends and interest, other income, realize and unrealized gain, are net of all brokerage commissions and execution costs. Results will vary amount client accounts. Performance calculated in U.S. dollars.

The Composite is fully discretionary, fee-paying accounts over $5 million that invest in a portfolio of approximately 25-35 companies with market capitalizations greater than $5 billion that are headquartered in North America, as well as in certain global firms located in other developed regions. This strategy is benchmarked to the S&P 500 Index.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2022. All rights reserved.

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