CLEARBRIDGE DIVIDEND STRATEGY FUND

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1 3Q 2018 Product Commentary CLEARBRIDGE DIVIDEND STRATEGY FUND Michael Clarfeld, CFA, Scott Glasser, and Peter Vanderlee, CFA Portfolio Managers Average annual total returns and fund expenses (%) as of September 30, 2018 Class A 3-mo 1-yr 5-yr 10-yr Excluding sales charges Including effects of maximum sales charges Since Incept. (11/06/92) Gross Net S&P 500 Index N/A - - Performance shown represents past performance and is no guarantee of future results. Current performance may be higher or lower than the performance shown. Investment return and principal value will fluctuate, so shares, when redeemed, may be worth more or less than the original cost. Class A shares have a maximum front-end sales charge of 5.75%. Total returns assume the reinvestment of all distributions at net asset value and the deduction of all Fund expenses. Total return figures are based on the NAV per share applied to shareholder subscriptions and redemptions, which may differ from the NAV per share disclosed in Fund shareholder reports. Performance would have been lower if fees had not been waived in various periods. Returns for less than one year are cumulative. For the most recent month-end information, please visit Gross expenses are the Fund's total annual operating expenses for the share class(es) shown. Net expenses are the Fund's total annual operating expenses for the share classes indicated and would reflect contractual fee waivers and/or reimbursements, where these reductions reduce the Fund's gross expenses. These arrangements cannot be terminated prior to December 31, 2019 without the Board s consent. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the numbers shown in the table above. S&P 500 Index is an unmanaged index of common stock performance. Key takeaways During the quarter the portfolio benefited from strong performance in the industrials, health care and IT sectors. Dividends today are a far more efficient mechanism for returning value to shareholders than they have been in decades. Growing cash flow is the only way to offset rising interest rates, so as the rate cycle progresses, a portfolio of high-quality dividend growers can help to offset the ravages of higher interest rates. Market overview and outlook The third quarter was a good one for Dividend Strategy and the stock market overall. Information technology (IT), health care, industrials and consumer discretionary stocks were all up around 10% or more in the market. Growth stocks continued to outperform, but by a much smaller margin than in the first half of the year. It has been an excellent year for dividend growth. In the past year, dividends have increased 8%, up from 7% the year before. With its focus on dividend growers, the ClearBridge Dividend Strategy is well positioned to benefit from this trend. Economic activity continues to be brisk. Second-quarter GDP showed the U.S. economy growing at 4.2%, the highest level since Unemployment is a historically low 3.9%, while jobless claims reached the lowest rate in half a century. The economy s strength has enabled the Federal Reserve to continue raising interest rates. The Fed has raised rates four INVESTMENT PRODUCTS: NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE

2 times in the last 12 months, and it expects to raise rates three more times in Given the broad significance of rising interest rates, we feel it s worth revisiting a topic we have covered in previous letters. As interest rates have risen, some investors have asked if dividend payers are still a good place to be. They see bonds offering better rates than they did a year ago and wonder if the time for dividends has passed. And, indeed, as interest rates have increased in the early part of this rate cycle, dividend-paying stocks have experienced turbulence. Dividend payers often underperform in the early part of a rising rate cycle. But as the cycle matures, dividend payers and especially dividend growers tend to more than recoup that initial underperformance. While there is no guarantee that the past is prologue in this interest rate cycle, there is good reason why dividend payers hold up well. Growing cash flow is the only way to offset rising interest rates. So as the rate cycle progresses, a portfolio of high-quality dividend growers can help to offset the ravages of higher interest rates. The healthy U.S. economy has driven strong corporate earnings in 2018, supporting robust dividend growth. Second quarter earnings reports released over the summer showed the third-highest growth rate since Both the economy and corporate earnings reflect, in part, the benefit of the recent corporate tax cut. With lower tax bills, companies have more cash to distribute to shareholders. The recent tax cut builds on a foundation that was laid in 2003, when the tax rate on qualified dividends was reduced to 15%. 2 This was a watershed event for dividend investors, as it meaningfully reduced the drag of double taxation. 3 The recent corporate tax cuts further reduce the burden of double taxation, making dividends today a far more efficient mechanism for returning value to shareholders than they have been in decades. A dollar s worth of pretax income today generates up to 67 cents in dividend value, up dramatically compared to prior tax regimes (Exhibit 1). Exhibit 1: Dividends Becoming Increasingly Attractive Source: ClearBridge Investments. Pre-2003 assumes corporate tax rate of 35% and maximum marginal tax rate of 39.6% assumes corporate tax rate of 35% and qualified dividend tax rate of 15% assumes corporate tax rate of 21% and qualified dividend tax rate of 15% for individuals earning under $400,000 and households earning under $450,000. For simplicity, table assumes a 100% payout ratio. During the quarter the portfolio benefited from strong performance in the industrials, health care and IT sectors. Union Pacific hit all-time highs as it announced it would implement precision scheduled railroading, an operating strategy that should lower operating expenses and boost profits. As an entirely domestic railroad company, Union Pacific has benefited significantly from tax cuts; it has raised its dividend by 20% in the last 12 months. In health care, Pfizer, Merck and Johnson & Johnson were all up double digits, lifted by: strong earnings, steady product approvals, positive clinical catalysts, good pipeline delivery and more benign regulatory rhetoric around drug pricing. In the IT sector, Visa, Mastercard and Microsoft all delivered nice performance for the portfolio. These companies exemplify our preference for stocks with recurring revenues, strong margins and returns and prodigious free cash flow. The market has done well thus far in 2018, and the strong economy gives reason for continued optimism. At the same time, the list of risks is as long as it feels trite: rising rates, fiscal deficits, trade wars, regular wars, climate change, political uncertainty, geopolitical fragility you get the point. In this period, which we would generously term interesting times, we remain steadfast and disciplined. We focus on highquality companies with relatively less economic sensitivity and the potential to compound earnings and dividends at attractive rates over the long term. Today s bull market is nine years old and valuations are at cyclical highs. Against such a backdrop, 1 Source: S&P 500 Index. FactSet Earnings Insight, September 7, Prior to 2003 dividends were taxed at an individual s marginal tax rate. 3 The shareholder is taxed first at the corporate level, as the corporation pays taxes, and then pays additional taxes on the dividends received. 2

3 we believe investing in a diversified portfolio of fundamentally strong dividend growers represents a sound course. Fund highlights For the quarter ended September 30, 2018, the ClearBridge Dividend Strategy Fund Class A shares had a cumulative return of 6.22%, excluding the effects of sales charges. In comparison, the Fund s unmanaged benchmark, the S&P 500 Index, returned 7.71%. On an absolute basis, the Fund had gains in nine of the sectors in which it was invested for the quarter (out of 11 sectors total). The main contributors to performance came from the financials, information technology (IT) and health care sectors, while the main detractors came from the energy and real estate sectors. On a relative basis, overall sector allocation detracted from performance for the quarter. In particular, the Fund s underweights to the health care and IT sectors and its overweight to the materials sector hurt relative results. Stock selection in the consumer discretionary and energy sectors also dragged on relative performance. On the positive side, stock selection in the financials sector and the newly created communication services sector (which expands the telecommunication services sector to include select companies from the consumer discretionary and IT sectors) added to relative performance. On an individual stock basis, the largest detractors were General Motors, Enbridge, Schlumberger, Weyerhaeuser and Anheuser-Busch InBev. Positions in Berkshire Hathaway, Microsoft, Apple, Blackstone and Merck were the greatest contributors to absolute returns in the quarter. During the quarter, we sold positions in Suncor Energy, in the energy sector, and Lamb Weston and Kimberly-Clark, in the consumer staples sector. 3

4 Top contributors The leading individual contributors to Fund performance for the quarter included: Apple (AAPL), in the IT sector, designs, manufactures, and markets personal computers, smartphones and a variety of related software, services and devices. Shares rallied following Apple s second-quarter earnings beat, helping the company reach $1 trillion in market cap. Apple is successfully raising the average selling price of its iphone portfolio, while returns are also being driven by strong growth in its software and services division, which includes the App Store, itunes and cloud services. Microsoft Corporation (MSFT), in the IT sector, is one of the largest software companies in the world. The company delivered another quarter ahead of consensus expectations and it provided stronger-than-expected guidance. Microsoft continues to see success with Office 365 and it remains on a strong cloud transition trajectory. Merck (MRK), in the health care sector, is a large pharmaceutical company. The company has a broad portfolio of products generating stable streams of cash flow and meaningful growth potential. We expect Merck s Keytruda, which helped the company beat revenue and earnings expectations in the quarter, to be a leading product in immuno-oncology, one of the most dynamic and promising areas in health care. Bottom contributors In terms of individual stocks, the leading detractors to Fund performance for the quarter included: Weyerhaeuser (WY), in the real estate sector, runs a diversified set of businesses focused on timberlands, wood products and real estate. Weyerhaeuser declined as lumber prices retreated from all-time highs and yield-oriented sectors came under pressure from rising rates. Nevertheless, Weyerhaeuser reported strong second quarter earnings and enjoys an attractive long-term footprint and outlook. General Motors (GM) is a global auto maker that designs, builds and sells a variety of auto brands around the world. Shares slid on concerns over the impact of rising commodity costs and the direction of the automotive cycle. General Motors nevertheless remains highly profitable, maintains a good balance sheet and a low cost structure, and its Cruise business represents a meaningful opportunity in the emerging area of autonomous vehicles. We believe that shares of GM already discount investor expectations for reduced industry sales. Schlumberger (SLB) is the largest oil services company in the world. International activity continues to take longer to recover than expected. With rising oil prices, we believe it s a question of when, not if, the international services business gains steam. 4

5 Top 10 equity holdings (%) Microsoft Corp 3.7 Berkshire Hathaway Inc 3.5 Home Depot Inc/The 2.9 Apple Inc 2.8 Blackstone Group LP/The 2.6 Texas Instruments Inc 2.5 Union Pacific Corp 2.5 Definitions and additional terms: Please note that an investor cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. The Federal Reserve Board ("Fed") is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments. Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. The S&P 500 Index is an unmanaged index of common stock performance. Johnson & Johnson 2.4 JPMorgan Chase & Co 2.3 Merck & Co Inc 2.2 Sector allocation (%) Financials 19.6 Consumer Staples 13.4 Information Technology 12.9 Industrials 9.5 Health Care 8.1 Communication Services 7.1 Materials 6.9 Energy 6.8 Consumer Discretionary 5.5 Utilities 4.5 Real Estate 3.6 Cash/Other 2.1 Percentages are based on total portfolio as of quarter end and are subject to change at any time. For informational purposes only and not to be considered a recommendation to purchase or sell any security. 5

6 Brandywine Global Clarion Partners ClearBridge Investments EnTrustPermal Martin Currie QS Investors RARE Infrastructure Royce & Associates Western Asset leggmasonfunds.com Youtube.com/leggmason Legg Mason is a leading global investment company committed to helping clients reach their financial goals through long-term, actively managed investment strategies. A broad mix of equities, fixed income, alternatives and cash strategies invested worldwide A diverse family of specialized investment managers, each with its own independent approach to research and analysis Over a century of experience in identifying opportunities and delivering astute investment solutions to clients What should I know before investing? Equity securities are subject to price fluctuation and possible loss of principal. Real estate investment trusts (REITs) are closely linked to the performance of the real estate markets. REITs are subject to illiquidity, credit and interest rate risks, and risks associated with small- and mid-cap investments. Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks. Short selling is a speculative strategy. Unlike the possible loss on a security that is purchased, there is no limit on the amount of loss on an appreciating security that is sold short. International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Derivatives, such as options and futures, can be illiquid, may disproportionately increase losses, and have a potentially large impact on Fund performance. Dividends may fluctuate, and a company may reduce or eliminate its dividend at any time. Fixed income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, a forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional. Portfolio holdings and sector allocations may not be representative of the portfolio manager's current or future investment and are subject to change at any time. ClearBridge Investments, LLC and Legg Mason Investor Services, LLC are subsidiaries of Legg Mason, Inc Legg Mason Investor Services, LLC. Member FINRA, SIPC CBAX D /18 BEFORE INVESTING, CAREFULLY CONSIDER A FUND S INVESTMENT OBJECTIVES, RISKS, CHARGES AND EXPENSES. YOU CAN FIND THIS AND OTHER INFORMATION IN EACH PROSPECTUS, AND SUMMARY PROSPECTUS, IF AVAILABLE, AT PLEASE READ THE PROSPECTUS CAREFULLY. 6