Fund commentary | Q1 2020
Opinions and commentary provided by MFS Investment Management Canada Limited.
Portfolio outlook and positioning
The Fund’s relative outperformance in the first quarter was not the result of a tactical change in positioning associated with the emergence of COVID-19. Rather, the year began with an eye toward the potential for greater volatility with a process and approach that has always favoured higher-quality companies, leading to a more defensively postured portfolio.
The portfolio manager believes the market will recover and ultimately move on from the impact of the pandemic, but this could take time. Moving forward, behavioural patterns could very well change in many cases. Things that were taken for granted may no longer feel safe. Many businesses will close, and unemployment will rise. It is important to remember that the market is a discounting mechanism, and the long-term impact of current events may not yet be fully priced in. It took almost three years for the market to recover after the 9/11 attacks. While markets in 2009 experienced more of a "v" shaped bottom, it still took several years for markets to return to any type of "normalcy". The portfolio manager believes this time around could be no different. The market will eventually recover. The world and the markets will move on; but this will likely take time. There may be many ups and downs along the way.
The portfolio manager believes this correction started in an overvalued market with excesses in both leverage and consumer spending. It was mostly the consumer that drove this market over the past few years, and that may subside going forward. Companies were overearning after levering up to buy back stock at high levels, while underinvesting for the long-term. Margins became unsustainably high. This has still to fully unwind, starting from a point of high valuations, which are just beginning to correct. Stocks were expensive. Combining high-valuations with a crisis leads to a corrective environment. While the spark may be different this time, the resulting correction is the same.
Nevertheless, the portfolio manager does believe the world will eventually recover and earnings will grow again, although this recovery could take some time. The Fund owns stocks with a long-term holding orientation and remains focused on higher-quality businesses across the market, staying away from highly leveraged and more cyclically oriented companies. The portfolio manager has compiled a list of high-quality companies determined what they believe is a reasonable price to pay for each. At the same time, the portfolio manager is cautious with respect to companies that were overearning and whose margins were too high at the onset of the crisis. On the flip-side, the portfolio manager also has a list of companies to sell and avoid. At the top of that list are companies with high leverage, unsustainably high margins, funding gaps and lower-quality earnings. The portfolio manager is using this market volatility as an opportunity upgrade the portfolio. At some point, there will be an opportunity to add risk, although they believe it is still too early to do so. For now, the portfolio manager is focused on companies that have sustainable business models, the ability to grow earnings over a multiyear period and little liquidity needs.
As of March 31, 2020, the portfolio was most overweight IT services, entertainment, health care equipment & supplies, professional services companies and select software firms. Within IT services, the portfolio manager continues to favour companies with exposure to digital payments, which may benefit from the strong secular trend of cash-to-card conversion. Within entertainment, the Fund holds overweight positions in gaming companies Electronic Arts, Activision and Take-Two Interactive, as well as subscription video on-demand firm, Netflix. Within the health care sector, the Fund has tended to be underweight highly regulated areas of the sector, such as traditional pharmaceutical firms and biotechnology stocks. It is also underweight health care service providers, given this sector’s lack of intellectual property and product differentiation. In professional services, top overweight positions include data providers such as Verisk. Top holdings in software remain Adobe, Intuit and Salesforce.com.
As of March 31, 2020, the portfolio was most underweight technology hardware, storage & peripherals, semiconductors & semiconductor equipment, and aerospace & defense companies. Within information technology, the portfolio remains underweight in areas of the sector that require higher capital intensity and are more cyclically exposed to global growth, such as hardware, storage & peripherals (meaningful underweight to Apple) and semiconductors (no exposure to Texas Instruments, Broadcom and Qualcomm). In the technology sector, the Fund’s lack of exposure to aerospace & defense companies (no exposure to Boeing, Lockheed Martin, and Northrop Grumman) driven by the fact that many of these business models tend to be capital intensive and more cyclical in their ability to generate earnings and cash flow. In addition, commercial aerospace companies, Boeing in particular, might be negatively impacted by changes in behaviour due to the coronavirus pandemic.
Significant transactions over the period included:
- Added to positions in Microsoft and Amazon during the quarter. In the portfolio manager’s view, both companies are dominant cloud-infrastructure providers and could continue to benefit from the long-term digital transformation as companies continue or, in some cases, accelerate their shift of business workflows toward cloud computing platforms.
- Established a position in enterprise cloud-computing solutions provider ServiceNow, one of the leaders in digital transformation and workflow automation software. The recent volatility created an attractive entry point from a valuation perspective.
- Re-established a position in video game company Activision Blizzard, which, along with existing holdings Electronic Arts and Take-Two Interactive, could benefit in the near-term from increased usage and viewership, and in the long-term, from an acceleration in the shift to digital versus console revenue.
Significant impacts on performance
Not holding shares of the aerospace company aided performance, as the stock price declined after widespread travel restrictions across the globe led the company to suspend production.
An overweight position in the software company helped returns as the stock price benefited from better-than-expected quarterly earnings.
An overweight position in the index-data provider, MSCI, supported results, as the company benefited from better-than-expected revenue growth, driven by strength in non-recurring subscription index revenues.
Holding shares of the maker of computer graphics processors detracted from performance. Despite better-than-expected earnings, its share-price suffered due to market volatility.
An overweight position in the hotel operator detracted from relative returns as the stay-at-home orders across the United States resulted in near-zero revenue for lodging companies.
An overweight position in the provider of global fleet vehicle fuel-cards held back performance as its shares fell with global travel volumes and fuel prices amid the COVID-19 pandemic.
|Compound returns %1||Since inception2||7 year||5 year||3 year||1 year||Q1|
|Sun Life MFS International Value Fund - Series A||15.5||16.6||12.0||14.4||7.8||-3.8|
|Sun Life MFS U.S. Growth Fund - Series F||16.8||17.9||13.3||15.7||9.1||-3.5|
|Russell 1000 Index||15.0||14.7||8.7||6.9||-2.0||-12.4|
1Returns for periods longer than one year are annualized. Data as of March 31, 2020.
2Partial calendar year. Returns are for the period from the fund’s inception date of October 1, 2010 to December 31, 2010.
Views expressed are those of MFS Investment Management Canada Limited, sub-advisor to select Sun Life mutual funds for which Sun Life Global Investment (Canada) Inc. acts as portfolio manager. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any mutual funds managed by Sun Life Global Investments (Canada) Inc. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. This commentary is provided for information purposes only and is not intended to provide specific individual financial, investment, tax or legal advice. Information contained in this commentary has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy.
This commentary may contain forward-looking statements about the economy and markets, their future performance, strategies or prospects or events and are subject to uncertainties that could cause actual results to differ materially from those expressed or implied in such statements. Forward-looking statements are not guarantees of future performance and are speculative in nature and cannot be relied upon.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Investors should read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The indicated rates of return are the historical annual compounded total returns including changes in security value and reinvestment of all distributions and do not take into account sales, redemption, distribution or other optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
While Series A and Series F securities have the same reference portfolio, any difference in performance between these series is due primarily to differences in management fees and operating fees. The management fee for Series A securities also includes the trailing commission, while Series F securities does not. Series A securities of the fund are available for purchase to all investors, while Series F securities are only available to investors in an eligible fee-based or wrap program with their registered dealer. Investors in Series F securities may pay a separate fee-based account fee that is negotiated with and payable to their registered dealer.