The third quarter began as a continuation of the strong equity market rally off the March lows. September 2nd marked the beginning of a brief but sharp selloff as investors reassessed stock valuations and economic conditions following a strong rebound propelled by unprecedented stimulus policies and a partial reopening of the economy. As the index fell for a brief period, the defensive growth characteristics of the portfolio were able to shine through, as the Fund picked up significant ground versus the benchmark. The selloff was interrupted by a resurgence in the tech stock leadership that had been driving the index for most of the year.
For the year-to-date period ended September 30, the environment proved challenging for the Fund’s style, which seeks above average, durable growth compounders at reasonable valuations. The Fund is underexposed to the narrow group of higher-valued growth names that have been leading the market higher. Not holding Amazon had the largest negative impact on the Fund’s relative performance this year. Amazon has benefitted from COVID-19 as the growth of its e-commerce and cloud businesses have accelerated sharply since March. However, the portfolio manager is comfortable not owning Amazon, which now trades at a P/E ratio of 122x trailing 12-month earnings, and being underweight to the higher valued group of stocks, both for style reasons and because growth in general appears expensive today.
The portfolio manager is optimistic about the Fund’s significant exposure to many of the key secular growth trends while staying true to its GARP (growth at a reasonable price) style. Top holdings include:
- Microsoft (cloud services and software growth)
- Alphabet (digital advertising and cloud platform)
- Accenture (global IT consulting)
- Visa and MasterCard (digital payments and e-commerce)
- Alibaba (e-commerce/payments platform and cloud services growth
- Tencent (messaging, cloud and gaming platform)
- Naver (search engine)
- Baidu (search engine)
- Electronic Arts (online gaming)
The portfolio manager is bullish about the long-term prospects of these companies.
The Fund invests with a long time-horizon and assesses investment opportunities in the context of a five-to ten-plus year time horizon. While still thinking long-term, portfolio turnover has remained somewhat elevated since the first quarter, as the team tried to take advantage of volatility and market dislocations. As expectations for market earnings appear to have been lowered for the next few years, some less cyclical names now stand out as relatively more attractive.
During the quarter, MFS started a new position in medical equipment company Medtronic, which it believes has less cyclical fundamentals compared to the broader market and an attractive relative valuation when looking out a few years. Med tech overall is still very attractive and the Fund holds peers Boston Scientific, Stryker, Becton Dickinson and Abbott. For Medtronic, MFS thinks the new CEO's plan for accelerated growth by pushing decision making down to group leaders, increasing accountability, and instilling a performance-driven culture seems reasonable and believes this may not be priced into the stock.
The Fund is significantly underweight the mega-cap tech group, so it added to positions in Alphabet, Alibaba and Tencent to keep the underweight from expanding further. These additions were funded by trimming several names that have generally outperformed and became more expensive. The Fund exited its position in adhesives manufacturer, Nordson. MFS also trimmed positions in Naver, Taiwan Semiconductor, Equifax and Moody’s on strong outperformance and a higher valuation. The Fund exited Ecolab, as the portfolio manager believes the company faces significant headwinds.
The portfolio manager’s commitment to its investment process and philosophy remains unchanged. They maintain a long-term investment horizon and focus on owning durable growth compounders where they feel confident in the sustainability of profits over the long-term. The Fund’s objective is to add value through a series of individual, bottom-up investment decisions, rather than through difficult-to-predict macroeconomic events.
Significant impacts on performance