The equity market rally that began in late March continued into the second quarter, sending the MSCI All Country World Index up 19.2% during the second quarter alone. Growth stocks outpaced value as the MSCI All Country World Growth index returned 25.1% in the second quarter versus 12.7% for the MSCI All Country World Value Index, the widest differential in performance between the two in the twenty-year history of the indexes.
This environment proved challenging for the Fund’s conservative GARP growth style that seeks above-average durable growth compounders at reasonable valuations. The portfolio manager’s investment style has historically performed best during difficult market environments (e.g., down markets or periods of heightened volatility) but has lagged during especially strong, absolute return environments like the second quarter. The Fund is underexposed to the fairly narrow group of higher-valued growth names that have been leading the market higher, which makes it difficult to keep up with the index. These names were surprisingly strong during the quarter, despite the COVID-19-driven shutdown in economic activity. In particular, an underweight to Apple and not holding Amazon had the largest negative impact on the Fund’s relative performance this quarter. The team is comfortable not owning Amazon, which traded at a P/E ratio of 138x trailing 12-month earnings and being underweight to this higher-valued group of stocks, both for style reasons and because growth in general appears expensive today compared to history after many years of expanding relative valuations. The Fund’s underexposure to growth/high valuation has widened recently, and the team wants to keep the underweight from continuously expanding and potentially overwhelming portfolio performance. In line with this, MFS increased exposure to key secular growth trends (e.g., cloud, ecommerce, digital payments, digital advertising), while staying true to its GARP style.
The team added a new position in Tencent (messaging and gaming). It increased its position in Alibaba (ecommerce/payments and cloud services), Microsoft (cloud services and software), Comcast (high-speed broadband), Electronic Arts (online gaming) and Naver (search engine). The Fund’s exposure to other stocks that have benefited from similar growth trends include Alphabet (digital advertising and cloud platform), Baidu (China's dominant search engine), Accenture and Cognizant (global IT consulting), Visa and Mastercard (digital payments) and Fiserv and Fidelity National Information Services (digital payments). The portfolio manager is optimistic about the long-term prospects for these companies, and while some of them were good performers this year, their contribution to portfolio results was not enough to offset the Fund’s underweight to the previously mentioned benchmark names.
The types of well-positioned and reasonably valued durable growth compounders the Fund focuses on generally delivered positive performance results during the quarter but lagged the overall index. Apparel maker Adidas shares rebounded in the second quarter after reporting signs of a sales recovery in China, its largest market. The portfolio manager believes the shares are attractively valued relative to their long-term growth prospects, which could benefit from the trend towards athleisure and the fact that it operates in a moated duopoly with Nike.
MFS invests with a long-term horizon, assessing investment opportunities in the context of a 5 to 10-year (or more) time horizon. While thinking long term, the team continued to trade slightly more than normal in the quarter in order to try to take advantage of market dislocations as dispersions remained elevated. The Fund started a new position in Boston Scientific, which had been pressured by a decline in acute surgical procedures. MFS purchased PRA Health Sciences and ICON PLC. Both are contract research organizations that run clinical drug trials on behalf of biotech and pharma companies that often lack the scale to do it themselves.
The Fund made several other trims on recent outperformance and higher valuation, including Ecolab, Mettler-Toledo, Nordson, Abbott Labs, and Kweichow Moutai. After a huge recovery in Marriott the portfolio manager sold the rest of the position in late May on the belief that travel-related climate change concerns will only increase over time.
In summary, the Fund’s commitment to its investment process and philosophy remains unchanged. MFS maintains its long-term investment focus on owning durable growth compounders where it has high confidence in the sustainability of profits over the long term.
Significant impacts on performance