Global equity markets posted a second consecutive quarter of positive performance in the third quarter of 2020, continuing a surprisingly strong rebound off the market lows of late March. Despite the continuing spread of the coronavirus and an uncertain outlook for the economic recovery, investors favored cyclical areas of the market, with leadership during the third quarter fueled by materials, industrials and consumer discretionary stocks. Energy was the only sector to show a significant decline as the weak global economy and disruption in air travel dragged oil prices down to the US$40 per barrel level. The financial services sector declined modestly as investors grappled with the pressures of low interest rates and rising credit costs for the banking system.
The Fund outperformed its benchmark, largely fueled by an overweight position and favorable stock selection in technology, the avoidance of most financial services and energy stocks and strong stock selection in consumer staples. The Fund’s underweight exposure to consumer discretionary, specifically avoiding the auto stocks, detracted from relative returns.
While equity valuations suggest a healthy economic recovery in the coming year, MFS is concerned about ever-growing risks to the downside. Before the pandemic, there were concerns about excessive levels of debt on the balance sheets of central banks and governments around the world. Those debt levels have increased as governments unleashed massive fiscal spending programs and central banks initiated efforts to avoid a calamitous depression caused by the COVID-19 pandemic.
MFS has a cautious outlook, and the portfolio remains defensively positioned. The Fund made few trades during the third quarter, trimming some outperformers and adding modestly to a few high-quality cyclical names.
On a year-to-date basis, the Fund has trimmed a number of high-quality stocks that outperformed, including: food product manufacturers Nestlé and Kerry Group; flavor and fragrance makers, Givaudan and Symrise; German residential real estate companies, Vonovia and Deutsche Wohnen, and; technology leaders Cadence Design Systems, Nomura Research Institute and Obic. The Fund reduced companies that it continues to favor long-term but have taken on additional debt and risks related to acquisitions, including Infineon Technology and Texas Instruments.
MFS added to its position some of the Fund’s cyclical holdings that underperformed in the selloff, including Samsung Electronics and SMC, a Japanese manufacturer of pneumatic equipment used in factory automation, as well as mining equipment maker Epiroc and elevator manufacturer and service company Schindler. The Fund added to Google parent Alphabet, based on confidence in the company's dominant position in market niches that will grow in importance over the next decade. An addition was also made to the Fund’s holdings in eyeglass frames and lens maker EssilorLuxottica.
The Fund added to its position in Knorr-Bremse, a German maker of braking systems for trains and commercial vehicles, which MFS believes is well-positioned to benefit from the safety and efficiency enhancements as the world transitions to electric vehicles.
The Fund is overweight to consumer staples, where MFS favors the brand name strength, global distribution networks, fortress balance sheets and the ability to adapt to the digital environment across a number of consumer product, food and alcoholic beverage companies. The strategy is overweight to information technology, owning computer software, systems and semiconductor companies considered dominant players in industry niches with competitive advantages MFS believes are supported by intellectual property. With an overweight in industrials, the Fund owns a number of businesses that are dominant leaders in their market niches and emphasize innovation to meet future customer needs.
The Fund’s most significant underweight is to financials, as MFS continues to avoid European and Japanese banks with complicated business models and over-levered balance sheets. The Fund has avoided most energy companies, which it believes will produce subpar returns over the long-term, based on their capital expenditure requirements, commodity-oriented markets and the pressure on fossil fuel emissions. The Fund is underweight consumer discretionary, where MFS believes there are fewer sustainable business models. MFS continues to avoid utilities, which they view as highly regulated, lower return businesses.
Significant impacts on performance