Sun Life MFS Global Total Return Fund

Fund commentary | Q3 2022

Opinions and commentary provided by MFS Investment Management Canada Limited.

Equity Market Review

Equity markets fell again during the quarter with the MSCI World Index (net div. in USD) down 6.2%, after falling 16.2% in Q2, resulting in a 25.4% decline, so far this year. Investors started the quarter in a more buoyant mood with the index up 7.9% in July, but sentiment quickly shifted back towards the bears with sharp falls in August (-4.2%) and September (-9.3%) after Jerome Powell’s short but clear message that the US Federal Reserve will not hesitate to raise rates even further to curb inflation. Interestingly, this has already brought the 10-year rolling return for the index down to 8.1% per annum compared to a 12.7% annualized return as at the end of last year.

Within equity markets, all sectors fell, except for consumer discretionary which was held up by mega-cap stocks Amazon and Tesla. The energy sector fell marginally, but outperformed the MSCI World Index, as oil and gas supplies remained tight after the Kremlin cut off gas supplies through the Nord Stream pipeline and said supplies will not restart until sanctions are eased. Governments were busy setting out relief packages to help consumers offset the cost-of-living crisis, sparked by rising energy bills. Year to date, all sectors have fallen double digits, except energy which is up 23% in a global market that is down 25.4%. The challenge with the energy sector is its sharp cyclicality and historic volatility. So far, it has all been a supply issue. The team now expects to see demand destruction start to bite as oil prices stay high and economies head towards a potential recession.

From a style perspective, there was less differentiation this quarter, with growth marginally outperforming value, reversing a little of the strong value bias to markets this year, with the biggest gap in many years between the MSCI World Value index (-18.5%) and the MSCI World Growth index (-32.4%) year to date. The technology sector rallied in July but gave up performance in August and September to finish the quarter with a similar return to the market. The valuation of these long-duration assets remains vulnerable to rising interest rates given their growth is set far into the future. In such volatile markets, investors prefer to back near-term certainty. Cyclical sectors like materials, real estate and communication services fared less well, as the number of profit warnings started to increase.

Fixed Income Market Review

Global Bonds experienced a volatile quarter as hopes of a US Federal Reserve “pivot” earlier in the quarter were firmly quashed as the Fed reaffirmed its commitment to ongoing rate hikes. A tight US labor market and elevated inflation data, with July and August US CPI prints showing broad based and unrelenting price pressures, emboldened the Fed to retain their hawkish rhetoric. Significantly, US Federal Reserve Chair Jerome Powell used a speech at Jackson Hole, Wyoming in August to deliver a decidedly hawkish tone which caused terminal rates to reprice sharply higher to 4.65%. Total returns continued to be poor with the Global Aggregate Index (hedged to the US dollar) dropping 3.34% in Q3, its third consecutive large quarterly loss. Losses were largely led by government bonds with credit markets more stable over the quarter especially relative to Q2.

Over the quarter, the Fed delivered two 75 basis point hikes to a range of 3.0% to 3.25%. These events caused the front end of the Treasury curve to sharply underperform with 2-year yields rising over 120 bps from their lows in the mid-summer. 2-year yields finished the quarter at 4.28%, the highest level observed since prior to the Great Financial Crisis. The US yield curve further inverted, with the spread between 10- and 2-year US Treasuries moving firmly into negative territory (-45bps), reflecting the growing probability of a US recession. Tightening monetary conditions associated with the Fed hikes were also indicated in the sharp rise in 10-year real yields, which rose 101 bps over the quarter to 1.68%, a level not seen since 2010.

The European Central Bank continued tightening at pace, including a previously inconceivable hike of 75 bps in September. Its prior July hike of 50bps had been the first one since 2011. The ECB’s hawkish pivot continued to disrupt the European bond market. Both the magnitude and speed of the rise will test the resolve of the ECB to utilize anti-fragmentation devices, now referred to as the TPM (Transmission Protection Mechanism), at a time of monetary tightening. The ongoing monetary tightening by the European Central Bank (ECB) had the impact of further accelerating the widening in European swap spreads. The widening in swap spreads is starting to make some high-quality issuers attractive.

UK bonds were extremely weak in Q3, massively underperforming other developed bond markets on the back of unexpected, unfunded tax cuts announced in a “mini-budget” by the incoming Prime Minister and Chancellor. The tax cuts, alongside fiscal support for energy bills, shook the market. Moves were exacerbated by collateral calls on liability matching interest rate swaps at UK pension funds which caused funds to sell gilts to raise liquidity. Fiscal concerns also prompted the S&P to place its AA rating on negative outlook, while the pound hit lows against the USD not seen since the mid-1980s.

Chinese bonds massively outperformed in Q3 as concerns continued regarding the stability of the real estate market and impact of COVID lockdowns on economic growth. Japanese bonds also outperformed with core inflation in the country stubbornly low. Governor Kuroda also committed to current yield curve control policies.

The Sun Life MFS Global Total Return Fund F outperformed its blended benchmark (60% MSCI World, 40% Bloomberg Barclays Global Agg Hedge C$) in Q3 2022. The Fund Series F returned -1.31% while the Fund’s blended benchmark posted -1.45% during the second quarter.

Equity Sleeve

Within the equity sleeve, stock selection in Financials, Industrials and Materials contributed to relative performance. An underweight position and stock selection in Consumer Discretionary primarily detracted from relative performance. Currency effect within Information Technology and Consumer Staples also hurt performance.

  • ConocoPhillips  – An overweight position in oil and gas company ConocoPhillips (United States) aided relative performance. The share price rose as the company reported earnings ahead of estimates, helped by better production volumes. In addition, the company increased its targeted 2022 capital return from $10 billion to $15 billion, which further supported the stock.
  • Charles Schwab Corporation – The portfolio's overweight position in financial services provider Charles Schwab (United States) helped relative performance. The stock price rose over the quarter as the company reported increased net interest margins and announced that it would lower its tier 1 capital requirement levels, potentially freeing up capital for other uses such as share buybacks.
  • Regal Rexnord Corp The portfolio's position in electric motors and power transmission components manufacturer Regal Rexnord (United States) contributed to relative performance on the back of solid financial results, primarily led by operational improvements within its Industrial segment.

  • Apple Inc. – Not owning shares of computer and personal electronics maker Apple (United States) detracted from relative performance. The stock price rose as the company reported better revenues than forecasted due to lower supply chain impacts versus expectations. Despite ongoing component shortages impacting Mac and iPad sales and global currency headwinds, the company continued to demonstrate the strength of its product ecosystem with broad-based growth. iPhone sales remained strong across all regions with revenue growth ahead of estimates.
  • Tesla Inc.  – Not owning shares of electric vehicle manufacturer Tesla (United States) detracted from relative performance. Despite a challenging quarter, driven by the company's Shanghai factory shutdown and increased costs related to new factories in Berlin and Texas, shares of Tesla appreciated as market expectations increased regarding its improving production and higher gross margin.
  • Amazon.com Inc. – Not owning shares of internet retailer Amazon.com (United States) detracted from relative performance. The stock price appreciated during the quarter as the company reported quarterly revenues that topped estimates, driven by revenue growth in its Amazon Web Services and advertising segments. Lower-than-expected shipping costs and overall headcount further drove the upside during the quarter.

Fixed Income Sleeve

  • Underweight duration in the U.K, U.S. and Canada
  • Yield curve positioning in U.K.
  • Security selection within Europe ex U.K. and Emerging Markets
  • Security selection within BBB rated bonds
  • Short exposure to CAD

  • Long duration in New Zealand and Korea
  • Yield curve positioning in China

Fund Positioning

The Fund has historically been allocated at approximately 60% equity weighting and 40% fixed income weighting. This is designed to remove the market timing element of portfolio management and allows the team to focus on security selection. The equity portion of the portfolio follows a value-based approach has generally been invested in a blend of global, large-cap value equity securities. On the fixed income side, the team employs a broad, global investment grade focused approach, across both government and credit markets.

  • Equity Positioning

The team expressed that this does not feel like a normal bear market. Bear markets don’t necessarily cause or come with recessions, but a recession can make a bear market much worse. Usually there is a collapse in risk appetite, often a function of a worsening macro environment where profits fall sharply, defensives outperform cyclicals and credit risks become important. A key feature of markets this year has not just been risk aversion, but the complete collapse in demand for bonds. A bond selloff is different, leading to valuation uncertainty, where avoiding valuation risk is key. There remains further downside risk in equities as valuations have fallen due to ‘multiple compression’—the price has moved, but earnings expectations have stayed high, making it difficult to anchor valuations. Add a recession and the equation becomes even harder. The team believes consensus earnings forecasts look way too high, indeed still suggesting earnings will rise this year by about 10% and still positive after stripping out the energy stocks (+3%). This seems unlikely to materialize as more companies struggle to pass inflationary cost pressures through to a weakening consumer. Leading indicators and CEO surveys point to tougher times ahead. On a brighter note, equity markets are forward looking and tend historically to bottom out before the trough in earnings. The debate is to what extent are current valuations looking through the inevitable fall in earnings as the market heads closer to recession.

Valuations have fallen and no longer look stretched but are not yet stressed to the same degree they were in the global financial crisis. The team has warned previously about the surge in asset prices and pockets of overvaluation which resulted from the extraordinary stimulus provided by central banks over the last decade. This kept bond yields artificially low and pushed investors into riskier assets, notably high growth stocks, often loss-making, and recent IPOs with a promise of returns far into the future. Many of these stocks have seen big share price collapses as reality beckons. It feels healthy that this ‘froth’ has been blown off the market as these more speculative assets fall from grace. Some better-quality technology stocks are starting to offer value putting them onto the radar which the Fund previously put off by high valuations.

The shape of the portfolio has not changed materially as the team makes gradual changes and invests for long-term. The biggest sector overweight’s relative to MSCI World Index are Industrials, Financials and Consumer Staples, where the team continues to see attractive opportunities. The team continues to reduce the Fund’s position in Consumer Staples by trimming stocks that have outperformed and have trimmed its position in Colgate given its relatively stretched valuation to fund better opportunities elsewhere.

This is a value strategy, not a ‘deep value’ strategy, with a clear focus on business durability and valuation. The team thinks carefully about the long-term prospects of businesses they own and pay a lot of attention to understanding the downside risk to business models. The Fund’s average holding period is six to seven years. They continue to find great opportunities across industries and geographies in good businesses with shares trading at attractive valuations, often overlooked in the short-term focus of other investors.

During the period, the team-initiated position to Northern Trust Corp (Financials), and Omnicom Group (Communication Services), and added to BNP Paribas SA (Financials), Glencore PLC (Materials) and Suncor Energy (Energy). The team trimmed Colgate-Palmolive (Consumer Staples), UBS Group (Financials), Travelers Cos Inc. (Financials), Wolters Kluwer (Industrials) and Texas Instruments Inc. (Info Tech).

  • Fixed Income Positioning

The team believes premiums of more than 60 bps between European and US investment grade makes European bonds look attractive and fairly prices the very strong probability of recession in Europe. They also feel the chance of recession in the US has increased over Q3, making the US market appear relatively expensive. The Itraxx Crossover Index,  an index that comprises the 75 most liquid sub-investment grade entities, has been very volatile in Q3; at its worst point it has been pricing in cumulative levels of default (assuming 40% recovery values) of over 20% over a 5-year period, a level which would be very hard to achieve even in deep recessionary conditions. On the fundamentals side, while a recession would inevitably lead to higher leverage and declining margins, they are inclined to see this as more of a challenge for equity holders with net interest coverage extremely strong for investment grade companies. Leverage also declined post COVID, and investment grade companies also benefited from a strong wave of debt issuance in 2020/21 at attractive funding levels.

Dispersion between sectors remains high, especially in Europe. This in turn means that cyclical sectors facing similar risk to fundamentals from an economic slowdown are trading at marked differences in valuations. Examples include chemicals versus certain luxury goods and retail companies. The current “taper tantrum” regime, where both risk-free yields and spreads have risen in tandem, has seen some huge drawdowns in longer-maturity corporate bonds, and presents some very heavy discounted bonds to par. For instance, many bonds around a 2045 maturity can be found at under 60 cents per dollar. Such bonds offer attractive convexity as they approach recovery values. They are also more desirable to hold in many cases than primary bonds, forcing new issues concessions to attract investors. The team continues to like hard currency emerging market bonds which they feel offer compelling relative value to developed market corporates. EM corporates have exhibited relatively resilient earnings and have lower leverage than developed peers. Spreads offered per turn of leverage are also far greater.

The team continues to favor some structured sectors such as higher quality CLOs and CMBS as a lower beta way to achieve carry with less economic risk relative to higher quality corporates. They have also been reducing benchmark short in agency mortgages. MBS appear fairly valued for an environment of quantitative tightening and cheap versus their long-term history. The team sees better opportunity in coupons not heavily owned by the Fed or by banks.

  • Rate & FX Positioning

The team likes markets which are at a mature stage of their tightening cycles, and where the underlying local economy is sensitive to tightening monetary conditions because of higher household leverage or inflated real estate markets. They feel such markets could see their central banks pause earlier than the Fed, leading to an outperformance of their local bond markets. Examples could be Canada and New Zealand, where the Fund was overweight. Canadian inflation appears to be showing signs of peaking and employment has declined for 3 months in a row, causing Canadian bonds to outperform sharply in Q3. The Fund was overweight South Korea bonds, which is another example of a central bank at a mature stage of their tightening cycle. In addition, its open, export-orientated economy is vulnerable to global trade and geopolitical risks.

The team dislikes the UK market, especially longer maturity bonds. The increased issuance because of the unfunded government tax cuts and energy rebates will cause increased issuance at a time of weakening domestic demand from UK pension schemes and quantitative tightening by the Bank of England. They are cautious on Italian bonds despite relatively attractive spreads. The team would not expect a durable outperformance to core European peers in the current environment. They expect ongoing volatility as the market adjusts to life outside more regular QE support and a slowing growth environment, made all the worse by rising fears of a European energy crisis.

The ECB might struggle to control Italian spreads and challenge market fragmentation while tightening rates. The most recent political turmoil in Italy also added unwelcome idiosyncratic risk, with foreign policy in Ukraine potentially exposing differences in the fragile coalition government. The new government could potentially scupper the €19 billion recovery fund, slow down reform and undermine investment confidence in Italy, which had been improving in recent years.

Although a clash with the EU is not an imminent risk (indeed Meloni softened her anti-EU tone during the electoral campaign), the team still sees risks for fiscal stability in the medium term. They prefer other expressions of periphery risk such as Cyprus and Greece. South American countries have been very proactive in raising rates with markets such as Mexico and Uruguay offering attractive real yields and FX valuations. The team continues to be defensive towards Japanese bonds, despite recent outperformance caused by ongoing support to the bond market by the Bank of Japan. Existing policies might increasingly be seen as unsustainable, with the JPY dropping a further 6.6% in Q3 causing the central bank to intervene in the FX market and harden its rhetoric. The Fund was also underweighted Chinese bonds, where valuations look expensive, especially on a hedged basis, with 10-year Chinese bond yields now 109 bps lower than US Treasuries.

Within FX the team continues to be long the USD especially against the EUR, CNY and the GBP. They are looking for currencies in emerging markets where the fundamentals and carry can balance the long USD view. Examples are the Mexican peso, the Chilean peso and the Brazilian real. The team also likes the Singapore dollar versus the Taiwan dollar, given the strong pipeline of inflation in Singapore, largely imported, but also on domestic factors (tight labor market, GST increase) leading core inflation to be well above their 2% target. Short TWD remains a positive carry position. So far there have been sizable foreigner equity outflows (TWD negative) from the stock exchange, which is tech/growth stock heavy, and these stocks seem like they will remain challenged for some time, given global recession risks and growth headwinds for China and semiconductors.

Fund performance

Compound Returns %¹ Since Inception2 10 Year 5 Year 3 Year 1 Year Q3
Sun Life MFS Global Total Return Fund - Series A

5.4

5.5 1.9 0.0 -10.5 -1.6

Sun Life MFS Global Total Return Fund - Series F

6.6

6.7 3.0 1.2 -9.4 -1.3
Sun Life MFS Glbl Return Benchmark

7.5

7.9 4.6 2.6 -12.3 -1.4

¹Returns for periods longer than one year are annualized. Data as of September 30, 2022.

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 SLGI Asset Management 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 SLGI Asset Management 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.

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