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Sun Life MFS Global Total Return Fund

Fund commentary | Q2 2022

Opinions and commentary provided by MFS Investment Management Canada Limited.

Equity Market Review

Equity markets have fallen sharply in Q2 with the MSCI World Index (C$) down -13.44%  for the quarter, hard on the heels of a -5.38% decline in Q1, resulting in a -18.8% decline so far this year and tipping investors into bear market territory. This marks the worst first half for equity markets since 1970.

The economic mood has clearly changed – from worries about inflation to added worries about how much rates will rise and the risk of recession. Investors are anxious and face more complexity and uncertainty over the path ahead. Central bankers now face a real policy dilemma – how far and how fast to raise rates into a weaker and slowing economy? Not doing enough risks stagflation (a toxic mix of fading growth and high inflation) whereas moving too far risks tipping the economy into recession – the risk of policy error has certainly risen.

What is most interesting is that there has been no place to hide. Most major asset classes have fallen sharply at the same time. The historic relationship between equity and bonds has broken down – both have fallen sharply. Bonds have seen their worst downturn since 1990 as investors brace for rapid rises in interest rates. Traditionally, bonds are supposed to act as a counterweight that tends to rally when riskier assets suffer. Even cash, the ultimate safe asset, has lost value in real terms due to surging inflation.

Within equity markets, the stand-out feature has been the one-dimensional nature of returns with energy topping the leaderboard again in Q2. Virtually every sector has fallen double digits year-to-date, whereas energy is up +25% ($US). There has never been a period when energy has outperformed by this much. Consumer discretionary and information technology were again the biggest decliners at the sector level after also falling sharply in Q1.

From a style perspective, there has been a clear shift to ‘deep value’ stocks and away from high growth stocks, resulting in the biggest gap between the MSCI World Value Index (-12% year-to-date) and the MSCI World Growth Index (-29% year-to-date) for 20 years. Expensive technology stocks have continued to fall sharply, as the valuation of these long-duration assets can be more vulnerable to rising interest rates, as growth is set far into the future. Investors have preferred to back near-term certainty. The problem with energy, of course, is its sharp cyclicality and historic volatility. Whilst so far it has all been a supply issue, one would now expect to see demand destruction start to bite as oil prices stay high and economies slow down.

Fixed Income Market Review

Global bonds extended their losses in the second quarter as central banks globally focused on persistent inflation, despite increasing evidence of slowing growth and increasing risk of recession. Such an environment provided a poor backdrop for both credit and rates markets, leading to record historical losses for bond investors. Risk sentiment was also impacted by increasing concerns around lock down

measures in China to contain COVID-19 cases. Several high-profile earnings disappointments from the likes of Target and Walmart also rattled investors and increased concerns that consumers were pulling back from discretionary spending amid rising food and energy prices.

The -4.30% Q2 return for the Bloomberg Global Aggregate Index (hedged to USD) meant 2022 has been the worst start to a calendar year (-9.06%) since records began for the Global Aggregate index in the early 1990s. The focus by central banks on anchoring inflation was epitomised by the Federal Reserve (Fed), who made the unusual move of raising rates by 75 bps at their June meeting following a surprisingly strong May CPI number. The move, the first of this magnitude since 1994, also further underwrote the strength of the USD as United States (US) real yields moved back into positive territory. Many other central banks surprised the market with the timing and magnitude of rate hikes. Several other previously dovish European central banks became far more hawkish in Q2 such as the European Central Bank (ECB), Riksbank (Sweden’s central bank) and particularly the Swiss National Bank which unexpectedly raised interest rates by 50 bps, its first hike in 15 years. In Australia, the Reserve Bank (RBA) also hiked rates despite previously saying they would not raise rates until 2024.

China continued its huge outperformance to Western bond markets in the post-COVID era. Local 10-year yields dopped beneath those of US Treasuries, limiting further yield opportunities for international investors on a hedged basis. By contrast, Canadian bonds were amongst the worst performing in Q2, with 10-year yield spreads to the US widening 14 bps. Within FX markets, the JPY was very weak, declining to multi-decade lows against the USD as the Bank of Japan (BOJ) maintained its loose monetary policy including negative overnight interest rates and daily operations in defense of its "around zero" target for 10-year bonds. This required huge bond buying by the BOJ including a record USD 81bn in one week in June, one of few central banks now increasing their balance sheet. This also meant Japanese government bonds outperformed other global bond markets in Q2.

Emerging market (EM) currencies such as the Chilean peso (CLP) and South African rand (ZAR) also suffered from the broad-based risk-off sentiment and declines in commodity prices such as copper. The main

exception was the Russian ruble (RUB) which appreciated close to 50% over the quarter on the back of capital controls and a rising current account surplus resulting from higher energy prices.

Credit markets were weak in Q2 and represented a high proportion of the index losses compared to Q1 where higher government yields were the main contributor. Global investment grade (IG) bonds widened 51 bps over the quarter to 175 bps compared to a 27 bps widening in Q1. Of note was the significant underperformance of European investment grade bonds which ended the quarter at 218 bps, only a few basis points away from the peak of the COVID-19 crisis. The moves also represented a 50 bps cheapening to the US investment grade market, reflecting the aforementioned ECB pivot and quantitative easing (QE) wind down. The market also sensed a greater chance of recession in Europe compared to the US, given the increased reliance on unreliable Russian energy supplies.

Lower-quality credit underperformed as concerns focused more on growth and not just rates which had caused BB-rated bonds to hold in well in Q1. US BB-rated corporates widened 122 bps to BBB in Q2, while CCC had a poor quarter by widening 418 bps. US high yield also started to underperform hard currency EM in Q2 with spreads for the index now above those of the JPMorgan EMBI (OAS of 526 bps for US high yield versus 460 bps for EM). Local EM was also under pressure given the risk-off tone to markets and redemptions from retail investors.

The Sun Life MFS Global Total Return Fund F outperformed its blended benchmark (60% World, 40% Global Agg Hedge C$) in Q2 2022. The Series F returned -6.93% while the Fund’s blended benchmark posted -9.84% during the second quarter.

Equity Sleeve

Within the equity sleeve, underweight positions and stock selection in Information Technology, Consumer Discretionary and Communication Services contributed to relative performance. Overweight positions and stock selection in Consumer Staples and Health Care also contributed to performance as the defensive sectors held up well during the quarter. Stock selection and underweight position in Energy hurt performance.

Individual Contributors: The top individual contributors during the period included not owning Amazon.com, Merck & Co Inc., Johnson & Johnson, not owning Tesla and not owning Nvidia Corp.

  • Amazon.com – Not owning shares of internet retailer Amazon.com (United States) supported relative returns. Despite the company's solid operational performance, the stock price declined as technology stocks came under pressure due to a combination of rising interest rates and a shift away from growth stocks to more defensive stocks, amid a global market drop and uncertain macroeconomic conditions.
  • Merck & Co Inc. – An overweight position in pharmaceutical company Merck (United States) bolstered relative performance. The company's earnings per share and revenue results exceeded expectations, driven by Gardasil, Lagevrio and Keytruda sales. Lower-than-expected selling, general, administrative, and research and development expenses further aided the quarterly outperformance.
  • Johnson & Johnson – An overweight position in diversified medical products maker Johnson & Johnson (United States) contributed to relative performance. The company's shares outperformed the broader market, as investors sought out defensive health care stocks, and the company reported a solid quarter with better-than-expected sales of medical devices.

Individual Detractors: The top individual detractors during the period included Schneider Electric, Rio Tinto, not owning UnitedHealth Group, not owning Exxon Mobil Corp and not owning Eli Lilly & Co.

  • Schneider Electric – An overweight position in electrical distribution equipment manufacturer Schneider Electric detracted from relative performance. In late April, the company reported better-than-expected first-quarter organic revenue growth in its Energy Management and Industrial Automation business segments. Despite these strong results, management's cautious near-term outlook, resulting from manufacturing and distribution disruptions caused by the Shanghai lockdown, appeared to have weighed on investor sentiment.
  • UnitedHealth Group Inc – Not owning shares of health insurance and Medicare/Medicaid provider UnitedHealth Group (United States) detracted from relative returns. The share price benefited from better-than-expected Medical Loss Ratio (MLR) figures. Additionally, the stronger onboarding of value-based members and a decline in COVID-19 hospitalizations further supported the stock's overall performance.
  • Rio Tinto Ltd – An overweight position in mining operator Rio Tinto (Australia) held back relative returns. The company provided quarterly financial results that came in below expectations, driven primarily by lower iron and copper production due to ongoing mine commissioning challenges, supply chain issues and COVID-19 disruptions.

Fixed Income Sleeve

  • Sous-pondération en duration aux États-Unis et au Canada
  • Sous-pondération des obligations à long terme au Japon

  • Overweight to corporate industrials and financial institutions versus treasuries and agency fixed rate bonds
  • Long duration in New Zealand and Korea
  • Yield curve positioning in Europe
  • Overweight to BBB rated bonds within investment grade

Fund Positioning

Fund Positioning and Outlook

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 and Outlook

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. 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 added position to General Dynamics Corp and initiated positions in Edison International, Alphabet Inc, Julius Baer Group and Zurich Insurance Group. The team trimmed Johnson & Johnson, Nestle SA, KDDI Corp, Eaton Corp and Texas Instruments primarily driven by positive performance to fund better opportunities.

Given the Fund’s bottom-up approach, the investment decisions are not driven by trying to predict the exact path of macro variables such as inflation and interest rates. The team is mindful of how these concerns weigh on company prospects and valuations. Overall, they believe the companies owned in the portfolio have sustainable competitive advantages and relatively strong pricing power aimed to withstand the impact of rising input costs better than peers.

The team continues to work closely with the team of global research analysts at MFS to ensure they understand the potential long-term implications of change when assessing the risk-adjusted returns of the companies they own. The team tries not to worry too much about macro gyrations, but does worry about paying the right price, as valuation is a key determinant of long-term returns. 

  • Fixed Income Positioning and Outlook

The Fund is becoming more favorable towards investment grade debt in Europe. The removal of the ECB as such an influential marginal buyer has destabilized European credit markets more so than the US, alongside the larger impact to local economies stemming from the Ukrainian crisis. European investment grade spreads now trade at a premium of over 50 bps to US peers, a level not seen since the sovereign crisis in 2011/12.

Issuance levels slowed sharply in Q2 reflecting declining investor appetite for the asset class, especially from lower-quality cyclical names. The team believes financials are better insulated from the economic slowdown, having built up significant capital buffers. They can also find names with idiosyncratic, positive catalysts in countries like the UK, US and Spain. Real estate exposure is a risk and something the team is monitoring closely, especially in countries like Sweden. They continue to be defensive in more cyclical sectors such as global autos. Credit curves have steepened in the sell-off and the they find that there are some value in extending the maturity of higher-quality industrials.

While emerging markets are supported by some top-down themes, the Fund’s positioning is also influenced by several research-led decisions which are often idiosyncratic in nature. Many of these positions are geographical and economically remote to some of the themes impacting the broader asset class, such as the Ukrainian conflict. Examples would be some of the hard currency positions in South America and Africa. Often, these overweights are also based on improving governance in these countries. Several of the Fund’s positions benefit from higher commodity prices, especially oil. From a top-down perspective, there are several reasons to be favorable on emerging markets. Some investors are scarred by the events of 2013's taper tantrum and suspect emerging markets will be similarly vulnerable this time around. However, there are some key differences compared to 2013 with many countries now less exposed to capital flight due to improved current account balances. Foreign reserves are also larger, and their currencies are already cheap to the USD. Critically, EM central banks started raising rates earlier than the Fed, with countries like Brazil starting in early 2021. Also, while debt-to-GDP has grown during the COVID period, it remains on average well below Western countries such as the US, France and the UK.

Fund performance

Compound Returns %¹ Since Inception2 10 Year 5 Year 3 Year 1 Year Q2
Sun Life MFS Global Total Return Fund - Series A

5.7

5.9 2.2 1.3 -8.6 -7.2

Sun Life MFS Global Total Return Fund - Series F

6.9

7.1 3.4 2.5 -7.5 -6.9
Sun Life MFS Glbl Return Benchmark

7.8

8.3 5.1 3.8 -9.8 -9.8

¹Returns for periods longer than one year are annualized. Data as of June 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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SLGI Asset Management Inc. is the investment manager of the Sun Life Mutual Funds, Sun Life Granite Managed Solutions and Sun Life Private Investment Pools.

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