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Sun Life MFS Global Total Return Fund

Fund commentary | Q4 2022

Opinions and commentary provided by MFS Investment Management Canada Limited.

Equity Market Review

Equity markets finished a rollercoaster year with a strong rally. The MSCI World Index (net div. in US dollars) returned +9.8% in the fourth quarter on optimism that the US Federal Reserve (Fed)may be winning the battle with inflation and can now enter a new phase of more modest rate rises. For the full year, the index fell by -18.1%, the biggest annual decline since 2008. There was certainly “no place to hide in 2022” with bond markets also falling sharply, recording the biggest decline since the 1960s, with the yield on US 10-year government bonds rising from 1.5% at the start of the year to finish at 3.9%. Global stocks and bonds lost over $30 trillion in total value over the year, according to Bloomberg estimates. Mega-cap technology stocks were particularly hard hit by rising interest rates, with the tech-focused Nasdaq index falling 33%. The reset came after strong returns in previous years driven by low inflation and falling interest rates and provided a dramatic end to the era of “cheap money.” Everything changed in 2022 with a transformation to a new era of higher inflation, rising rates, and heightened geopolitical tensions, which completely changed market leadership.

All sectors rose during the fourth quarter, except for Consumer Discretionary, with a strong rally in cyclical sectors, such as Energy, Industrials, Materials and Financials. Looking at the full year, Energy was by far the stand-out feature with a strong positive return when many sectors fell by double digits. Also interesting to note, a disconnect has opened against the oil price which started the year at $72 and year-on-year was +19%, driven mostly by supply side issues since Russia’s invasion of Ukraine.

From a style perspective, there was a notable outperformance of value versus growth for the quarter and the year. For the full year, the picture was more extreme with value beating growth by the widest margin for many years. It was clearly a year in which investors preferred to back near-term certainty in volatile markets and reappraise what they were willing to pay for long-duration growth assets.

Fixed Income Market Review

Global bonds staged a long overdue recovery in Q4 as data indicated a potential plateauing of global inflation despite regional variations. While central bankers were keen not to be interpreted too dovishly, investors chose to look beyond the hawkish rhetoric. Meanwhile, the large number of interest rate increases in Q4 only met already hawkish expectations. Credit markets also benefited from the subsequent easing of financial conditions and hopes of a soft landing or at least a milder recession in the United States (US). Mild winter weather in Europe also served to ease energy price concerns. The combination of these factors resulted in the first positive quarter of the year, with the Bloomberg Global Aggregate Index (Hedged to USD) returning 0.99%. The gains were led by credit, with government bonds still under pressure especially in Europe and Japan. The gains in Q4 were moderate compared to the heavy losses earlier in the year. The index fell 11.22% for the year, easily the worst year since its inception in the early nineties. It also marked the first time that global bonds have dropped for two consecutive calendar years.

The Fed delivered two rate hikes during Q4, pushing the upper bound of the Fed Funds rate to 4.5%. Despite these hikes, and generally strong US labor data, the market remained reluctant to push the Fed's terminal rate much higher than previous expectations. The key focus of the market remained the monthly CPI prints which despite exhibiting stubbornly high core measurers, failed to beat elevated market expectations, providing some market relief and weakness in the US dollar (USD). The US yield curve continued to flatten with the 2s/10s curve inversion falling further into negative territory (-55 bps) highlighting ongoing recessionary concerns. Real yields were little changed over the quarter. 10-year real yields ended the quarter at 1.58%, close to a post-GFC crisis high, reflecting ongoing tight monetary conditions.

Non-US Treasuries underperformed the US over the quarter, as the European Central Bank (ECB) adopted a markedly hawkish tone. The Bank of Japan (BoJ) also surprised markets by widening the trading range of 10-year Japanese government bonds (JGBs) from +/- 25bps to +/- 50bps (from a zero yield). The move prompted investors to speculate that the central bank might soon prepare the markets for an end to its ultra-loose monetary policy.

The ECB's hawkish tone put pressure on European bonds. The ECB also upgraded its inflation forecasts for 2023 to 6.3% (5.5% had been the forecast as recently as September) and outlined their plans for Quantitative Tightening (QT) measures to begin in March at a pace of €15 bn per month.

United Kingdom (UK) bonds massively outperformed in Q4, reversing the declines of Q3, as the new Chancellor stabilized the gilt market with numerous revisions from the previous disastrous "Mini Budget" under the Truss regime. Meanwhile, the Bank of England (BoE) continued to raise rates to 3.5% as it aimed to calm rampant inflation and ongoing tight labor markets. The BoE was however keen to push back on aggressive market pricing which was previously expecting terminal rates to reach above 5%. It also continued to be cautious on the economy, forecasting a "prolonged" recession ahead.

While rates performance was mixed in Q4, credit posted good gains with global investment grade spreads tightening 32 bps to 147 bps over the quarter. European investment grade bonds significantly outperformed their US peers despite a hawkish ECB. European credit was helped by declining European energy prices resulting from milder winter temperatures and the outperformance of the banking sector. Sterling credit also recovered as the incoming government stabilized the local bond market and reversed many of the previous unfunded tax cuts from the previous mini budget. High yield outperformed with US spreads 83 bps tighter, with lower-quality bonds marginally outperforming. The best performance was, however, reserved for EM hard currency bonds which tightened 93 bps to 374bps.

The Sun Life MFS Global Total Return Fund F outperformed its blended benchmark (60% MSCI World, 40% Bloomberg Barclays Global Agg Hedge C$) in Q4 2022. The Fund Series F returned 8.16% while the Fund’s blended benchmark posted 5.33% during the fourth quarter.

Attribution

Equity Sleeve

Within the equity sleeve, an underweight position in Consumer Discretionary and an overweight position in Financials contributed to relative performance. Stock selection within the Consumer Discretionary and the Financials sectors also contributed positively to the Fund’s performance. Currency effect with in Information Technology added to performance. Stock selection within Industrials detracted from relative performance.

  • Tesla Inc  – Not owning shares of electric vehicle manufacturer Tesla (United States) contributed to relative performance. The stock price declined due to uncertainty surrounding production shutdowns at the company's Shanghai manufacturing plant, reduced vehicle deliveries, increased competitive concerns and questions regarding Tesla CEO Elon Musk's acquisition of social media platform Twitter.
  • Amazon.Com Inc – Not owning shares of internet retailer Amazon.com (United States) contributed to relative returns. The stock price declined during the quarter as the company reported softer-than-expected revenue and operating profits, driven by weaker-than-expected performance in Amazon Web Services (AWS) and a softening in consumer demand.
  • Apple Inc – Not owning shares of computer and personal electronics maker Apple (United States) contributed to relative performance. The company's stock price came under pressure due to concerns over supply chain disruptions and slowing iPhone volumes.

  • Roche Holding Ltd – The portfolio's overweight position in pharmaceutical and diagnostic company Roche Holding (Switzerland) weighed on relative results. The stock price came under pressure after the company announced that its phase III GRADUATE trials for slowing the clinical decline in people with early Alzheimer's did not meet their primary endpoints.
  • Regal Rexnord Corp  – The portfolio's position in electric motors and power transmission components manufacturer Regal Rexnord (United States) weighed on relative returns as the company reported weaker-than-expected growth trends across the board. This, together with high inventory levels across industrial and consumer stocks, weakened the share price performance.
  • Exxon Mobil Corp – Not owning shares of integrated oil and gas company ExxonMobil (United States) detracted from relative performance. The stock price rose as the company posted higher-than-consensus earnings, particularly in its downstream segment, and increased its return to shareholders through stock repurchases and dividends.

Fixed Income Sleeve

  • Overweight to corporate industrials and financial institutions.
  • Underweight treasury
  • Security selection within Europe ex UK corporate industrials (BBB rated bonds) and Europe ex UK financial institutions (A rated bond)
  • Yield curve positioning and long duration against EUR curve
  • Short exposure to CAD

  • Overweight exposure to USD, EUR and JPY

Significant transactions (equity only)

  • During the period, the team initiated position to Pfizer Inc (Health Care), Volvo AB Group (Industrials) and Sanofi (Health Care), and added to ENI SPA (Energy) and Alphabet Inc (Communication Services).
  • The team trimmed Honeywell International Inc (Industrials), UBS Group (Financials), Merck & Co Inc. (Health Care), JM Smucker Co/The (Consumer Staples) and KDDI Corp (Communication Services), and sold Lockheed Martin Corp (Industrials).

Fund Positioning and Outlook

Equity

  • The Team expressed that, 2022 did 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 where profits fall sharply, defensives outperform cyclicals, value underperforms quality and credit risk is key. In this bear market the fall in valuation was all due to “multiple compression”—the price fell, but earnings stayed high. Valuations have certainly fallen and in many cases no longer look stretched. Profit margins have begun to roll over but remain at elevated levels compared to history. The concern is that consensus earnings forecasts remain too high. The debate is to how much valuations are looking through a fall in earnings as markets edge closer to recession. On a brighter note, equity markets are forward-looking and historically tend to bottom out before the trough in earnings.
  • The shape of the portfolio continues to adjust as the team finds relative value opportunities. The Fund has started to close some of the underweight to Information Technology as some stocks start to offer reasonable value, notably adding to Microsoft, economic research and consulting company Nomura Research, electronics company Kyocera and Samsung during the quarter. The weighting of Information Technology within the MSCI World Index has fallen from 23.9% at the start of the year to 20.2% at the end. Other key changes over the course of the year have been in Communication Services, where the Fund has increased its holdings with purchases of Alphabet and Omnicom, and in Consumer Staples where the Fund reduced holdings where some stocks looked relatively more expensive.
  • This is a value strategy, not a “deep value” strategy, with a clear focus on both business durability and valuation. The Team thinks carefully about the long-term prospects of businesses the Fund owns and pays a lot of attention to understanding the downside risk to business models. The Team continues 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.
  • Given the Fund’s bottom-up approach, the team’s decisions are not driven by trying to predict the exact path of macro variables such as inflation and interest rates. They are, of course, very 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 to withstand the impact of rising input costs better than peers. The Fund is seeing companies across the portfolio raising prices, notably in Consumer Staples, Industrials and paints. With regard to rising interest rates, the portfolio is overweight Financials, which should benefit if economic growth holds up, and cushioned by underweight exposure to bond proxy sectors like Utilities and Real Estate. The portfolio is less exposed to “long duration” assets, notably Technology stocks with high terminal values, which are at risk from higher discounting as interest rates rise.

Fixed Income

  • Over the quarter, the main portfolio changes were to continue to reduce the Fund’s underweight position in US Agency Mortgages. The team also added to investment grade overweight through a combination of industrial and bank bonds. Despite the rally, investment grade bonds are still attractive with spreads at recessionary levels especially in Europe. The team was, however, in favor of some risk reduction in certain sectors that have performed very well such as airlines and subordinated financials, rotating instead into areas like telecoms, consumer non-cyclicals and European supranationals such as Euro Stability Mechanism (ESM).
  • While a recession would inevitably lead to higher leverage and declining margins, the Fund is inclined to see this as more of a challenge for equity holders since net interest coverage is extremely strong for IG companies. Leverage declined post-COVID and investment grade companies also benefited from a strong wave of debt issuance in 2020–2021 at attractive funding levels.
  • The Fund continues to prefer financials versus industrials as financials, which the team views, are better insulated from the economic slowdown, having built up significant capital buffers. The team is inclined to believe the woes of banks such as Credit Suisse are company specific and not an indication of wider sector issues.
  • From a regional perspective the Fund is seeing more opportunities in Europe than the US. European valuations are more favorable, and the continent is now facing lower energy-related pressures.
  • The Fund continued to warm to the US Agency Mortgage sector. While lower housing turnover means slower prepayment speeds on existing mortgage-backed securities (MBS), it should also result in lower mortgage origination – a supportive technical as it means reduced issuance of MBS. While helpful, the balance of technical factors remains negative for the asset class, but has likely seen its worst. Quantitative tightening means that a large, price-insensitive buyer (the Fed) is in the process of systematically reducing its commitment to the asset class. Moreover, there remains a technical risk, albeit minimal, that this unwind could become more active over time (outright sales versus allowing holdings to roll off). In addition, banks – the second-largest source of demand – are also less inclined to buy as deposit growth slows/reverses, loan growth continues and cash buffers are bolstered. Foreign buyers have also been sidelined by dollar strength and high FX hedging costs, but could become more interested if dollar strength has indeed ended and FX hedging costs fall.
  • With the looming prospect of recession, the team thinks MBS spreads are – like those of other spread product – susceptible to widening. However, any fundamentally-driven spread widening is likely to be of lesser magnitude when compared to that of the credit markets, suggesting room for relative outperformance versus credit.
  • The team continued to reduce their underweight portfolio duration position relative to benchmark over the quarter, adding to markets such as Canada, Japan, South Korea and the U.K. The team favours markets such as Canada that are at a mature stag of their tightening cycles and where the underlying local economy is sensitive to tightening monetary conditions due to higher household leverage or inflated real estate markets. They believe such markets could see their central banks pause earlier than the Fed, leading to an outperformance of their local bond markets.
  • The Fund is defensive towards European bonds, feeling the ECB might be required to tighten rates higher and maintain higher rates longer than market expectations to durably control inflation. Given this view, the team likes flattener trades and feel longer-maturity German bonds will outperform shorter-maturity 2-year and 5-year bonds. The team’s view towards Europe is further weakened by concerns over Italy where they remain defensive given the vulnerability of the local bond market to a reduction in the ECB’s balance sheet and rising rates. While the newly formed right-wing government have exhibited fiscal constraints to date, their longer-term policies are still unclear with the economy struggling from sharply higher energy costs. Given the above risk, the team continues to prefer other expressions of European periphery risk such as Cyprus. Separately, the team closed the position in local currency Icelandic bonds over the quarter.
  • The team has turned more positive on U.K. bonds following the release of the revised budget which stabilized both the currency and local bond market. The market continues to price an aggressive rate hike path for the Bank of England, which the team feels they might struggle to meet given huge downward pressure on consumer expenditure from lower real wages and higher mortgage costs. U.K. bonds outperformed significantly over the quarter and were the best performing developed bond market, marking a sharp reversal of fortunes.
  • The team is defensive on Japanese bonds despite being quite attractive on a hedged to USD basis. This position reflects the uncertainty around future monetary policy, especially as Kuroda looks to step down in the early part of 2023. A full normalization of Negative Interest Rate Policy/Yield Curve Control policy would likely improve JBG market functioning.
  • The team believes Chinese bonds are expensive and are yet to price in improved economic prospects from the easing of Covid policies. As a result, the Fund reduced its CNY duration position relative to benchmark over the quarter. The Fund was overweight South Korean bonds, which is another example of a central bank at a mature stage of its tightening cycle with the focus increasingly moving away from inflation and towards financial stability risk.
  • The team continues to find value in select local currency South American bond markets such as Mexico where attractive real yields should support both front-end bonds and the currency. Countries like Uruguay are also benefitting from political stability and favourable economic reform as well as having an ambitious environmental, social and governance agenda.

As a reminder, 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.

Fund performance

Compound Returns %¹ Since Inception2 10 Year 5 Year 3 Year 1 Year Q4
Sun Life MFS Global Total Return Fund - Series A

6.0

 6.2 2.9 1.7 (6.2) 7.8

Sun Life MFS Global Total Return Fund - Series F

7.2

 7.4 4.2 2.9 (5.1) 8.2
Sun Life MFS Glbl Return Benchmark

7.8

 8.2 5.0 3.2 11.6 5.3

¹Returns for periods longer than one year are annualized. Data as of December 31, 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.

Sun Life Global Investments is a trade name of SLGI Asset Management Inc., Sun Life Assurance Company of Canada and Sun Life Financial Trust Inc.

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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