Sun Life MFS Global Value Fund

Fund commentary | Q1 2022

Opinions and commentary provided by MFS Investment Management Canada Limited.

Market Review

The new year certainly started out down a very different path, with the global equity market falling sharply. The biggest talking point is clearly the Russia-Ukraine conflict, which has fuelled the inflation debate, slowed the path of global growth and rekindled geopolitical risks. The greatest impact has been on commodity prices, and looking into the detail reveals more of a story. Energy has been the standout sector with a 31% total return. Russia supplies 11% of global oil production and 17% of global gas (40% of European gas).

Early in the quarter, expensive technology stocks sold off, as these long-duration assets are more vulnerable to rising interest rates, but the late rally in markets pushed many valuations back up again. By quarter end, the materials and utilities sectors moved into positive returns, but every other sector finished down, with double digit falls in information technology, consumer discretionary and communication services. Value stocks outperformed growth stocks by a wide margin, especially those that that benefit from rising commodity prices and those that benefit from rising interest rates.

Central bankers have shifted their language on inflation and ditched the term ‘transitory’ as it was causing confusion. More importantly, they have started to take decisive action, by raising interest rates and unwinding the extraordinary levels of quantitative easing that have supported asset prices. News on COVID-19 and the omicron variant has faded into the background, with the positive stories of reopening and a ‘new normal’ approach to living with the virus, offset by the negative impact of ongoing disruption to global supply chains, especially in China with their zero tolerance approach causing major shutdowns. This continues to add to inflationary pressures.

The Sun Life MFS Global Value Fund F lagged the MSCI World Index for the first quarter. The strategy was strongly ahead of the index early in the period as high growth stocks sold off sharply, notably technology, where the portfolio is underweight. However, relative performance tailed off later in the quarter as commodity stocks (underweight) surged post the Russian invasion of Ukraine, and technology stocks rallied again.

The key detractors were stock selection in materials, consumer staples and industrials. Within materials, holdings in paint companies PPG Industries, Akzo Nobel and Axalta Coating underperformed due to raw material cost pressures. All are raising prices and confident of offsetting the impact over time, but there is always a lag effect. High levels of industry consolidation and historic pricing power suggests they will be successful. Within consumer staples, Henkel was weak for similar reasons. The Fund’s industrial holdings in Masco, Stanley Black & Decker, Ingersoll Rand and Johnson Controls were a drag on relative performance as shares were weak reflecting inflationary pressures, housing market exposure and general cyclicality as growth rates weakened. Energy was a small negative factor overall. Strong performance from holdings in ConocoPhillips, Hess and ENI failed to compensate for the underweight to the sector, given the strong rally.

Stock selection in communication services and healthcare, together with the underweight position in information technology contributed to performance. Within communication services, not owing high profile stocks, such as Meta Platforms (Facebook) and Netflix helped as both stocks fell sharply after disappointing on growth. The Fund’s holding in KDDI, the Japanese telecom provider, was also a positive factor. Strong performance in healthcare was led by holdings in Bayer, Johnson & Johnson and Medtronic, which all performed well. Within information technology, avoiding stocks like Shopify and PayPal and the underweight to Microsoft were the key reasons for good stock selection.

Significant transactions

During the quarter, the team added to several existing holdings on increased conviction to their investment thesis and/or opportunities presented by short-term price weakness. The team also trimmed positions in stocks where valuations have become less attractive to fund the better opportunities. 

Add/Buy

• During the quarter the team started a new position in Iberdrola to finish the quarter with 97 holdings. Iberdrola, the Spanish-listed electric utility, is a leading global power provider and grid operator for consumers and industries across Europe and the Americas. Iberdrola is a clean energy specialist and is the global number one in renewables, with leadership in the energy transition to renewable solar and wind power from its traditional roots in legacy power generation. They have pledged to spend €75 billion over the next five years to double their renewable capacity and are set to be a major beneficiary of the EU’s €800 billion Recovery and Resilience fund, focused on supporting investment in green energy projects and digitalization. MFS sees Iberdrola’s growth being funded internally from strong cash generation and balance sheet leverage, which is modest.
• Early in the quarter, the Fund added to Henkel, the household products company, which has traded on a low valuation yet has robust plans to upgrade the core business.
• Within financials, the team continued to build their positions in Goldman Sachs and JP Morgan, encouraged by valuation support, strong balance sheets and earnings leverage to rising interest rates.
• The Fund added several times to holding in Aptiv Plc, a global auto parts supplier well positioned for the electric and autonomous vehicle transition.
• The Fund continued to build positions in Stanley Black & Decker and Masco, both with home building and renovation exposure.
• The Fund added to Intel due to the attractive valuation. The team also supports Intel’s business plan to build out leading semiconductor supply from its US base, which is important to ensure security of the global supply chain.
• Other notable adds this quarter included Microsoft, CGI, Regal Rexnord, Equifax, Samsung Electronics and Wolters Kluwer.

Trim/Sell

• Key trims included Lockheed Martin, KBC, Home Depot, Pernod Ricard, Novo Nordisk, Texas Instruments, Heineken, Northrop Grumman, RELX, Tesco, Nomura Research andRichemont.
• The team funded the purchase of Iberdrola with a trim to holding in U.S.-based Duke Energy, which has traded at a  higher multiple and pays a lower dividend.
• The team funded the purchase of Intel with a trim to holding in Taiwan Semiconductor, driving by its high valuation.

Fund Positioning

Overall, equity valuations have eased back a little, but remain elevated compared to historic levels. The long-term picture hasn’t changed —peak profits, peak margins, peak M&A, close to peak valuations. Governments have mountains of debt to repay and central banks must unwind balance sheets the size never seen in history. This encouraged investors to take more risk, with little alternative to owning equities when bond yields have been so low. This is now starting to change. Interest rates are rising, and a huge unwind of QE has begun, which questions how the spectacular returns from owning global equities over the last decade (+10.9% per annum) can be repeated. Predicting the outcomes in the near term are impossible, but it seems prudent to forecast the potential of lower overall returns from equities over the decade ahead.

The outlook remains positive, but the big drivers of last year’s returns, strong earnings growth and huge liquidity flows, have started to reverse, which might take away the anchor for markets. MFS believes this year will depend on how much more earnings can grow (consensus forecast 6% for the MSCI World Index) and the pace of interest rate rises necessary to combat inflation. Long-duration assets, such as technology, are particularly sensitive to changes in interest rate expectations. Adding geopolitical risks, which are now back foremost in investors’ minds, it seems right for the potential of volatility to remain pretty high.

At a stock level, there were large falls in Russian-listed or Russian-exposed stocks due to the impact of sanctions and some profit warnings in high profile names such as Meta Platforms (Facebook), Netflix and Shopify, which all disappointed on growth. Chinese stocks were extremely volatile on concerns about the regulation of the internet giants, property default risk and more COVID lockdowns. The Fund does not own any of these stocks in the portfolio and does not have any direct exposure to Russian stocks or Chinese technology or property companies. The only Chinese company the Fund owns is a small position in Yum China, the fast food restaurants business. The team has also taken advantage of the recent volatility and added to existing positions or initiated new positions that traded at attractive valuation funded by trimming or disposition of holdings that traded at high valuation (see details in the significant transaction section).

¹Returns for periods longer than one year are annualized. Data as of March 31, 2022.
²Partial calendar year. Returns are for the period from the fund’s inception date of September 30, 2010 to December 31, 2010.