Fund commentary | Q4 2022
Opinions and commentary provided by MFS Investment Management Canada Limited.
Opinions and commentary provided by MFS Investment Management Canada Limited.
The year finished with the optimism that the market has reached the “pivot point” in the battle with inflation and can now enter a new phase of more modest rate rises after the Fed hiked rates seven times, including four hikes of 0.75% in a row before the latest increase of 0.5%. In total, the Fed raised by 4.25% points over the year, the biggest monetary tightening since 1981. US inflation has fallen for the fifth month in a row to 7.1% from a peak over 9% in June, its highest level in 41 years. This eases pressure on the Fed, which is still hoping to engineer a soft landing rather than falling into outright recession. All major central banks, with the notable exception of the Bank of Japan, have been rapidly tightening monetary policy this year. The Bank of England raised rates eight times, with inflation so far only falling a touch from 11.1% to 10.7% and is predicting a harsh recession. In Europe, the European Central Bank raised rates.
The worry is that the risk of “policy error” is now higher as central banks try to finesse rates to beat inflation, offset by the risk of doing too much and tipping into recession. This shift has started to be reflected in share price moves in the fourth quarter, with the Fed making clear it will keep rates higher through 2023, with no reductions until 2024, with tougher economic times the trade off in managing inflation. The previous cycle of incremental moves—typically small and easily anticipated—has been replaced with much larger and repeated changes to interest rates, following wild swings in fiscal policy as governments dealt with the pandemic. The longer-term implications of both are still not fully understood. The fear is that continued higher interest rates will cause more casualties as debt costs mount up. Distress is already visible in emerging markets. The question is whether the era of cheap money is simply being interrupted or is ending for good.
Despite tight labor markets, economists spent most of the year downgrading their growth forecasts. In its October report, the IMF forecast global growth to slow from 6% in 2021 to 3.2% in 2022 and 2.7% in 2023, the weakest growth profile it has forecast since 2001, excluding the Global Financial Crisis. It forecast growth in the US to slow to 1.6% in 2022 and 1.0% in 2023, with some major European economies, like Germany and Italy in recession by 2023. It expects growth in China to slow from 8.1% in 2021 to just 3.2% in 2022 and only rebound to 4.4%growth in 2023. The OECD’s recent forecasts were even lower, with just 2.2%global growth in 2023. This seems to contrast with bottom-up forecasts for company earnings growth which have stayed surprisingly strong.
The year was also marked by big swings in currency markets, with U.S. dollar strength finally reversing in the fourth quarter. The euro recovered after falling to U.S. dollar parity and sterling rose from its lowest level on record against the US dollar during the budget crisis in September. The yen touched a 32-year low against the US dollar before recovering.
From a style perspective, there was a notable outperformance of value versus growth for the quarter and the year, with the MSCI World Value index +14.7% (net div. in US dollars) in Q4 versus the MSCI World Growth index +4.7%. For the full year, the picture was more extreme with value beating growth by the widest margin for many years, with the MSCI World Value index -6.5% (net div. in US dollars) versus the MSCI World Growth index -29.2%. 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.
The Sun Life MFS Global Value Fund outperformed its benchmark, MSCI World Index for the quarter.
This was due to a combination of positive stock selection, positive sector allocation and a positive currency impact for the quarter. The team’s disciplined focus on both business durability and valuation has meant the strategy has historically provided the most value for clients in more challenged markets, and this was again true in 2022.
Good stock selection in Consumer Discretionary and Financials were the key reasons for outperforming the MSCI World Index during the quarter. Within Consumer Discretionary, not owning Tesla and Amazon was beneficial to relative performance as the stocks fell by 54% and 26%, respectively. The Fund’s holding in Richemont within luxury goods was also a key positive factor. Within Financials, good stock selection came from a range of key holdings, notably Mitsubishi Financial, UBS, BNP Paribas, J.P. Morgan Chase and NatWest. The strategy also benefited from its underweight in Information Technology, notably from not owning Apple and being underweight Microsoft.
Stock selection in Health Care and Industrials was a drag on relative returns against the MSCI World index during the quarter. In the case of Industrials, this was partially offset by the overweight position which helped as the sector recovered strongly, along with other cyclicals in the fourth quarter. Within Health Care, the Fund’s holdings in pharmaceuticals company Roche and medical device company Medtronic were relatively weak after Roche reported some R&D setbacks and Medtronic missed its growth forecasts. Within Industrials, manufacturing company Regal Rexnord was weak after disappointing investors with news of a $5 billion acquisition, hard on the heels of still consolidating its merger last year and pushing leverage higher than previously assumed. Home improvement and building products company, Masco fell after disappointing Q3 results and cuts to full-year profits guidance as volume declines have left margins under pressure. Stock selection in Energy was marginally positive with strong returns from holdings in Hess, ENI and Conoco Phillips, offset by the impact of not holding Exxon Mobil and Chevron, which also performed strongly.
The shape of the portfolio continues to adjust as the team finds relative value opportunities. They have started to close some of the large underweight to Information Technology as some stocks start to offer reasonable value, notably adding to Microsoft, Nomura Research, 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, and as a result, the Fund’s underweight has reduced from -11.5% to -8.5%. Not owning Apple is a significant portion of that (index weight 4.2% at year-end). The other key changes over the course of the year have been in Communication Services, where the Fund has increased holdings and closed the underweight with purchases of Alphabet and Omnicom, and in Consumer Staples where the team has reduced holdings from 11.3% to 8.5% of the portfolio over the year, where some stocks look relatively more expensive. The team has sold Colgate and trimmed back holdings in Nestle, Diageo and Pernod Ricard.
At the year end, the biggest sector overweights relative to the MSCI World Index are in Financials and Industrials, where they continue to find the most compelling value opportunities. The biggest sector underweights are in Information Technology (reduced) and Consumer Discretionary. The underweight to Health Care has increased over the year after selling pharmaceutical company Novo Nordisk and clinical laboratory company Quest and trimming medical devices company Thermo Fisher, offset partially by Roche, clinical research company Icon, and a larger position in pharmaceutical company Bayer.
This is a value strategy, not a “deep value” strategy, with a clear focus on both business durability and valuation. MFS 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. 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.
|Compound Returns %¹||Since Inception2||10 Year||5 Year||3 Year||1 Year||Q4|
|MSCI World NR CAD||
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, 2020 to December 31, 2010.
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