Sun Life MFS Global Value Fund

Fund commentary | Q2 2022

Opinions and commentary provided by MFS Investment Management Canada Limited.

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.

  • The key reasons for outperformance against the MSCI World Index were the underweight and good stock selection in information technology and consumer discretionary. Both sectors have sold off the most during Q2. At a stock level, the portfolio benefitted (relative to the Index) from not owning Amazon and Tesla (both consumer discretionary) and from not owning Nvidia and Apple (both IT).
  • Stock selection in health care was mixed. Holdings such as Cigna and Johnson & Johnson performed well and featured prominently in the top relative contributors, whereas not holding UnitedHealth and Eli Lilly were a drag on relative returns as both stocks held up well in a down market.
  • Notable individual contributors
    • 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.
    • Cigna Corp – The portfolio's overweight position in global health services provider Cigna (United States) supported relative performance. The stock price rose as the company's financial results beat market expectations, led by strong performance in Cigna Healthcare, particularly better-than-anticipated medical loss ratio rebates and stronger operating income growth.
    • Tesla – Not holding shares of electric vehicle manufacturer Tesla (United States) supported relative performance. Although the company reported strong first-quarter financial results, production shutdowns at Tesla's plant in Shanghai reduced vehicle deliveries and appeared to have weighed on investor sentiment.

  • Energy and utilities were a small drag on relative returns overall, as the strategy is slightly underweight both sectors and these sectors fell less than the market. Whilst the stocks the Fund owned performed well, they were offset by not holding bigger names, such as Exxon Mobil, which have a bigger impact on index returns.
  • Individual detractors
    • 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.
    • Charles Schwab Corporation – An overweight position in financial services provider Charles Schwab (United States) weighed on relative performance. The company reported quarterly earnings per share results below market estimates, primarily due to lower-than-expected net interest and asset management income, coupled with lower trading commissions.
    • 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.

 

Opportunities/risk management

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 has been 6-7 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. During the quarter, the team started 4 new positions and eliminated 2 to finish the quarter with 99 holdings:

Add/Buy

  • Alphabet (new) – The Fund started a new position in Alphabet, the parent company to Google. The team has always liked the dominant global position in search (~85% market share) and its clear scale advantage, plus the ability to exploit opportunities like YouTube. Alphabet has been very successful at growing its cloud business to become a strong third player behind AWS (owned by Amazon) and Microsoft. The team recognizes the cyclical risk to Alphabet as most earnings come from advertising, but now believe the valuation is attractive to start a position. The valuation can now be justified based without needing to make heroic assumptions on the start-up businesses.
  • Julius Baer (new) is a pure play on the growth of wealth management, benefitting from long-term structural growth, whilst being a capital light business model with limited credit risk. Whilst based in Switzerland, it operates with strong positions across Europe and Asia and could grow, helped by strong execution and branding. 15% of revenues are tied to net interest income, which will benefit from higher interest rates, without the credit risk of a bank. The balance sheet is conservative, with surplus capital, and the stock has paid close to a 6% dividend yield and has traded under 10x forecast earnings. 
  • Icon (new) is a Clinical Research Organization (CRO), which is contracted by pharma and biotech companies to manage clinical trials and complex medical testing. It is now the joint market leader after the recent acquisition of PRA Health Sciences. The business has grown 7% pa over the last decade and has plenty of scope for further growth. The nature of trials is growing more complex, time sensitive and subject to regulatory scrutiny, giving economies of scale to larger players. This is a highly cash generative business aimed to pay down debt and return more cash to shareholders. 
  • LVMH (new) is the world’s leading luxury goods business, with coveted brands in fashion and leather goods, watches and jewelry and spirits. The industry has historically grown faster than GDP. It’s brand history, legacy and high investment create strong barriers to entry and pricing power. LVMH are experts in brand management and historically proven they can grow brands that were mismanaged by others. The stock has de-rated due to China risk, providing an interesting entry point at an attractive valuation.
  • The team added to several existing positions based on stronger conviction behind the investment thesis and/or opportunities presented by recent price weakness, such as Bayer, Nasdaq, Charles Schwab, Hitachi, Regal Rexnord, ENI, Roche, Hess, Experian, Microsoft and Schneider

Trim/Sell

  • KBC (exit) – The team sold the remaining position in KBC, the Belgian bank, to fund the new position in Julius Baer, where valuation is arguably more attractive, and it has less credit exposure. KBC is more exposed to the risk of recession across its European businesses.
  • Nomura Research Institute (exit) – The team sold the remaining position in Nomura Research Institute (NRI), the Japanese IT consulting business. Whilst the team continues to like its strong market position in Japan and top tier capital allocation, the valuation is now full and adequately reflects these qualities.
  • The team trimmed large positions in consumer staples such as Nestle and Diageo, which have performed well and look more fully valued to fund other opportunities.
  • The team also trimmed large positions in health care which have performed well such as Novo Nordisk, Johnson & Johnson and Quest Diagnostics
  • The team  trimmed several other positions after recent outperformance, such a Texas Instruments, KDDI, Travelers, Chubb and Honeywell, to fund better opportunities.

 

Fund Positioning Outlook

The correction in markets seemed long overdue as investors came into the year with high valuations and high levels of earnings – peak profits, peak M&A, close to peak valuations and peak returns – a dangerous cocktail which has now started to unwind. All of the correction so far is due to ‘multiple compression’ – in other words, valuations have fallen but earnings have held up remarkably well (so far). The team feels the next shoe to drop looks to be an earnings decline as companies are hit by falling demand and some fail to pass through stubbornly high input cost inflation. It is impossible to predict how much earnings might fall, with historical precedents like the Global Financial Crisis and tech bubble collapse not necessarily good guides to the future. Stock markets are forward looking and at some point will look through the earnings decline to brighter times ahead. Arguably, for many cyclical stocks, this may already be happening. It is impossible to predict exactly when the market might bottom or whether this is just the start of a longer ‘bear’ market. It is a challenging time for central bankers as they try to cool inflation without tipping economies into recession. Investors are definitely in a period of ‘regime change’ with rising interest rates ahead of us and the start of quantitative tightening (QT). No one knows what this will mean as QT has never been done before.

It seems right to question how the spectacular returns from owning equities over the last decade can be repeated. Predicting the outcome in the near term is impossible, but the team feels it seems prudent to forecast lower overall returns from equities over the decade ahead. The good news is that starting valuations are notably lower than they were six months ago.

The shape of the portfolio has not changed materially as the team invests for the long term and likes what they own. The top sector overweights relative to the MSCI World Index are industrials, financials and consumer staples, where they continue to see attractive opportunities. The team has been reducing the position in consumer staples by trimming stocks that have outperformed, notably Nestle and Diageo. The portfolio is underweight information technology and consumer discretionary, where many valuations still look rather stretched, but the team has used the opportunity to buy new stocks such as LVMH and add to Microsoft.

Given the Fund’s bottom-up approach, the decisions are not driven by trying to predict the exact path of macro variables such as inflation and interest rates. The team is, 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 aimed to withstand the impact of rising input costs better than peers. The team is seeing companies across the portfolio raising prices, notably in consumer staples, industrials and paints. With regards to rising interest rates, the portfolio is overweight financials, which they feel could benefit if economic growth holds up and cushioned by little 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 bigger discounting as interest rates rise.

Fund performance

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

9.5

9.9 4.2 3.7 -8.9 -9.3

Sun Life MFS Global Value Fund - Series F

10.7

11.2 5.4 4.9 -7.9 -9.0
MSCI World NR CAD

10.9

12.1 7.5 6.5 -10.8 -13.4

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 September 30, 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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