In November, a clear election result and positive news from multiple vaccine trials buoyed equity markets. The fourth quarter rally was largely fuelled by COVID-19 vaccine optimism. This helped to unleash a powerful pro-cyclical rotation as value outperformed growth. There was a strong rotation in sector leadership, however high-valuation stocks and low-quality stocks still continued to outperform the market.
In the fourth quarter, the portfolio was overweight consumer staples. Many of the Fund’s consumer staples holdings have pricing power and derive a significant portion of their revenues from underpenetrated emerging markets countries, which has historically led to higher revenue growth and more stable earnings growth than the overall market. While e-commerce is negatively affecting many industries, this disruption has not impacted 'brown spirits' distillers, such as Diageo and Pernod, to the same degree as other industries, as these spirits typically take many years to produce.
The portfolio was underweight consumer discretionary and communication services. The underweight to consumer discretionary stems primarily from the Fund’s avoidance of multiline and specialty retailers, many of whom are facing pressure from e-commerce competition. The Fund’s underweight to communication services is the result of not owning many telecommunications companies that MFS believes typically do not have sustainable above-average growth or pricing power.
The overall positioning of the portfolio has not changed materially. The portfolio manager continued to build or initiate positions in high-quality businesses they believed had attractive risk/return profiles, while trimming or eliminating companies they believed had become more fully valued or were facing structural headwinds.
Key trades during the fourth quarter included the following:
- Initiated a position in Cap Gemini, one of the world's largest IT services companies. New management has improved the business in several dimensions and recently acquired an engineering R&D company, which increases its exposure to higher growth areas and provides support to further margin expansion from cost synergies.
- Bought Prosus, a holding company whose underlying net income is derived primarily from its ownership of Tencent. MFS believes Tencent has a significant pathway for growth of its chat and payments businesses, and owning Prosus gives the portfolio additional Tencent exposure at a discount.
- Bought Mahindra & Mahindra, an Indian conglomerate whose crown jewel is their tractor manufacturing business. The portfolio manager believes the company has the ability to build on their leading market share in tractor sales, fueled by the potential for structural growth in India driven by agricultural yield improvements.
- Added to the position in SAP after a recent profit warning made the valuation more attractive. The profit warning was due to increased investment in their cloud business and a faster transition from licenses to subscriptions.
- Sold the position in Mettler-Toledo International at higher valuations after strong share price performance.
- Sold the position in Japan Tobacco on concerns about their ability to manage the shift to heat-not-burn technologies.
- Sold food catering company Compass Group due to lower conviction around future margins given the negative impact of the pandemic, which may continue even after the pandemic ends.
The year of 2020 witnessed the fastest bear and bull market cycle in history, driven by news of a global pandemic, the policy response by central banks and governments and the development of a vaccine. Equity indexes had narrow leadership, and factors such as momentum, high valuation and low quality outperformed the overall market.
The Fund owned attractively valued steady companies. Names like Nestle, Roche, and Novartis are businesses that MFS believes have a greater chance of delivering earnings growth more consistently and predictably than the overall market. The portfolio manager has consistently focused on these types of high-quality companies and that has not changed. Coming into 2021, MFS believes the strategy is positioned to potentially benefit from a combination of market leadership broadening out, a return to fundamentals driving market returns and a renewed focus on valuations. The Fund seeks to own high-quality businesses with significant exposure to long-term secular growth trends, including growth of the emerging markets middle class, aging demographics across the developed world and reshoring.
The global economy continues to recuperate from the early 2020 recession, but the question remains whether this rebound will turn into a full-blown recovery. Unlike many recessions, which were the result of self-inflicted excesses, the pandemic was an exogenous, non-economic catalyst. As a result, the rebound and any economic scars resulting from this downturn may be different from prior downturns and recoveries. While equities generally closed at or near all-time highs to end 2020, earnings remain well-below pre-pandemic levels.
The portfolio manager expects the markets to remain choppy into 2021, as there is limited visibility on how the virus variants and vaccine programs will impede or support economic activity against the backdrop of potential ongoing stimulus. MFS believes having a long-term investment timeframe, grounded in strong fundamental analysis, have never been more important. Things like the impact of a massive increase in the level of government debt, significantly lower interest rates for an extended period of time, pension underfunding and lower long-term global growth could prove not to be transitory.
Significant impacts on performance