Sun Life MFS International Value Fund

Fund commentary | Q1 2022

Opinions and commentary provided by MFS Investment Management Canada Limited.

Market Review

As inflation reached 40-year highs in January and investors anticipated an acceleration in interest rate hikes, equity markets started the year on a downward trend. Long-duration, high-quality equities, technology stocks in particular, experienced the steepest declines, admittedly from elevated valuation levels after robust outperformance last year. Meanwhile, energy led the market in January and early February due to increasing demand as the economy recovered from COVID, and financials outperformed on expectations for higher rates and improving earnings.

The Russian invasion of Ukraine on February 24^th shocked the world and the Ukrainians’ courageous resistance surprised it, upending the rules-based order that has to a large extent characterized international relations since the end of World War II. Energy and commodity prices surged as Russia produces 12% of global oil and supplies 40% of Europe’s natural gas needs. Russia and Ukraine also account for about 30% of the global wheat supply. Meanwhile, consumer discretionary stocks declined on increasing recession concerns, and consumer staples stocks pulled back on inflationary pressures and revenue exposure to Russia, which accounts for revenues in the midsingle-digit percentage range for most companies in the sector.

The Sun Life MFS International Value Fund lagged the MSCI EAFE Index for the first quarter. The environment was markedly different from typical market corrections, which are generally concurrent with a weakening economy. On a historical basis, the Fund has always outperformed the index in quarters when the market declined by 5% or more, going back to at least 2003. In the first quarter of 2022, however, Energy stocks, which the investment team has avoided, led the market performance by a wide margin. Financials, where the Fund has a substantial underweight, outperformed as central bankers in the U.S. and U.K. are intent on raising interest rates to bring down inflation, even as recessionary pressures are increasing. Information Technology, the largest overweight in the portfolio, was the worst performing sector, and consumer staples, the portfolio’s second largest overweight, also lagged the broader market on concerns about inflationary pressures and Russian revenue exposure.

Significant transactions

Add/Buy

• Initiating a position in German exchange operator Deutsche Boerse, where the team favors the company’s exposure to market volatility and rising interest rates, while avoiding balance sheet risk.
• Starting an investment in ASML, the Dutch lithography equipment company that has a near monopoly in leading edge lithography tools, which is supported by a wide moat due to its complex supply chain, after the share price decline earlier in the quarter.
• Initiating a holding in consulting and French IT services provider Capgemini, an IT services player that is improving its business model over time through more digital and cloud-based revenue mix, and more offshore labor to increase cost flexibility during downturns in the business.
• Starting a position in Beiersdorf, where the team likes the beauty category, with its historically above-average growth, strong gross margins and mean-repelling competitive environment, and the team anticipates improvement in the company’s growth and margins from ongoing brand investments.
• Adding to South Korean tech giant Samsung Electronics, where the team favors the company's leading-edge technology capabilities, its leadership in computer memory (DRAM), its high levels of investment in R&D and strong track record of capital allocation supported by a conservative balance sheet, with 25% of the company's market cap in cash.

Trim/Sell

• Trimming investment in Taiwan Semiconductor, to manage the position size in a world of increasing geopolitical risks.
• Exiting holdings of French dairy products and water company Danone, where management has made limited progress on improving profit margins and expanding or enhancing the WhiteWave brands since the 2017 acquisition.
• Where allowed, eliminating US-based consumer products company Colgate Palmolive, on concerns about inflationary pressures and to manage exposure to US-listed stocks.
• Reducing investment in Spectris, a UK-based maker of precision instrumentation and controls, where the team doesn’t see that the company is realizing synergies or additional growth opportunities across its various divisions.
• Trimming position in French flavour and fragrance company Givaudan, where valuation is extended and the team has incremental worries about input cost inflation, consumer demand destruction and slowing innovation among consumer product companies.

Fund Positioning

As we entered 2022, the team was cautious about rising inflation and higher interest rates, excessive levels of debt and lingering COVID-19 concerns. Three months into the year, the challenges have only increased and now include a war in Europe, constrained supply and higher prices for energy and increasing recessionary pressures. The team anticipated that the portfolio might lag the broader market in the initial stages of a market correction and that the high-quality stocks that outperformed by a wide margin last year might underperform in the early stages of a market correction. That scenario did in fact play out in the first quarter, and the portfolio underperformed the MSCI EAFE Index. In an extended market correction, however, the team remains confident that the high-quality, conservatively capitalized companies that the Fund owns could outperform the broader market over the long term.

The strategy remains overweight information technology, where the Fund owns computer software, systems and semiconductor companies that are dominant players in industry niches, with competitive advantages that are supported by differentiated intellectual property. The Fund is also overweight consumer staples, where the team favors the brand name strength, global distribution networks, strong balance sheets and the ability to adapt to the digital environment across a number of consumer product, food and alcoholic beverage companies. The Fund is overweight industrials, where it owns businesses that are leaders in their market niches, emphasizing innovation to meet future customer needs.

The Fund’s most significant underweight is financials, as it continues to avoid European and Japanese banks with complicated business models and over-levered balance sheets. The Fund is underweight Health Care, on concerns about patent cliffs, the high cost of drug development and increasing government pressure on drug prices, and underweight consumer discretionary, where the team finds fewer businesses that meet their criteria for cash flow generation and sustainability over the long term.

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 October 1, 2010 to December 31, 2010.