Portfolio outlook and positioning
The U.S. market, as measured by the S&P 500 Index, moved higher in Q1, driven by continued optimism in COVID-19 vaccines and by additional fiscal and monetary stimulus. Smaller-caps outperformed mid- and large-caps, and value outperformed growth. At the sector level, energy and financials outperformed as energy prices and rates increased.
Since November, cyclical stocks have rerated as excitement surrounding positive vaccine news and economic reopening has led to elevated expectations for a significant GDP print this year. However, the portfolio manager believes this enthusiasm will eventually taper off as the effect of higher input costs, rising rates and potential tax increases could weigh on profitability expectations.
Health care and technology are two sectors in which MFS continues to hold a positive view and feels well-positioned to benefit from any future growth potential.
In health care, the portfolio manager has seen COVID-19 testing beneficiaries, such as Thermo Fisher and Danaher, lag other health care names since vaccine news was released in November and sport relatively attractive valuations today. These businesses provide much more in the way of instruments and equipment beyond COVID-19 testing. MFS believes tailwinds are building for accelerated growth in new diagnostic and therapeutic platforms to meet the expanding needs of drug development in a strong therapeutic innovation cycle, of which these companies are likely to participate.
In information technology, MFS continues to favor vertical software businesses such as Adobe, Autodesk, and Cadence Design Systems, which the portfolio manager believes have not traded at extreme price-to-sales multiples. The portfolio manager prefers vertical software businesses over horizontal software, as they tend to focus on improving and optimizing a product set for one specific industry versus trying to be all things to all people. In addition to software, the Fund continues to favor semiconductor capital equipment companies. Here, names like Lam Research, Applied Materials and ASML remain top positions. MFS believes these companies are structurally advantaged in a market demanding "more brains in more things." As an increasing number of large players commit to building out semiconductor manufacturing capacity in the coming years, the long duration growth opportunity continues to emerge.
Looking at the U.S. equity landscape from an industry perspective, MFS seeks to identify which companies are growing at above market rates and where the profit pools could go over the next decade. This exercise provides a helpful check on the outlook for growth stocks. It also helps explain why certain growth-oriented companies, despite the near-term market rotation, have continued to take market share and why, the portfolio manager believes, this trend may continue over the longer-term.
A look at autos & housing industry and thinking about where future growth potential is likely to come from, one could argue, future growth is likely to come from underpenetrated areas of the industry with large addressable markets, such as electric vehicles and the Internet of things (i.e. smart elevators, smart cars, connected homes, etc.). Even in traditionally lower-growth areas like consumer staples, niche brands and healthy eating are long-term trends which are enabled largely by the Internet and e-commerce as consumers have more choices available to them. MFS also sees this trend in more traditional value sectors such as energy and financials. In energy, profits and growth are going to solar or other alternative sources of energy while in financials, most of the growth has come from Fintech.
In health care, MFS believes growth will likely come from areas like biotech, telehealth, next generation tools and life sciences companies. In industrials, similar to autos & housing, it’s all things digital, direct to consumer, and the Internet of things. In leisure, estimated growth is expected in areas like streaming video on-demand and video games. Finally, in retailing, MFS believes it’s all about e-commerce, digital or omni-channel or more direct to consumer businesses.
It’s the portfolio manager’s belief that over time, sustainable earnings growth will come from companies that possess pricing power, the result of sustainable competitive advantages, high barriers to entry, intellectual property and differentiated products and services, many of which reside in the growth universe.
Significant transactions over the period included:
- Established a position in Uber Technologies. A company with global scale, improving unit economics and accelerating revenue growth in the long-term secular growth area of ride hailing and delivery, that may also benefit from increased activity over the near-term due to re-openings.
- Established a position in Icon PLC, a contract research organization that runs pharmaceutical trials on behalf of the biopharma industry. MFS believes health care R&D budgets will expand, and Icon is positioned for industry growth while having improved their quality of business through expanded customer diversification.
- Participated in the IPO for Bumble, a company MFS believes is well-positioned for long-term secular tailwinds in the shift from offline to online dating and anticipates the company will see increased activity over the near-term due to pent-up demand as various lockdowns are lifted.
- Exited the Fund’s position in Teladoc Health. While MFS remains favorable on the long-term shift toward telehealth versus in-person visits, it believes that the valuation currently prices in a significant amount of optimism.
- The Fund exited its positon in IHS Markit following the announcement that S&P Global would acquire them for $44 billion.
Significant impacts on performance
