MFS Meridian® Funds – Continental European Equity Fund

MFS Meridian^® Funds – Continental European Equity Fund
Navigating the European Equities Market: An Insider’s Guide

THIS INFORMATION IS FOR MARKETING PURPOSES ONLY.

 

Risks of the fund
The fund may not achieve its objective and/or you could lose money on your investment in the fund. Stock: Stock markets and investments in individual stocks are volatile and can decline significantly in response to or investor perception of, issuer, market, economic, industry, political, regulatory, geopolitical, environmental, public health, and other conditions. Concentrated: The portfolio's performance could be more volatile than the performance of more diversified portfolios. Geographic: Because the portfolio may invest a substantial amount of its assets in issuers located in a single country or in a limited number of countries, it may be more volatile than a portfolio that is more geographically diversified. Please see the prospectus for further information on these and other risk considerations.

Matthew Barrett, ASIP

Equity Portfolio Manager

Why should clients consider investing in European equities?

Matthew Barrett:

Well, firstly, European markets are more diversified than many other markets, certainly compared to the UK and the US. That's in terms of both sector and in terms of geographic exposure where they're making their revenues and profits. And then from a UK investor's perspective, we've got a bigger pond to fish in, in terms of finding good businesses with great long-term growth prospects. Then in terms of valuation, Europe looks cheap relative to many markets, certainly relative to the US. Now, that's been true for quite a long time now, but if we look at it on a long-term view, we really are at quite extreme levels now.

Does taking an active approach to Continental Europe matter?

I'd argue that in the current environment where the macro outlook is pretty uncertain and geopolitics look to be more fractious for an extended period of time, that provides a real opportunity for us as active investors to create value for our clients. In my view, there's so much money being run passively now that it's starting to lead to market inefficiencies and distortions. So for us as active managers, that provides us with opportunities that we can start to exploit. While we've been consistent in our approach and investment philosophy since the inception of the portfolio, I personally have had primary responsibility for the fund over the last 14 years. During that timeframe, we've seen a lot of economic cycles, a lot of geopolitical events, and yet we've managed to deliver strong risk-adjusted returns over all rolling five-year periods. And finally, we've got a great team of analysts who do a fantastic job of picking winners and avoiding losers, and that makes me very confident that we've got repeatable and sustainable performance approach.

What are the key characteristics of the strategy?

A couple of things really, I'd say we take a long-term approach, by which we mean five to ten years, and our compensation is aligned with that. So, our analysts and our portfolio managers are typically compensated on three and rolling five year performance. For dinosaurs like me, possibly five to ten, so timeframe is a big factor, and then just really the quality of the businesses that we invest in. We're looking for businesses that have strong intangible assets, management teams that invest behind those intangible assets and then allocate excess capital effectively. And then the final point is we're conscious of what we pay for those businesses. So, we're looking for good quality businesses that generate strong and sustainable returns on capital, but we're very conscious what we pay for them, and we sometimes maybe look for opportunities when the market's being more short-term in their approach to valuing those businesses.

How is the portfolio constructed, and has this changed over time?

So, our approach to portfolio construction has been very consistent over time. We try to generate the majority of alpha from stock selection rather than the sector allocation, and this has certainly been the case historically. Another way we think about risk is simply in terms of three risk buckets, so we think about defensives, cyclicals, and financials, and we think about the relative positioning of the fund against those three broad risk buckets. We've typically been underweight financials. It's hard for us to find businesses that earn an excess return on capital and with the sort of qualities that we're looking for, strong intangible assets. So, financials typically has been an underweight.

In terms of cyclicals versus defensives, we're looking at what's discounted in stock prices. So, we're looking at through the cycle metrics to see which areas are attractive and we position the portfolio accordingly. We're also conscious of what currencies our companies own their revenues and profits in and how that compares to the benchmark as a whole. Finally, in terms of position sizing, we use scenario analysis to determine the potential range of outcomes from an individual investment, and we use that to inform how large an active position we take in that individual security.

What is your edge, and what are you looking to exploit?

Two factors really, firstly time. We've seen over the last 60 years investors' time horizons have done nothing but come down. They're now some of the lowest. The average holding period in the market is some of the lowest we've ever seen, so that provides us with opportunities. When the markets are thinking short-term or concerned about near-term variables, often that gives us an opportunity to invest in a name or it may provide an opportunity to add to a name that we already own. And then on the flip side, when the market's overexcited, it perhaps gives us an opportunity to sell out of a name or trim it.

If we look at the turnover on the portfolio over time, it's typically been around 15%. So, our average holding period is certainly a lot longer than the markets. I think the average holding period of the market at the moment is around eight months, so we take a substantially longer-term view.

And then the second point really is our focus on returns. We like businesses that earn a positive spread on their economic capital. We like management teams that understand the value of their intangible assets that invest behind them, and then we're very focused on the sustainability of those returns. So, a business might have high returns now and not very attractive, but what's the sustainability of those returns over time?

Given the strategy’s track record, how have you delivered consistently strong risk-adjusted performance?

I think there's a number of factors. If I had to boil it down to three, I think it's the quality of the businesses that we invest in and what we pay for them, so valuation is an important part. Then, I think in terms of portfolio construction, we typically don't take outsize sector over and underweights. We want most of the performance in the portfolio to come from stock picking. That's where our analysts really have strength. So, certainly if you look back over time, around 70 or 80% of the performance of the fund has come from stock picking. We don't like to make outsize bets on individual sectors. We will be overweight to sector or underweight to sector, but not in a very substantial way. Finally, I'd say our global research platform. We've got fantastic analysts across the globe rating stocks are one, two, three, so simplistically a buy seller or a hold. Over the long term, they've done a great job of picking winners and avoiding losers, and so that's really a fantastic resource for me and it's my starting point of the process.

What is your approach to dealing with macro uncertainty and geopolitical tensions?

While generally we think it's a fool's errand to try and predict the future, and therefore it would be dangerous to try and position the portfolio accordingly, what we tend to do is look at what's discounted in stock prices. So, what outlook is the market discounting? Has it become too optimistic? Has it become too negative? We're looking at through the cycle returns and through the cycle valuations for our businesses, and that's really what informs our macro. In terms of geopolitics, we feel this is going to become an increasingly important factor. We are of the view that we're moving from a unipolar to a multipolar world. We are likely to see more geopolitical friction going forward, and that has lots of implications, certainly in terms of potential inflation over the longer term. So, geopolitics certainly features a lot more heavily than it would've done say two years ago.

We think things are going to be more volatile. With regards to Europe specifically, obviously conflict in the Middle East and in Ukraine can have a significant impact on energy prices or could potentially impact energy prices. Europe's pretty reliant on external sources of energy. It's been a factor in the past. The sort of businesses that we invest in are pre-capital lights. They don't tend to be large consumers of energy, so we feel if there is an environment where energy prices rise, portfolio should do quite well despite the fact that we're underweight energy as a sector. Another area where geopolitics factors into our decision making is we're very conscious of where in the world the businesses we invest in generate their revenues and profits. So, we're less focused on where they happen to be domiciled, but where their real economic businesses sit. And in recent years, we're also very focused on where their supply chains sit as that can have a meaningful impact. In terms of our company's exposure to China, we're also conscious of that, and in particular we're looking to avoid areas that are more politically sensitive.

How do you expect the strategy to behave in different market conditions?

Historically, the strategy has done very well in tough markets, so markets which are down more than 5% in a quarter, we have strong returns. Then, in more normal trending markets, we tend to do pretty well. Environments where we tend to underperform is strong risk-on markets. So, typically we think of an environment where the stock market's up more than 5% in an individual quarter. That's been a period where the strategies tended to lag, and then also I'd say given our focus on quality, in an environment where you see credit spreads contracting meaningfully, so financial risk being reduced across lower quality companies, that's an environment in which the strategies typically struggle.

 

Please note that this is an actively managed product.

The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. No forecasts can be guaranteed.

See the fund's offering documents for more details, including information on fund risks and expenses. For additional information, call Latin America: 416.506.8418 in Toronto or 352.46.40.10.600 in Luxembourg. U.K.: MFS International (U.K.) Ltd., 1 Carter Lane, London, EC4V 5ER UK. Tel: 44 (0)20 7429 7200. European Union: MFS Investment Management Company (Lux) S.a r.l. 4 Rue Albert Borschette, Luxembourg L-1246. Tel: 352 2826 12800 . MFS Meridian Funds is an investment company with a variable capital established under Luxembourg law. MFS Investment Management Company (Lux) S.ar.l. is the management company of the Funds, having its registered office at 4, Rue Albert Borschette, L-1246 Luxembourg, Grand Duchy of Luxembourg (Company No. B.76.467). The Management Company and the Funds have been duly authorised by the CSSF (Commission de Surveillance du Secteur Financier) in Luxembourg. The Funds are established as a "restricted foreign scheme" in Singapore; therefore, material in connection with the offer or sale of the funds may only be distributed to persons in Singapore that are qualified under Sections 304 and 305(2) under Chapter 289 of the Securities and Futures Act. This document has not been reviewed or approved by the Hong Kong Securities and Futures Commission. MFS Meridian Funds may be registered for sale in other jurisdictions or otherwise offered where registration is not required. MFS Meridian Funds are not available for sale in the United States or Canada or to US persons. Unless otherwise indicated, logos, product and service names are trademarks of MFS and its affiliates and may be registered in certain countries. Information on investors rights is made available in English and, as the case may be, in local language at meridian.mfs.com. MFS Investment Management Company (Lux) S.à r.l. may decide to terminate the marketing arrangements of this fund in accordance with the appropriate regulation. The offering documents (sales prospectus and Key Information Documents (KIDs), or in the U.K. Key Investor Information Documents (KIIDs)), articles of incorporation and financial reports are available to investors at no cost in paper form or electronically at meridian.mfs.com, at the offices of the paying agent or representative in each jurisdiction or from your financial intermediary. KIDs are available in the following languages: Danish, Dutch, English, French, German, Italian, Norwegian, Portuguese, Spanish, and Swedish. KIIDs and he sales prospectus and other documents are available in English. MFS Investment Management Company (Lux) S.à.r.l. This material is for use only in United Kingdom and Europe.

Unless otherwise indicated, logos, product and services names are trademarks of MFS and its affiliates and may be registered in certain countries.

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