MFS® International Diversification Fund - Quarterly Portfolio Update

Hi, my name is Nick Paul, and I am a co-portfolio manager on the MFS International Diversification Fund. Thank you for taking the time to join us for our second-quarter 2025 update.

Specific to the International Diversification Fund, while the fund modestly underperformed the MSCI All Country World ex US Index during the period, it delivered strong absolute performance for dollar-based investors. By comparison, for the year, the fund is strongly outperforming the S&P 500 through the end of June.

In this context, we’ve been talking for quite some time now as it relates to the attractiveness of international markets versus the US in terms of both potential relative outperformance, which we have witnessed this year, but more importantly, in the context of the benefits of diversification given the historic concentration risk in US benchmarks.

It’s been our view that the strong outperformance of US markets versus non-US markets, witnessed over the last decade, would be hard to replicate over the next, call it, ten-plus years and, more importantly, that diversification in a world of higher inflation and higher interest rates would become increasingly important. And it appears, at least over the near term, this is starting to play out.

So the question then becomes, for those investors who had previously given up on the benefits of international investing or perhaps decreased their exposure to the asset class over the recent past, “did I miss this trade,” or “do international markets still look attractive versus US stocks from both a valuation standpoint and, more importantly, in terms of where investments are likely to be made over the next 10-plus years and the potential impact of those investments on earnings.”

As we sit here today, despite the strong year-to-date outperformance of international stocks, from a valuation perspective, the asset class still trades at near historic lows versus the US, looking back over the last 25 years. In fact, today the MSCI All Country World ex US Index trades at about a 35% discount to the S&P 500. So purely from a valuation standpoint, for those investors that may not have an allocation to the asset class or remain under allocated, I would say that it is not too late to reconsider the benefits of diversification and to take a second look at international equities.

Now with that said, one of the important lessons learned over the last 10-plus years of strong US outperformance, is that valuation alone is not an investment thesis and stocks that are “cheap” can stay cheap for a long time if there is a lack of a catalyst from an earnings perspective. In this context, while technology and artificial intelligence will be an important part of our daily lives going forward, we also believe future trends will likely benefit a wider cohort of sectors and industries outside of just the tech-centric US companies that comprise the majority of US indices. Trends such as increased capex spending, higher interest rates benefiting the financial sector, particularly banks, spending to upgrade infrastructure, energy, the energy transition, defense and national security, as well as the reshoring and the localization of supply chains, just to name a few. And while many US companies stand to benefit from these trends, many more international companies stand to benefit as well.

And this is exactly what’s been driving the outperformance of international stocks so far this year. Within the MSCI All Country World ex US index, for example, aerospace and defense names are up over 70% year to date on persistent geopolitical conflicts and increased spending targets in Europe by NATO allies. Non-US banks are up close to 30% on higher net-interest income from higher interest rates, as well as higher fee income and solid balance sheets. We see construction and engineering stocks up almost 27%, benefiting from robust government support, with major investments targeting things like infrastructure, renewable energy products, transportation upgrades and sustainability initiatives, and I could go on.

So in closing, like we mentioned in our last quarterly update, the question really becomes, “with so much change taking place in the world, will what worked well in the past, continue to work well in the future (i.e., tech-heavy US equities),” or “are we, in fact, still in the very early innings of a sustained change in market leadership?” And while only time will tell, it does seem we’ve entered a new market dynamic, and in this current market environment, the long-standing benefits of diversification appear alive and well. With that, thank you for your time today and I hope to see all of you again next quarter

Thank you.

 

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