MFS® International Equity Strategy - Quarterly Portfolio Update

MFS^® International Equity Strategy - Quarterly Portfolio Update

Hi, my name is Brett Fleishman, one of the Institutional Portfolio Managers on our International Equity strategy. Today, I will review first-quarter 2024 performance, provide insights on current margins and valuations of companies in the MSCI EAFE Index and highlight why investors have been excited about India recently.

The MSCI EAFE Index rallied 5.8% in the first quarter after appreciating 18.2% in 2023. Growth stocks outperformed value stocks, with investor optimism around artificial intelligence improving future productivity — and GLP-1’s reducing obesity — the primary drivers. Additionally, the highest-beta stocks outperformed the overall market as investors anticipated a positive impact on the earnings of cyclical stocks from impending rate cuts.

Historically, we have found it more challenging for our strategy to outperform the MSCI EAFE index in strong up-market quarters, and the first quarter of 2024 was no exception. Typically, investor optimism — rather than company fundamentals — drives stocks higher when the market rallies sharply, and lower-quality stocks outperform higher-quality stocks. When this happens, as it did in the first quarter, it becomes a headwind for our strategy, which has a strong high-quality bias.

This slide highlights the profitability and valuation of the MSCI EAFE Index over the past 20 years. The right chart illustrates how significantly the index has re-rated in recent months. In October 2023, the index was trading at 12.2x forward earnings, a discount to its long-term average. Today, just five months later, the index is trading at 14.4x forward earnings, a premium to its long-term average. As noted earlier, investor optimism has sparked the recent market rally. With the index now trading nearly one standard deviation above its long-term average, it seems unlikely that multiple expansion will drive the index higher from here. Instead, if this market rally continues, the catalyst is more likely to be earnings growth. For reference, the consensus forecast for 2024 earnings growth is 5.7%.

The left chart of this slide suggests why it could prove challenging for earnings growth to drive the index significantly higher from here. Though the average company’s net margin has declined modestly since peaking at 9.8%, it remains significantly elevated compared to the average of the past 20 years. Both pricing power and cheap debt contributed to net margins expanding the past few years, and these factors have become headwinds more recently — and may pressure earnings growth in the near term. Having said that, we believe our companies would likely experience less margin pressure than the average MSCI EAFE company would since our companies have more pricing power and less financial leverage.

While US and Japanese stocks have performed well over the past year — thanks to the Magnificent 7 and improving corporate governance, respectively — Indian stocks have performed even better. The top left chart may be the biggest reason for this optimism. This chart forecasts the expected change in the working population of several countries between 2018 and 2028. As you can see, India’s working population is expected to grow significantly, while most countries — including the US and China — are expected to grow very little or even decline. The top right chart confirms that investors have taken notice, with meaningful foreign direct investment inflows to India over the past decade. From a macro perspective, the bottom two charts highlight how India’s manufacturing sector has been expanding while inflation has remained stable.

During the first quarter of 2024, Daniel Ling and Filipe Benzinho, the lead Portfolio Managers of the International Equity strategy, traveled to New Delhi with other MFS investors to meet with Indian companies across various sectors. This trip reinforced their view that India has seen material structural improvements under the leadership of Prime Minister Modi. We believe India is well positioned to grow faster than the overall market due to positive demographics and fiscal, monetary and political stability. Having said that, we also believe current Indian valuations reflect much of this good news, and we are finding it challenging today to identify high-quality Indian companies whose valuations are reasonably priced.

As long-term investors, we believe the International Equity strategy is aligned well with long-term secular growth trends. For many years, our strategy has had significant exposure to the growing middle-class consumer and the aging population, globally. We continue to have exposure to these trends through consumer products, alcoholic beverage, medical device and life insurance companies. In more recent years, the strategy has also invested in nascent trends such as the energy transition, reshoring and artificial intelligence.

We believe these secular growth trends should help our companies grow earnings more quickly than the overall market over the long term, but we remain cautious today since company margins and valuations are elevated. In the event earnings growth decelerates from here, we believe our strategy is well positioned since our companies typically have less earnings volatility than the overall market. Regardless of macroeconomic backdrop, our investment philosophy will remain unchanged. We will continue to use our long-term investment horizon to take advantage of short-term price dislocations.

Thank you very much for taking time out of your busy schedule to listen to our first quarter 2024 update.

##PRODUCTS##

The views expressed are those of the speakers 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 from the Advisor. No forecasts can be guaranteed. Past performance is no guarantee of future results.

Important Risk Considerations:
The strategy may not achieve its objective and/or you could lose money on your investment.

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.

International: Investments in foreign markets can involve greater risk and volatility than U.S. investments because of adverse market, currency, economic, industry, political, regulatory, geopolitical, or other conditions.

Please see the applicable prospectus for further information on these and other risk considerations.

The portfolio is actively managed, and current holdings may be different.

Index data source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

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