Staying the Course in Mid Cap Investing

Laura Granger:

Okay. Hello and thank you for taking the time to tune into our discussion on U.S. mid-cap growth. My name is Laura Granger and I'm the institutional portfolio manager on the MFS U.S. growth team. I'm really happy to be joined today by Eric Braz, who is co-PM on the MFS U.S. mid-cap growth strategy. Today we'll spend a few minutes to talk about why we think mid-cap growth offers great opportunities for investors, talk a little bit about how we approach investing in mid-cap growth and also why we believe active management matters in the asset class. So let's get started with the first question, Eric.

Eric Braz:

Sure.

Laura Granger:

Thanks for joining. So mid-cap growth has generated some very strong returns for clients over the last decade. And let's first start on just the asset class. Why do you think mid-cap growth provides such strong opportunities for investors?

Eric Braz:

Well, first and foremost, I think the asset class is a bit more inefficient relative to what you see in large-cap growth. There's a lot fewer analysts and coverage on the street of the mid-cap companies, so I think that's an exciting opportunity. You can find things that people haven't identified yet. Also too, the companies in the mid-cap growth index are more mature than small. So these are real companies doing real business and you can identify companies earlier in their lifecycle. A lot of the companies that we've invested in over time have become larger companies in the large-cap growth index as well. And so more inefficient index companies a little later in their lifecycle, but still young, and then you can find what potentially could be the next large-cap growth stock. So overall, I think it's a very exciting asset class to invest in.

Laura Granger:

Yeah. And giving the opportunity to find these companies earlier in their growth cycle that can emerge as leaders in growing markets has been great for our large-cap strategy as well because it's been a feeder of ideas for our U.S. large-cap growth portfolio.

Eric Braz:

Absolutely.

Laura Granger:

Yeah. So the next question, we're starting to hear more from clients about potentially indexing in the mid-cap growth space, which is surprising in a way because active managers have added value over time. But one of the challenges that active managers has faced is this index concentration has been growing over time. We're accustomed to talking about index concentration in the large-cap space, but not so much in mid-cap. And of course one of those names that we hear about all the time is Palantir, which I think at its peak was close to nine and a half percent of the mid-cap growth index with a $330 billion market cap. So can you just talk about some of the challenges that managers face with this benchmark and talk about how the benchmark has been rebalanced and what you see going forward?

Eric Braz:

Yeah, so I think in the past few years it has been a challenging space to invest against relative to the index because the index has become so concentrated. As you talked about, Palantir is the one that really stands out, topping out over 900 basis points of the index. If you think back historically to the entire lifecycle of the mid-cap growth index, the largest name ever was JDS Uniphase at 420 basis points in 2001. So the peak of the tech bubble, the largest stock in the index was 420 basis points. Palantir topped out over 900, 2x plus of that. So it has been tough sledding against the index over the last few years, but what I would say is that I think people who talk about moving to passive now are in a completely wrong spot because now the index just rebalanced.

Palantir has left. It's a more diversified index and an index that we think, with strong stock picking, you can beat. And so the other dynamic that's happening as well is the index is actually going to rebalance twice a year on a go-forward basis. And so historically it only rebalanced once a year. So it was style and market cap in June of every year. And now starting November of 2026, the index will also rebalance another time for just market cap. So if we think about Palantir being a $300 billion market cap, that'll never happen again. There'll never be a $300 billion market cap company that you'd have to fight against in the index.

And so I think holistically the index has been more concentrated relative to what it was historically, but the dynamic that we saw with Palantir and at 900 basis point active weight will not be the case on a go-forward basis. So I think now is a time where you can really stock pick against the mid-cap growth index, which is historically where we've done the best, when we're able to do fundamental bottoms-up idiosyncratic stock picking against an index. And I think that that sets up for outperformance in the future.

Laura Granger:

Yeah, great. So now that the index is rebalanced, are there any names that you see in the index that potentially could turn into another Palantir just given where they're weighted now or their growth dynamics?

Eric Braz:

Yeah. So you have to think about names that are big in the index now and could they be... What type of bagger, how much bigger could they be on a multiple basis? And so the largest name in index today is Royal Caribbean. That's a $90 billion market cap company. If we fast-forward one year or if we fast-forward to November of '26, I highly doubt that Royal Caribbean's going to be a four times stock or a $360 billion cruise company. And so I'm not worried about a stock like that. Maybe a stock that I could be more worried about is something like Coinbase, which is approximately 25 or 30 basis points in our index and $90 billion as well.

If that stock was a four-bagger and it was a $360 billion stock, while that would still be a headwind, that'd only be 25 or 30 basis points go to 100, 120. So again, that dynamic where you're fighting against a 900 basis point position, I don't really see that happening in the future, especially with the index rebalancing twice a year.

Laura Granger:

Great. Great. All right, so let's shift focus now to the MFS mid-cap growth strategy. Can you just spend a little bit of time explaining to folks how you and Eric Fischman approach managing the mid-cap growth area?

Eric Braz:

Yeah, so the one thing to remember about all this is it's a process that's been in place for probably over two decades and that we continue to apply it and we think it's driven good long-term performance. So the core of it is that fundamentals drive earnings and cash flow, earnings and cash flow drive stocks. And we're trying to identify where we think the market is underestimating the rate and duration of growth in some of these stocks. While we are a growth fund, we don't chase, we're not going to typically go after the highest flying names in the index. We want to find what we think are consistent compounders over a long period of time that we can buy and hold for a long time. And so those are the names that we're looking for.

We're also very incremental in how we trade in and out of stocks. We're very patient. We're not going to swing a portfolio on some sort of macro view. And then we also risk manage. So the names at the top of the portfolio, the largest names aren't the ones that we think have the biggest upside. They're the ones that we think have the lowest range of outcomes. And so again, looking for those really steady compounders that will compound growth over a long period of time that we think we can buy at a reasonable multiple because the market is not appreciating that rate and duration of growth that we see.

Laura Granger:

Okay, great. And so that focus on the long-term, high quality companies that can generate consistent above-average rate and a duration of growth, building the portfolio from bottom-up stock selection within that risk aware framework of the benchmark, it's resulted in portfolio returns that are fairly consistent and predictable. So can you just talk a little bit about why you think the portfolio fits very well for defined contribution plans?

Eric Braz:

Yeah, so again, I mean, I think when we talked about how we invest is we're not going to chase growth. And so what you find for us is that we typically are never number one and we're not going to be the last. We typically find ourselves in the top half of our peers on an annual basis and we compound that consistent return over a long period of time. You find us typically in the top quartile. And we think that that type of investment and really protecting our investors, particularly on the downside, but keeping up on the upside. So the portfolio has a beta of about 0.9 and so... But because we have these higher quality companies that we're able to compound earnings, we typically keep up and up markets and really make our hay on the downside. And so again, what that winds up is when you look over a 10 or 15 year period, you wind up seeing a top quartile fund. But again, we're never going to be one, we're never going to be last, and we're typically in the top half on an annual basis.

Laura Granger:

Yeah. So it's that consistency of returns that, like you said, when you compound those returns over time result in top quartile returns for our clients. And so thanks so much for taking the time to answer these few questions. Really appreciate it. And thank you all for joining. And if you have any other questions about our U.S. midcap growth strategy, please reach out to your MFS representative. Thanks and have a great day.

 

The views expressed are those of the speaker 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.

 

Individual securities mentioned are for illustrative purposes only and may not be relied upon as investment advice or as an indication of trading intent on behalf of any MFS product.

 

Past performance is no guarantee of future results. No forecasts can be guaranteed.

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. Mid-cap: Investments in mid-cap companies can be more volatile than investments in larger companies. Growth: Investments in growth companies can be more sensitive to the company's earnings and more volatile than the stock market in general. 

 

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