MFS Investment Team, shed lights on topics such as their team structure, how various risks have affected their investment decisions, and the major portfolio changes over last year.
Category Winner: Best Global Emerging Markets Bond Fund - MFS Meridian Emerging Markets Debt A2 USD
Inception Date: 2002 Oct 01
Morningstar Rating (as of 2015-03-31):
Total Net Assets (Mil, as of 2015-03-31): 3,743.16 USD
Manager: Matthew W. Ryan, Ward Brown
Manager Start Date: 1998 Aug 01, 2008 April 01
M: Morningstar MFS: MFS Investment Team
M: Could you highlight any major changes you made to the portfolio over the course of 2014? Were there any particular holding that drove the fund’s performance for the year?
MFS: Our portfolio strategy in 2014 was characterized by five general themes:
1. We underweighted high-yielding, high-beta countries with deteriorating credit metrics (e.g., Venezuela, Ukraine, Argentina, and Pakistan).
2. Conversely, we added exposures to countries with improving or stable fundamentals (e.g., Dominican Republic, Indonesia, and India).
3. We maintained rather high corporate exposure, particularly in investment-grade countries such as Mexico, Peru and Chile. We judged the risk-reward of selected corporate opportunities in these and other countries to be more attractive than that of various sovereign bonds challenged by heightened country-specific risks and/or vulnerable to lower oil prices (e.g., Brazil, Russia, Ukraine, Venezuela and Argentina),.
4. We underweighted certain investment-grade sovereigns, judging their bond spreads to be too compressed (or rich).
5. We maintained low EM currency exposure. The strong dollar theme as well as more challenging balance of payments conditions in a number of EM countries (due in large measure to weaker commodity prices and declining terms of trade) is an unsupportive fundamental mix for EM currencies.
Our strategy did well against its peer universe in 2014, the A2USD share class at NAV finished the year in the top 30th percentile of its Morningstar peer group, the EAA OE Global Emerging Markets Bond. We underperformed our benchmark index, however, largely because of underweights in various investment grade sovereigns (positioning that, in our view, should benefit the portfolio as the Fed inches closer to beginning its rate hiking cycle and as US Treasury rates widen in response).
The fund's relative underweight to the high-yield and lower-quality names within the index was overall a significant contributor to the relative performance of the fund. The portfolio was underweight Russia due to Ukraine-related sanctions risk as well as the impact of lower oil prices, and this decision was additive to relative return. We eliminated Ukraine from the portfolio on concerns about rising default risk. The portfolio's underweight to Venezuela was also a significant contributor to relative performance in the second half of the year, as the country's already unsustainable policies became more apparent with the decline in oil prices.
The theme of underweighting sovereigns with deteriorating fundamentals was not entirely successful, however. In fact, our underweight in Argentina hurt relative performance, notwithstanding the default on restructured NY law bond debt and deteriorating macroeconomic fundamentals.
Decisions to overweight sovereigns with improving or stable credit fundamentals generally contributed to relative performance. Overweight positions in Hungary, Dominican Republic, Peru, and Iceland, among others, contributed to 2014's relative performance.
The fund's corporate bond exposure generally added value until the last quarter of the year, when the accelerating decline in oil prices caused oil-related names to sharply underperform. Our corporate positioning in oil-related credits was modest, but painful. While we judged our positions to be more insulated from oil price declines, these credits still suffered.
The surprisingly strong rally in US Treasuries – supported by global disinflation and buying demand sparked by the announcement of the European Central Bank's QE program – undermined the strategy to underweight certain low spread, investment grade sovereigns, as these credits benefitted from the supportive global rates environment.
Finally, the fund's small exposure to EM currencies in 2014 was a slight detractor from overall performance. We remain cautious in our currency exposure. While there are EM currencies that, in our view, could provide good value relative to the US dollar in 2015, the overall environment for EM currencies will likely be difficult.
M: What is your economic outlook for 2015 specific to the markets you cover and how are you positioned to take advantage of opportunities and/or mitigate potential risks?
MFS: In our view, a number of cross-currents are likely to characterize the global backdrop for investing in emerging markets debt, making it difficult to embrace a strongly bullish view on the outlook for the asset class. Rather, we think the global macroeconomic and financial backdrop, as well as divergences in creditworthiness among countries, will result in disparate performance outcomes. Superior country and security selection will likely prove essential to alpha generation.
We see significant differences between countries on a fundamental basis, and we expect those differences will be borne out in differentiated performance as the market rewards countries and companies with stable to improving fundamentals (for example, Mexico, Indonesia, and Dominican Republic) and punishes those exhibiting fundamental deterioration (Venezuela, Russia, Ukraine, and Brazil). We have attempted to overweight the former set of countries, while underweighting the latter.
In connection with the idea of differentiation, it is worth noting that a number of EM economies (most prominently the BRICS) are presently undergoing a process of rebalancing. Internal and external macro imbalances need to adjust to a new global reality of lower growth, lower inflation, lower commodity prices, and lower global trade. While the expansion of global liquidity offers technical support to the asset class, it could retard the rebalancing by providing funding for current account deficits. Very broadly, we have been underweight the BRICS in recognition of challenging macro conditions.
We believe that the global environment and EM-specific developments create both challenges and opportunities for the asset class. We will continue to use our research-intensive approach to identify divergences between fundamentals and valuation, and the result will be a very selective approach to the broad opportunity set offered by the asset class in 2015.
M: Can you comment on the macro risks facing the global economy, including potential US rate hikes, QE programs in the Eurozone and Japan, and the growth headwinds facing the emerging world? How do these risks affect your investment decisions?
MFS: As referenced above, we think a number of cross-currents are likely to characterize the global backdrop for investing in emerging markets debt. We comment on key macro risks, and their impact on the global backdrop and the EM debt asset class, below.
• We continue to expect a moderate pace of global growth, though the cycle may hardly be characterized as globally synchronized. The U.S. is expected to be a leader, at least relative to its potential. We have seen some encouraging signs of better growth in Europe and Japan, but several emerging economies are close to recession or already contracting (e.g., Brazil, Russia, Venezuela, and Ukraine). In our view, an expanding global economy provides a broadly positive backdrop for risk-taking in emerging markets debt.
• We also think that global inflation will remain tame. In our view, the global economy is likely in the midst of a multi-year process of returning to inflation targets.
• We expect that commodity prices will stay weak. Challenging fundamentals leave us cautious on the prospects for a sustained recovery in oil prices in the near-term. It may not be until the second half of the year that we begin to see meaningful evidence of a supply response to price declines, and it is possible that the mismatch between supply and demand could persist well beyond 2015. Our expectation is that this dynamic will continue to contribute to differentiation between EM issuers, with net oil exporters suffering (some worse than others depending on fiscal buffers, reserve levels, and policy adjustments), while net oil importers benefit.
• Dollar strength remains the theme in EM currencies. As noted above, the U.S. economy seems likely to perform relatively well, and the resulting tightening bias in US monetary policy is expected to maintain a strong dollar theme in currency markets. That said, crowded long dollar positions mean that pauses or corrections will occur. However, we expect the general trend of pro-dollar factors to continue, leaving us cautious on the prospects for EM FX appreciation in the year ahead.
• With slow growth and low inflation, we expect that movement in global interest rates will be relatively subdued – whether it is upward movement in the U.S. as the first Fed hike approaches, or downward movement in Europe as the ECB pursues its asset purchase program. Divergent policies between the two central banks may be characterized as a "tug-of-war," the likely result of which may be a larger global pool of liquidity. This environment is likely to remain favorable for EM interest rates.
• We see several potential sources of global event risk in 2015. Perhaps the most prominent of these is Euro zone political risk. The style and anti-austerity policy orientation of the new Greek government is raising "Grexit" risks. In addition, the election cycle in other EU countries poses the threat of more disruption (e.g., Podemos in Spain). We also remain concerned about the as-yet-unsettled question of a hard landing vs. a soft landing for the Chinese economy. Data have been weak, forecasts have been lowered, and it seems likely that the shift toward gradually slower growth will continue. Nevertheless, leverage in the Chinese economy is high and this suggests some risk of a sharper adjustment that could impact the global economy through lower trade and reduced demand for commodities. Other geopolitical "hot spots," e.g., Russia/Ukraine, ISIS/Levant, Iran/Israel nuclear, and tensions in the South China Sea will probably remain localized risks, but the threat of escalation cannot be discounted.
• We remain moderately constructive on the risk environment for 2015. The US economy remains on an above-trend trajectory, while Europe seems to be regaining its footing. Cheap oil should prove to be a net positive for global growth, while the ECB's QE program should support risk-seeking behavior on the part of investors.
M: How is your investment team organized? Have there been or do you anticipate any changes to the investment team or structure over the course of the year? Do you anticipate adding to the team in the near future?
MFS: Idea generation for MFS Emerging Markets Debt portfolios is a highly collaborative process in which each member of the team is expected to contribute to the creation of alpha.
Portfolio Managers Matthew Ryan and Ward Brown are ultimately responsible for the investment decisions made with the team's input. They collaborate on portfolio positioning and discuss trends with sovereign analysts Erik Weisman, Neeraj Arora, Kjetil Birkeland, emerging markets debt traders Patrick Mead and Matthew Ruscitto, and currency traders Tim Albrecht and Bryan Hughes. The portfolio managers also rely on MFS’ other fixed-income portfolio managers and fixed-income credit analysts. Our team of quantitative analysts supports model development and risk management.
Also supporting the team is institutional portfolio manager Rob Hall and investment product specialist Michael Adams.
The emerging markets debt investment universe has grown and become more diverse over recent years. To continue to ensure strong coverage of the universe, MFS has grown sovereign and corporate analytical resources. In 2014, sovereign analyst Kjetil Birkeland was added to the team. MFS also added two corporate analysts to the department who are enabling other analyst team members to focus more heavily on EM corporates. We will continue to monitor the growth in EM debt markets and staff appropriately to ensure deep analytical coverage.
M: Can you highlight any areas where you feel that the investment team or the investment process can improve upon?
MFS: MFS continuously seeks to improve the breadth and depth of our global research platform. In recent years, particular emphasis has been placed on expanding our corporate, EM sovereign, and quantitative research analyst resources. We are also placing analysts into our global research platform, including in Boston, Toronto, and London. We will continue to grow the team as global fixed income markets evolve.
In terms of decision making, we believe our investment process is sound. However, we are continually reviewing the efficacy of investment decisions and performance, and opportunities can emerge to strengthen our process. For instance, the portfolio management and quantitative teams have worked closely together to evolve our local currency process, enhancing security selection and risk management. The result has been improved performance for our clients and shareholders.
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