MFS Meridian Funds–European Value Fund‧Morningstar Fund Awards 2010 Special Editorial

Winner of Europe Large-Cap Equity

MFS Meridian Funds – European Value Fund

We continue to have MFS’s fund for the Fund Award Special Editorials this week. Though MFS is not a familiar name to Hong Kong investors, this is one of the three houses that was honored two or more awards for the year 2010. Besides the Global Large-cap Equity category award, MFS’s European Value Fund also became the winner of the Europe Large-Cap Equity category.

Performance

MFS Meridian Funds – European Value Fund, the winner fund, truly adheres to MFS’s belief in long-term investment, and it’s long-term performance does strengthen investors’ confidence in it. The fund earned 0.14% and 4.74% respectively over the past three and five years on an annualized basis as at May-end 2011. This performance looks just fair in absolute terms, but it’s good enough to beat its rivals. In the same time span, the average fund in the category reported a loss of 5.37% and a tiny gain of 0.97% respectively. In 2010, the fund went up 6.06%, ranking in the best quintile in its category.

Key to Success

Similar to the MFS Meridian Funds – Global Equity Fund, long term focused investing is the religious belief of among the management team members. Ben Kottler, Investment Officer and Institutional Portfolio Manager of MFS Investment Management, emphasized the team’s focus on the companies’ fundmentals and their business models. “We spend much more time on looking backward. We are really trying to understand how the companies produce return over time, what are the sustainability of their returns, what are the risks of the businesses, etc. aiming at to distinguish quality and low quality businesses.”

Unlike the Global Equity Fund, the European Value Fund enjoys greater flexibility in lower quality businesses investing. “As long as the price is sufficiently discounted, we also buy lower quality business.” Kottler claimed. It doesn’t mean that they will put investors’ capital at risk. Kottler emphasized that the team invests in a risky company only if they can see the company had a reasonably high probability to improve, such as new management or restructuring. 

Focuses

It is true that the European Value Fund has bias toward riskier companies - the fund has higher exposures to small- and mid-caps as compared to peers, but the team implements a tight risk control. “Most of the holdings are small or mid-sized companies, but we tend to have bigger weight on the larger stocks. I agreed that smaller caps generally display higher volatility, but what we invested in are not those cases.” Synthes (a Swiss medical equipment company), Henkel (a German Consumer company) and Givaudan (a Swiss based chemical producer) are some good examples. This strategy is proven successful – the fund’s return volatility is lower than its peers.

On the country allocation front, however, we find that the fund focused on less-risky developed Europe, especially UK. Why? “It isn’t because we have some sort of positive about UK compare to the rest of the Europe. It is just the reflection of the UK market’s feature – large and diversified with good businesses which trading at attractive valuation.” Kottler explained. “We like to invest in businesses with long track records, but many companies listed in Emerging Europe not been trading for very long. We have plenty of exposure indirectly to Eastern European economy even we are not investing directly in companies listed there.”

Though European debt crisis were the top concerns now, Kottler, as a genuine stock picker, pays scant attention to this. Instead, he and his team assess the risk through bottom-up fundamental analysis. Adopting the value approach is sometimes painful. “In absolute term, if we get a setback in economy or sovereign debt defaults, it will be tough for the whole European world. But I think we would do well in that situation as we have relatively little exposure on the countries most at risk, and also the financial services sector.” 

This reminded Kottler’s bitter memory. The Fund has underweighted financials since 2008 owing to the dire prospect of the industry. However, the Fund has never reversed this underweighting position even the industry shined again in mid 2009 and they had several investment ideas at that time. This undeviating steadiness hurt its performance in 2009. “The mistake we made during the financial crisis is that we did not have greater courage in our conviction. So we maintained our underweight position to European banks in 2009. And I think we should be more aggressive.” This mistake reinforced the team’s belief in bottom-up stock selection, which is the strongest expertise.

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No one hates earnings growth. Kottler believes that investors in general tend to be optimistic by nature. “Investors may spend a lot of time dreaming about what might go right, we, however, spend most of the time worrying about what might go wrong to protect investors’ capital.” Investors love funds with brilliant return when market goes up, but we think the best fund should be the one capable of protecting investors’ capital when the market falls.