MFS® International Equity Strategy - Quarterly Portfolio Update

Hello. My name is Chris Sunderland, I am one of the institutional portfolio managers on the International Equity Portfolio. I'm pleased to report that the portfolio outperformed the MSCI EAFE Index for the year of 2024, but it was mainly in line with the index for the fourth quarter.

The EAFE Index fell during the quarter by about -8.1% (in US dollar terms). This was partly due to the strength of the US dollar versus non-US currencies, which rallied sharply following Donald Trump’s election victory in early November. Convinced that Trump that may follow through on his campaign promises of deregulation, tax cuts and tariffs on US imports, investors bid up the US dollar, assuming that these pro-growth initiatives would eventually result in higher inflation and, subsequently, higher interest rates. So, from a style perspective for the quarter, value stocks were down 7.1% in US Dollar terms but they outperformed growth stocks, which were down 9.1% in US Dollar terms during the quarter.

 While the US Federal Reserve cut interest rates in December for the third consecutive time, the Fed also forecasted fewer interest rate cuts in 2025 than it had previously anticipated. The Fed’s change in interest rate expectations was the result of inflation remaining higher than expected. Not surprisingly, after investors digested the Fed’s new guidance, value-oriented financials rallied to finish the quarter as the best-performing sector in the MSCI EAFE Index.

 Geographically, however, Japan was one of the best-performing regions, down 3.6% in US dollar terms during the fourth quarter after lagging other regions in the previous third quarter. Japanese banks performed particularly well, driven by investor optimism that the Bank of Japan would continue to raise interest rates in 2025. The Bank of Japan raised interest rates twice in 2024, in March and July, after keeping interest rates negative the prior eight years.

 In contrast, Europe ex-UK was the worst-performing region, down -10.5% in dollar terms in the fourth quarter. Within this region, independent power and renewable electricity producers, IT services and beverage producers were among the biggest laggards. And like the Fed, the European Central Bank also cut interest rates twice in the fourth quarter. At its December policy meeting, the ECB noted that disinflation was tracking well in the eurozone and on target to reach its medium-term target goal of 2%.

 Finally, I would note that despite what the central banks are trying to do, we are seeing interest rates move higher for longer-term treasuries, as investors are believing less in the central bank moves at the moment.

 One of the risks we are assessing pertains to the potential impact of US tariffs on our multi-national companies based outside the US. While it is still too early to assess the impact on each individual company, so far the market has appeared to penalize some obvious areas that are expected to be hurt by tariffs and currency movements, including some European companies within the alcoholic beverage industry. I’ll come back to those later.

In general, we believe these companies will seek to mitigate tariff risks through a combination of passing on tariff costs to customers and through cost reduction. At the stock level, we tend to focus on individual companies’ ability to adjust to cost and pricing pressures and we will continue to avoid business that have undifferentiated products, thin margins, high leverage and stretched balance sheets. We also will work constantly with our analysts to assess the longer-term impact on a company-by-company basis, and this shapes the portfolio’s positioning.  

Given the underperformance of Europe versus other developed regions in the quarter, we decided to analyze the potential impact of tariffs on European company revenues. As you can see on the left chart, the US represents about 26% of the revenues for European companies. However, on the right, notice that only 6.6% of those revenues represent goods that are exported to the US and would be negatively impacted by tariffs. Certainly, the negative investor sentiment around this topic has overwhelmed the underlying fundamentals and led to underperformance of the region and certain industries. But we believe this is a little bit overdone and it has possibly created attractive investment opportunities in the region. But overall, we believe the portfolio is well positioned against tariff risks based on our diversification of revenues across geographies, across sectors and across industries.

One area that has lagged lately and may be impacted by US tariffs is alcoholic beverages, but we continue to maintain a constructive long-term view on the industry. For example, we own global spirits manufacturers Diageo and Pernod Ricard, which we consider attractively valued at current P/E levels. We believe spirits companies in this industry remain one of the most attractive growth categories in consumer staples, which are driven by share gains from beer and wine in developed markets, and also consumers in emerging markets trading out of local spirits into premium global spirit brands. Both companies have high exposure to brown spirits, and they have made continuous investments in their brands through advertising and promotions to strengthen their positions in emerging markets.

Certainly, the potential for US tariffs is a concern, but we believe it is likely they will be less impactful than expected. For instance, the US doesn’t produce cognac or scotch, so there is less ‘leverage,’ if you will, for tariffs on this segment. Also, the spirits companies we own tend to have durable pricing power and the ability to pass on higher costs to the end consumer if necessary. Furthermore, they are especially set up to benefit over the next year as raw material costs fall and inventory de-stocking abates.

As 2025 begins, there are many questions on investors’ minds. How will Trump’s second term, with his focus on deregulation, tax cuts and tariffs impact the global economy? Are central banks making a policy mistake? Can the Chinese economy rebound, which has been weighed down by its embattled property market? Will longstanding existing regional conflicts persist or will new regional conflicts emerge? And will demand for artificial intelligence services and GLP-1 products remain robust?

The reality is that no investor knows the answers to all these questions. In this strategy, we try to take advantage of short-term market dislocations by adding or trimming to existing positions while employing a long-term investment horizon. We believe this approach has been effective in various market environments historically and should serve you well given how much macroeconomic and political uncertainty exists today. In 2025, we will continue to invest in high-quality companies that we believe can grow earnings above and more durably than the overall market, while maintaining a strong valuation discipline. 

So thank you very much for taking the time to listen to the International Equity fourth quarter update.

Fundamental Equity Investment Strategies Details

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.

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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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