MFS Meridian® Funds – Prudent Capital Fund: The Purpose of Prudent Investing

MFS Meridian^® Funds – Prudent Capital Fund: The Purpose of Prudent Investing

THIS INFORMATION IS FOR MARKETING PURPOSES ONLY. RECORDED ON 4 SEPTEMBER 2024

Important Risk Considerations
The fund may not achieve its objective and/or you could lose money on your investment in the fund. 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, and other conditions. Bond: Investments in debt instruments may decline in value as the result of, or perception of, declines in the credit quality of the issuer, borrower, counterparty, or other entity responsible for payment, underlying collateral, or changes in economic, political, issuer-specific, or other conditions. Certain types of debt instruments can be more sensitive to these factors and therefore more volatile. In addition, debt instruments entail interest rate risk (as interest rates rise, prices usually fall). Therefore, the portfolio’s value may decline during rising rates. Portfolios that consist of debt instruments with longer durations are generally more sensitive to a rise in interest rates than those with shorter durations. At times, and particularly during periods of market turmoil, all or a large portion of segments of the market may not have an active trading market. As a result, it may be difficult to value these investments and it may not be possible to sell a particular investment or type of investment at any particular time or at an acceptable price. The price of an instrument trading at a negative interest rate responds to interest rate changes like other debt instruments; however, an instrument purchased at a negative interest rate is expected to produce a negative return if held to maturity. Derivatives: Investments in derivatives can be used to take both long and short positions, be highly volatile, involve leverage (which can magnify losses), and involve risks in addition to the risks of the underlying indicator(s) on which the derivative is based, such as counterparty and liquidity risk. Value: The portfolio’s investments can continue to be undervalued for long periods of time, not realize their expected value, and be more volatile than the stock market in general. High Yield: Investments in below investment grade quality debt instruments can be more volatile and have greater risk of default, or already be in default, than higher-quality debt instruments. Strategy: There is no assurance that the portfolio will achieve a positive rate of return or have lower volatility than the global equity markets, as represented by the MSCI World Index, over the long term or for any year or period of years. In addition, the strategies MFS may implement to limit the portfolio’s exposure to certain extreme market events may not work as intended, and the costs associated with such strategies will reduce the portfolio’s returns. It is expected that the portfolio will generally underperform the equity markets during periods of strong, rising equity markets. Please see the prospectus for further information on these and other risk considerations.

What is the Fund?

What is the Prudent Capital Fund? Prudent Capital is a very conservatively managed fund that parallels the philosophy of a family office or an endowment. So, what does that mean? For family office or an endowment, the capital that they manage represents a lifetime of savings that has to provide for future generations.

That being the case, for those entities, to manage risk they don’t focus on a particular benchmark. Rather their goal is to preserve and grow capital in real terms through-cycle. In particular, if you’re managing capital that needs to provide for future generations, the aim is to be cautious when equity valuations are elevated and the risk of losing money is very high. On the other hand, when the risk reward is favorable and valuations are attractive, then they have the optionality to lean in and deploy capital.

How does the Fund manage risk?

How does the Fund manage risk? So, we have three levers to manage risk — security selection, asset diversification and tail risk protection. Let’s talk about each of these in turn.

So, security selection, I think, is perhaps the most important aspect, the most important lever that fund managers can use to manage risk. So, for example, if you’re picking a stock, you have three ways to lose money. The earnings can go down, the multiple that people pay for those earnings can go down, or something can go wrong with the balance sheet. A liability can blow up and wipe out the value of the equity. And so what we’re trying to do within Prudent is to select stocks that have less earnings risk, less multi risk and less balance sheet risk on average than the broader investment universe.

The second way to manage risk is asset diversification. Now, no matter how good you are at picking stocks, in general, most stocks have some correlation with the broader equity markets.  So, if the equity market goes down, your stocks may get down less, but they probably still will go down, at least for a period of time. However, by diversifying and owning other assets, for example, bonds or commodities, you can at times create a situation where either the assets fall less than the market or in some cases the assets actually go up as the equity markets fall.

Finally, there’s tail risk protection. So, if you look at big, big events like the COVID crisis in February 2020, March 2020, if you look at the financial crisis in 2008, 2009, when you have a big economic shock and there’s a lot of leverage in the financial system, what happens is that lots and lots of funds have to de-lever, meaning they have to sell the assets that they can sell, not that they want to sell, but that they can sell where there’s liquidity at the same time. When that happens, correlation across asset classes converges towards one, and everything goes down together.

To try and address those situations, Prudent Capital has the option — well, the right but not the obligation — to try and buy options on risky assets. So if we can look around the world and find very cheap sources optionality on big asset bubbles, we’ll spend a little bit of money each year trying to sort of hedge those tail risk events.

Has the strategy worked?

So has the strategy worked? Generally, the prudent strategy has worked well. The one exception to that track record was the period September 21 through September 22, when Russia invaded Ukraine.

This was a very unusual situation because when Russia invaded Ukraine, inflation spiked dramatically, and the Federal Reserve was forced to ramp interest rates very quickly from 0.25% to eventually over 5%. In that period, the fund did fall in value by more than we expected it to, but it was a very unusual situation because all six of the asset classes in the fund, including the risk-free assets, declined at the same time.

I say it’s unusual because the whole point of owning many different assets and tail risk protection is that in general that diversification does protect you. And in this situation, it did to some extent in the sense that the fund fell less than the overall market, but it still fell more than we would’ve liked.

Why should investors consider the Fund now?

So why should investors consider Prudent Capital now? Well, let’s look at the risks. So firstly, equities are very expensive relative to history. US equities, which now make up around 70% of the MSCI World benchmark, have rarely been more expensive than they are today. If we look at historical returns for the US market, given current starting valuations, average 1-, 3-, 5-, and 10-year returns have generally been very poor and in many cases negative.

At the same time, risks are very elevated. If we look at the US, while growth appears to be strong, the US government is now running a roughly 6% fiscal deficit, the peak of the economic cycle. What does that mean? So, for context, in the last hundred years, the US has only run deficits of this magnitude in times of severe economic or national crisis. If the US economy weakens from here, then the US deficit could become really quite extreme.

And at the same time, on a macro level, there are signs of weakness emerging. Wage growth in the US is slowing, unemployment is rising, credit card defaults are rising, auto loan defaults are rising and corporate bankruptcies are rising as well. So the economic backdrop is really quite unfavorable in the US relative to the valuations that people are paying.

If we look outside the US, for example, in China, China for many years has been sitting on one of the largest real estate and banking asset bubbles in the world, and today that bubble appears to be popping. You’re seeing banks go bust, you’re seeing house prices decline. You’re seeing real strain on the Chinese consumer, which was one of the biggest sources of growth over the last decade.

And then if we look at Europe, for the first time in history, we now have foreign troops on the ground in a country with nuclear capabilities. Ukraine’s soldiers are now in Russian territory. That’s pretty much unprecedented from a risk perspective. So, how do we pull that together? So if we just simplify things down, investors are currently paying close to record high valuations for corporate earnings that are based on record high margins at a time when the economic backdrop is visibly weakening. So, just looking at the data, if ever there were a time to be cautious, it seems to me that this may be it. Thank you for watching.

 

The views expressed are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any MFS investment product.

Unless otherwise indicated, logos and product and service names are trademarks of MFS^® and its affiliates and may be registered in certain countries.

Please note that this is an actively managed product.

See the fund’s offering documents for more details, including information on fund risks and expenses. For additional information, call Latin America: 416.506.8418 in Toronto or 352.46.40.10.600 in Luxembourg. European Union: MFS Investment Management Company (Lux) S.a r.l. 4 Rue Albert Borschette, Luxembourg L-1246. Tel: 352 2826 12800. U.K.: MFS International (U.K.) Ltd., One Carter Lane, London, EC4V 5ER UK. Tel: 44 (0)20 7429 7200.

MFS Meridian Funds is an investment company with a variable capital established under Luxembourg law. MFS Investment Management Company (Lux) S.à.r.l is the management company of the Funds, having its registered office at 4 Rue Albert Borschette Luxembourg L1246, Luxembourg, Grand Duchy of Luxembourg (Company No. B.76.467). The Management Company and the Funds have been duly authorized by the CSSF (Commission de Surveillance du Secteur Financier) in Luxembourg.

The funds are established as a “restricted foreign scheme” in Singapore; therefore, material in connection with the offer or sale of the funds may be distributed only to persons in Singapore who are qualified under Sections 304 and 305(2) under Chapter 289 of the Securities and Futures Act.

MFS Meridian Funds may be registered for sale in other jurisdictions or otherwise offered where registration is not required.

 

MFS Meridian Funds are not available for sale in the United States or to US persons.

Information on investors rights is made available in English and, as the case may be, in local language at meridian.mfs.com. MFS Investment Management Company (Lux) S.à r.l. may decide to terminate the marketing arrangements of this fund in accordance with the appropriate regulation. Unless otherwise indicated, logos and product and service names are trademarks of MFS^® and its affiliates and may be registered in certain countries. The offering documents (sales prospectus and Key Information Documents (KIDs)) or in the U.K. Key Investor Information Documents (KIIDs), articles of incorporation and financial reports are available to investors at no cost in paper form or electronically at meridian.mfs.com, at the offices of the paying agent or representative in each jurisdiction or from your financial intermediary. Information on investors rights is made available in English and, as the case may be, in local language at meridian.mfs.com. MFS Investment Management Company (Lux) S.à r.l. may decide to terminate the marketing arrangements of this fund in accordance with the appropriate regulation.

 

This material is for use only in Austria, Central America, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, North America, Norway, Singapore, South America, Spain, Sweden, Switzerland, Taiwan, and the United Kingdom.

 

FOR INVESTMENT PROFESSIONAL USE ONLY. Not intended for retail investors.

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