THERE'S NO SUBSTITUTE FOR SKILL Sourcing active manager performance

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1 ROBERT ALMEIDA Investment Officer MFS Investment Management THERE'S NO SUBSTITUTE FOR SKILL Sourcing active manager performance The views expressed in this presentation are those of the speaker and 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 other MFS investment product. Past performance is no guarantee of future results AGENDA The Active Passive Debate How are active returns achieved? Active management Breadth of opportunity is cyclical Opportunity Cost Conclusions 2 1

2 The Active Passive Debate Net flows of US equity active and passive products 250 US equity net flows, USD billion 150 Passive Active Source: Morningstar Direct as of 31 st December Includes US Open End and ETFs, but excludes fund-of-funds and obsolete funds. Includes at Morningstar Categories included in the US Equity Category Group. 3 The Active Passive Debate % of large cap active managers that outpaced benchmark 5-years ended Dec Value Blend Growth Source: Morningstar Value is Morningstar Large Value Category vs. Russell 1000 Value Index Total Return, Blend is Morningstar Large Blend Category vs. S&P 500 Index Total Return and Growth is Morningstar Large Growth Category vs. Russell 1000 Growth Index Total Return Past performance is no guarantee of future results. It is not possible to invest directly in an index Morningstar, Inc. All Rights Reserved. The Morningstar information contained herein: (1) is proprietary to Morningstar; (2) may not be copied; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. 4 2

3 DEFINING A TRUE MARKET CYCLE 6.9 years (15%) Market cycle 8.6 years (2) Market cycle Peak Peak Trough Trough Bull market Bear market Bull market Bear market Bull market Source: "Defining a Market Cycle," Manning & Napier Clarity about time horizon builds alignment 5 MARKETS ARE INCREASINGLY SHORT TERM NYSE average holding periods Average holding periods (years) ~8 months Source: Ned Davis Research. Data as of 31 December Lengthen the investment time horizon 6 3

4 HOW ARE ACTIVE RETURNS ACHIEVED? The Fundamental Law of Active Management 1 IR = IC * N number of investment opportunities Portfolio Manager Skill Breadth of Opportunity What are investors signaling? No difference between skilled and average managers? Breadth permanently evaporated? 1 Kahn, Ronald, 'Seven Quantitative Insights into Active Management Part 3: The Fundamental Law of Active Management," BARRA Newsletter, Winter Grinold, R.C. 'The Fundamental Law of Active Management.' The Journal of Portfolio Management, Vol. 15, No. 3 (1989), pp TOP QUARTILE VS MEDIAN ACTIVE MANAGERS 5-year periods of annual excess returns of US Large Cap Blend (LCB) Equity Managers Average of 5 periods Average annual excess return 6% 4% -4% -0.05% 1.03% -1.54% 1.17% 5.21% Median active managers -1.06% Top quartile active managers 1.11% 1.31% 0.05% -0.49% -1.71% -6% -4.76% Source: Analysis based on Morningstar data (net of fees). Top quartile and median taken from the Morningstar Large Blend category. Excess returns, net of all fees including 12b-1 but excluding sales charges, are relative to the S&P 500 TR Index. Analysis covers all share classes and includes funds that have since been liquidated or merged, but excludes index funds. Includes extended performance where available. 8 4

5 ACTIVE PERFORMANCE OVER TIME GLOBAL EQUITIES 5-year periods of annualized excess returns Average annual excess return 8% 6% 4% 4.78% 6.67% 0.15% 3.84% 1.74% 5.34% Average of 5 periods Median active managers 1.37% Top quartile active managers 3.89% 0.75% % 0.88% Source: Analysis based on Morningstar data (net of fees). Top quartile and median taken from the Morningstar World Stock category. Excess returns, net of all fees (including 12b-1) but excluding sales charges, are relative to the MSCI World NR USD Index. Analysis covers all share classes and includes funds that have since been liquidated or merged, but excludes index funds. Analysis includes extended performance where available. The 50 th percentile doesn't reflect value added from active management 9 TOP QUARTILE VS MEDIAN ACTIVE MANAGERS Excess returns of US LCB active managers based on dispersion in S&P % 4% Top quartile active managers Median active managers 5.39% 1.66% 0.93% -1.64% Rising markets Falling markets 20 out of 25 years 5 out of 25 years Source: Analysis using Morningstar data. Rising and falling markets based on calendar year returns when the S&P 500 rose or fell ( ). Top quartile and median taken from the Morningstar Large Blend category. Excess returns, net of all fees (including 12b-1) but excluding sales charges, calculated against the S&P 500 TR Index. Analysis covers all share classes and includes funds that have since been liquidated or merged, but excludes index funds. The falling markets are 1990, 2000, 2001, 2002 and

6 TOP QUARTILE VS MEDIAN ACTIVE MANAGERS Excess returns of US LCB active managers based on dispersion in S&P % Top quartile active managers 4.54% Median active managers 4% 0.67% -1.05% -1.37% Most-dispersed markets Least-dispersed markets The greater differences between highest and lowest stock returns The lesser differences between highest and lowest stock returns Source: Analysis based on Factset and Morningstar data. Market dispersion based on the calendar year return difference between companies at the 10 th and 90 th percentile Calendar years with market dispersion in the top and bottom quartile were considered most or least dispersed, respectively. The top quartile and median taken from the Morningstar Large Blend category. Excess returns, net of all fees (including 12b-1) but excluding sales charges, are calculated against the S&P 500 TR Index. Analysis covers all share classes and includes funds that have since been liquidated or merged, but excludes index funds. Most-dispersed markets (1991, 1998, 1999, 2000, 2003 and 2009) had average dispersion of 97%. Least dispersed markets (1994, 1996, 2005, 2006, 2012 and 2014) had average dispersion of 54%. 11 DEMONSTRATING CONVICTION THROUGH LONG-TERM ACTIVE INVESTING Excess returns by holding period and active share % US equity funds Average annual excess returns 1% -1% Longer holding period, higher active share -1. Shorter holding period, higher active share -0.9% Longer holding period, lower active share -1.6% Shorter holding period, lower active share Source: Cremers, M. and Ankur Pareek, 2014, "Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently," Working Paper. Annualized returns relative to the fund's self-declared benchmark where available, otherwise benchmark that minimizes active share is selected. US equity mutual funds Returns are holdings-based, net of all fees (including 12b-1) but excluding sales charges. Active share is calculated by summing the absolute difference in weight of each holding in the portfolio versus the index and dividing by 2. Higher active share and longer holding periods have added value 12 6

7 THE POWER OF AN ACTIVE LONG-TERM APPROACH Annual excess returns by holding period and active share World stock funds Average annual excess return 4% 3% 1% -1% -3% Longer holding period, higher active share Shorter holding period, higher active share Longer holding period, lower active share Shorter holding period, lower active share 0.48% 1.05% % 3.81% -0.14% 2.04% 5-year 10-year 15-year 20-year 1.0 Source: Analysis based on Morningstar data as of 12/31/14. Morningstar World Stock funds (surviving funds only) with MSCI World as primary benchmark. Cohorts created by grouping funds based on higher- or lower-than-average active share and turnover. Oldest share class with extended performance used where available. Excess returns are net of all fees (including 12b-1), but excluding sales charges. Analysis excludes index funds and funds-of-funds. Turnover ratio used as a proxy for holding period. Excludes funds that did not report turnover or holdings data as of 12/31/14. Active share is calculated by summing the absolute difference in weight of each holding in the portfolio versus the index and dividing by 2. Higher active share and longer holding periods have added value 13 BREADTH OF OPPORTUNITY IS CYCLICAL Excess returns of US LCB active managers based on dispersion in S&P S&P 500 (6-month average) Source: Strategas as of 12/31/15. Dispersions use current index constituents. 7

8 BREADTH OF OPPORTUNITY IS CYCLICAL S&P Constituents from Cumulative return % Cumulative return % % Positive Earnings Negative Earnings Source: Compustat earnings per share (EPS) data. Each portfolio of positive and negative earnings companies is rebalanced monthly and market cap weighted. BREADTH OF OPPORTUNITY IS CYCLICAL S&P Constituents from Cumulative return % Cumulative return Positive Earnings Negative Earnings 56% 53% Source: Compustat earnings per share (EPS) data. Each portfolio of positive and negative earnings companies is rebalanced monthly and market cap weighted. 8

9 OPPORTUNITY COST Hypothetical growth of excess value of a $100,000 portfolio (over 8% baseline return) Excess value $1,000,000 $750,000 $500,000 $250,000 An excess return of 1% may provide an additional $968k in portfolio value Excess value $968k $693k $440k $211k $ Investment horizon (years) Excess return of 0.25% Excess return of 0.5 Excess return of 0.75% Excess return of 1.0 Notes: Hypothetical example assumes a 40-year investment time horizon and an initial portfolio value of $100,000. The passive portfolio earns an 8% annual return. Excess returns are above and beyond the passive; for example, excess return of 0.5 uses an 8.5 annual return. Total portfolio values after 40-years for the passive and excess return of 1.0 are $2,172,452 and $3,140,942, respectively. This is a hypothetical example shown for illustrative purposes only. CONCLUSIONS Market cycles and investor time horizon are often inconsistent There is a difference between active managers Long term focus and conviction are a strong combination Alpha harvesting is cyclical 9

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