MFS EMERGING MARKETS DEBT FUND

Transcription

1 Q3 18 Investment Update MFS EMERGING MARKETS DEBT FUND Uncovering fixed-income opportunities in emerging markets worldwide Focuses primarily on debt issued by emerging market countries; however, the fund may invest in corporate debt issued by companies located in emerging market countries. Benchmark: JPMorgan Emerging Markets Bond Index Global Fund objective Seeks total return with an emphasis on high current income, but also considering capital appreciation. Key performance points The - Class I underperformed the JPMorgan Emerging Markets Bond Index Global on a relative basis during the third quarter of 2018 with a return of 1.46% versus 1.87% for the index. Contributors: Underweight China, where we feel low spreads offer insufficient compensation for risk Underweight Zambia and Venezuela, both below investment-grade credits facing significant financing risks Overweight positions in oil exporters Kazakhstan, Qatar, and the United Arab Emirates Sovereign selection and an underweight in Russia, which faces the risk of further U.S. sanctions An overweight and selection in Paraguay Detractors: An overweight and selection in Argentina Underweights in outperforming high-beta B-rated credits 1, including Oman, Ecuador, and Pakistan Portfolio residual cash The use of EM corporates, which broadly underperformed sovereigns for the quarter An overweight in India Underweight Mexico, where our concerns about medium to long-term fundamentals do not seem adequately reflected in asset prices. Positioning We continue to focus on driving outperformance through alpha, not beta. Key points on portfolio positioning include: Against a global macro backdrop that continues to be less supportive of EMD, we have maintained an alpha-oriented focus, seeking to add value by differentiating between positive and negative risk/reward prospects. We have placed more emphasis on positioning in dollar EM sovereigns and quasi-sovereigns, given better liquidity and relative value considerations. We have been focusing on stable countries where valuation has become more attractive, especially in quasi-sovereigns and corporates, due to generalized selling pressure (e.g., India, Peru, Chile); structurally improving stories (e.g., South Africa); and higher-yielding countries with robust adjustment programs and multilateral support (e.g., Argentina, Ukraine, Egypt).

2 Our more selective, lower-beta orientation has also been reflected in lower exposure to local currency assets, which, while selectively cheap, are also vulnerable to continued episodes of market volatility. We are still finding attractive opportunities in emerging markets currencies, but the hurdle (required excess return) is higher. In addition, we have remained relatively defensive in the portfolio's corporate positions, exercising a high degree of selectivity given higher market volatility, lower corporate bond liquidity, and relatively tight valuations vs. sovereigns. Generally, the portfolio's corporate exposure has nevertheless remained consistent with levels of the portfolio's longer-term history as new issues and attractive secondary market opportunities have emerged. Finally, we have been maintaining a modest U.S. Treasury duration underweight on the expectation of additional curve widening. We believe the expectation of further bouts of volatility means greater dispersion of performance, favoring a strategy that is focused on fundamentals, relative value, and differentiation. Below we provide detail on the what we believe were the major changes in country positioning during the quarter: In Latin America, we: Reduced exposure to El Salvador to an underweight on fundamental deterioration. We see political risk in the rising fortunes of the populist former mayor of San Salvador, Nayib Bukele, who recently switched his party affiliation to improve his chances of election next year. In our view, a Bukele presidency would likely be negative for the country's policy direction. Increased an underweight in Brazil on worries about the political risks facing the country. Polls ahead of the first round of the presidential election raised concerns about a second round run-off between the far-right and far-left candidates (Bolsonaro and Haddad, respectively). Heading into the fourth quarter, we began to anticipate via positioning the more market-friendly right-wing candidate's strong showing in the first round, which has since raised market hopes that fiscal reforms are now more likely. Increased an overweight in Chile by adding to some existing quasi-sovereign and corporate positions that had cheapened on systemic risks. Added exposure to the Dominican Republic via participation in the sovereign's new issue. Reduced an overweight in Paraguay as valuation became less attractive. Slightly reduced the portfolio's underweight in Mexican bonds by establishing a small position in peso-denominated Mbonos. At the same time, we trimmed exposure to the Mexican peso, which had been an outperformer. Reduced an underweight Colombia on the view that the economy is exhibiting an upturn, with support from stronger oil prices, and that the new center-right government should pursue marketfriendly policies. Increased an underweight in Costa Rica. In Europe, we: Following a stronger-than-expected policy response (rate hike) from the Turkish central bank in September, we tactically increased the portfolio's exposure to Turkey from underweight to overweight. We added both dollar sovereign bonds and a position in the lira. Longer-term, we anticipate balance sheet deterioration to continue, but we sought to take advantage of a market that had overpriced the probability of a near-term default. More recently, Turkish assets have benefited from the release of U.S. Pastor Brunson, which should alleviate the risk of U.S. sanctions. Increased the portfolio's underweight in Russia on concerns about sanctions risk, trimming sovereign and quasi-sovereign exposure. Added to an overweight in Ukraine on progress toward reform regarded by the International Monetary Fund (IMF) as a prerequisite to the release of the next tranche of its financing program. Added slightly to a modestly overweight position in Hungary. In the Middle East and Africa, we: Increased the portfolio's overweight in South Africa via participation in a new quasi-sovereign issue, as well as through the purchase of a corporate bond in both the primary and the secondary market.

3 While South African growth has been disappointing, in part because of drought, but also because of inventory drawdowns, there has been some improvement in the current account deficit as a result (with help from a weaker rand). We expect growth to pick up in the quarters ahead. More broadly, we have been encouraged by the prospects for better governance under President Ramaphosa. There are challenges ahead in the process of reform, but the government appears committed to achieving market-friendly outcomes. Increased an overweight in Egypt, which has continued to make progress on reforms required under its IMF program. Growth has accelerated, public debt levels have moderated, and external imbalances have improved. Increased Angola to an overweight on expectations of an IMF program and evidence of the new government's commitment to reform. Recovery in oil prices should also help heal fiscal and current account deficits. Add to the portfolio's position in Qatar, another credit benefiting from stronger oil prices. Reduced exposure to Cote d'ivoire on political concerns. Recent cabinet changes are indicative of heightened tensions between the parties making up the country's governing coalition. In Asia, we: Established a small corporate bond position in Thailand (financials) and in Macau (gaming) via the purchase of new issues. Initiated positions in Pakistan, which seems likely to obtain an IMF program, and Papua New Guinea, which issued its first dollar sovereign debt in September. Reduced Sri Lanka on concerns about the country's external vulnerability (i.e., high gross external financing requirements vs. FX reserves). Eliminated the portfolio's exposure to Indian rates and the Indonesian rupiah, while taking a small position in the Thai baht. Outlook Outlook: Risks warrant cautious, but volatility may offer opportunity We think that a challenging global backdrop will persist, and that the markets are likely to experience episodic volatility as various headwinds draw investors' attention. Nevertheless, improved valuations, both in EM spreads and yields, offer selective opportunities. Moreover, while some EM countries will experience a period of slower growth, a number could make progress adjusting imbalances. Against this backdrop, we think careful country and credit selection will be critical to outperformance. In our view, beta-oriented and passive strategies are likely to continue to be challenged in this environment. While we remain cautious, that caution is expressed more in where we are taking risk (alpha) than in how much aggregate risk we are taking versus our benchmark index (beta). Below we offer our global base case, highlighting the tail risks to our views. Global base case While global growth is expected to remain reasonably solid, it has become less synchronized and more U.S.-led. EM growth has been showing signs of slowing. China has been reining in credit growth, and a number of EM central banks have raised rates in an effort to stabilize financial conditions. G-3 monetary policy is gradually becoming less accommodative, with the Fed likely to continue to lead the way. The dollar has largely held its 2Q gains and could remain relatively strong in the near term given cyclical support. While cyclically supported, the dollar remains structurally challenged by rising twin deficits. Geopolitical risk will remain elevated. Key risks include heightened tension in the Mid East (e.g., Syria, the U.S. withdrawal from the Iran nuclear deal), the potential for further U.S. sanctions against Russia, increased and broad-based U.S. tensions with China, and lack of agreement on North Korean denuclearization. Rising U.S. protectionism remains a key risk to EM and a source of volatility for all risk assets. While prospects appear favorable for passage of a USMCA replacement to NAFTA, the trade conflict with China has farther-reaching consequences and seems likely to escalate.

4 Global tail risks U.S.-China trade tensions could escalate into a broad-based and lengthy trade war. U.S. fiscal stimulus could push the Fed to tighten more aggressively. China s economy could slow more than expected. The recent increase in U.S. Treasury rates suggests risk that the curve could further bear steepen if investor demand for a term premium grows. EM Fundamentals Broad EM credit metrics (e.g., fiscal and external accounts) have generally been improving or stable, but vulnerability is heightened in certain countries (e.g., Argentina, Turkey, and Brazil). Relatively strong EM growth trends are being dampened by market volatility and tighter financial conditions. "Problem countries," i.e., those with considerable imbalances, still need more adjustments, and that process will entail a period of policy-induced weakness in economic activity. Some commodity prices may experience more headwinds from protectionism and growth concerns. The electoral calendar and newly-elected regimes will continue to inject some uncertainty into the outlook for EM. Valuation External EMD spreads have widened, becoming cheap versus U.S. high-yield corporates and somewhat cheap to U.S. investment-grade corporates. Despite some improvement, EM corporates still look rich to EM sovereigns. EM local yields have also widened, but are still historically tight to U.S. Treasuries. EM FX looks relatively cheap, but we believe will remain vulnerable given its higher beta to global market volatility, as well as its historically low carry. With volatility expected to persist, EM valuations may present selective opportunities. Technicals Demand could remain soft in the near-term. Investor positioning is somewhat lighter, but cross-over and retail participants appear to remain nervous, and institutional inflows are slowing. Flows have been very sensitive to asset class performance, with recent rallies interrupting outflows. Supply technicals are modestly supportive. EM issuance has been showing signs of picking up, but still appears manageable.

5 Performance review as of 9/30/18 Portfolio % Q Year 3 Years 5 Years 10 Years Class A without sales charge Class A with 4.25% maximum sales charge Class I Class R4* JPMorgan Emerging Markets Bond Index Global Lipper Emerging Mkts. Hard Currency Debt Cat. Avg Fund Expenses Class A Class I Class R4 Gross Expense Ratio Net Expense Ratio Gross expense ratio is the fund's total operating expense ratio from the fund's most recent prospectus. Net expense ratio reflects the reduction of expenses from fee waivers, reimbursements, and the exclusion of interest and fees. Elimination of these reductions will result in higher expenses and lower performance. Performance data shown represents past performance and are no guarantee of future results. Investment return and principal value fluctuate so your shares, when sold, may be worth more or less than the original cost; current performance may be lower or higher than quoted. For most recent month-end performance, please visit mfs.com. Performance results reflect any applicable expense subsidies and waivers in effect during the periods shown. Without such subsidies and waivers the fund's performance results would be less favorable. All results assume the reinvestment of dividends and capital gains. The performance is as of the date shown; it may not include the fund's entire investment portfolio and is subject to change. *Performance for Class R shares includes the performance of the fund s Class I shares, adjusted to take into account differences in sales loads and class-specific operating expenses (such as Rule 12b-1 fees), if any, for periods prior to their offering. Please see the prospectus for additional information about performance and expenses. Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The Index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan's prior written approval. Copyright 2017, J.P. Morgan Chase & Co. All rights reserved Beta: Beta is a measure of the volatility of a portfolio relative to the overall market. A beta less than 1.0 indicates lower risk than the market; a beta greater than 1.0 indicates higher risk than the market. It is most reliable as a risk measure when the return fluctuations of the portfolio are highly correlated with the return fluctuations of the index chosen to represent the market. Alpha: Alpha is a measure of the portfolio's risk-adjusted performance. When compared to the portfolio's beta, a positive alpha indicates better-than-expected portfolio performance and a negative alpha worse-thanexpected portfolio performance. 1 For all securities other than those specifically described below, ratings are assigned to underlying securities utilizing ratings from Moody's, Fitch, and Standard & Poor's rating agencies and applying the following hierarchy: If all three agencies provide a rating, the middle rating (after dropping the highest and lowest ratings) is assigned; if two of the three agencies rate a security, the lower of the two is assigned. Ratings are shown in the S&P and Fitch scale (e.g., AAA). All ratings are subject to change. U.S. Government includes Page 5 of 6

6 securities issued by the U.S. Department of the Treasury. Federal Agencies includes rated and unrated U.S. Agency fixed-income securities, Sales Charges Class I shares ("I") have no sales charge or Rule 12b-1 fees and are available only to eligible investors. Class R4 shares ("R4") have no initial sales charge or CDSC. Shares are available only to certain retirement plans. The JPMorgan Emerging Markets Bond Index Global tracks debt instruments in the emerging markets (includes a broader array of countries than the EMBI Plus). Index returns do not take into account investmentrelated fees and expenses. It is not possible to invest directly in an index. Important risk considerations The fund may not achieve its objective and/or you could lose money on your investment in the fund. Investments in debt instruments may decline in value as the result 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 Fund's share price may decline during rising rates. Funds 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. 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. Emerging markets can have less market structure, depth, and regulatory, custodial or operational oversight and greater political, social, and economic instability than developed markets. 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. 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. Please see the prospectus for further information on these and other risk considerations. This portfolio is actively managed, and current holdings may be different. The views expressed are those of MFS 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. No forecasts can be guaranteed. Before investing, consider the fund's investment objectives, risks, charges, and expenses. For a prospectus, or summary prospectus, containing this and other information, contact your investment professional or view online at mfs.com. Please read it carefully. MFS investment products are offered through MFS Fund Distributors, Inc., 111 Huntington Avenue, Boston, MA Page 6 of 6