MFS' Medalist Funds Reflect a Strong Culture

Morningstar

The Parent pillar is one of five components driving the Morningstar Analyst Rating. The Parent pillar rating reflects how well firms care for fund investors' capital, and it reflects Morningstar's research that has shown that fund shareholders have a better experience when they keep their assets with firms that have demonstrated that they have aligned firm and fundholders' interests. Morningstar's analysts look at several key features of a firm to determine a fund's Parent pillar rating, including corporate culture, fund managers' incentives, oversight from the fund board, regulatory history, and fees.

MFS earns a Positive parent rating, and that solid showing has supported strong Morningstar Analyst Ratings for MFS funds. Of the 20 strategies Morningstar rates, 18 receive medals (as does its target-date series), indicating Morningstar's analysts expect the funds to outperform peers on a risk-adjusted basis over the long term. Below are highlights from this firm-level research.

A Collaborative Culture
Home to the country's oldest open-end mutual fund, MFS has a long history in investment management. While its first fund, launched in 1924, still exists and continues to focus on domestic stock selection, the firm has increasingly become globally focused and today offers a wide breadth of funds that invest across asset classes, both domestically and abroad.

A key to the firm's staying power has been its ability to hone an investment-focused culture. It has typically promoted from within, and chairman and CEO Robert Manning and president and CIO Michael Roberge both came up through the analyst ranks, as have most of the firm's portfolio managers. Not all employees are able to fill such roles, however, and the firm has developed a career-analyst track to retain its research talent. Analysts can be compensated at the same level as their portfolio manager counterparts, and MFS reports that turnover among its analyst staff is also relatively low. Compared with similarly sized peers, MFS has an above-average manager-retention rate.

MFS takes a thoughtful approach to hiring and strives to find investors who will thrive within the firm's collaborative, research-focused environment. The firm's deep bench of 80-plus analysts divides research responsibilities across sector and capital structure. No matter the strategy or sector, an overarching theme across the firm's bottom-up research is its focus on finding higher-quality companies, or those with durable business models and high and sustainable levels of free cash flow. Indeed, the firm's lineup generally includes funds with attractive upside/downside capture ratios, as the funds' focus on higher-quality fare typically provides a buffer in downturns but still allows for participation in up markets. The funds also typically have relatively high international stakes, even in its domestic-focused portfolios, a result of MFS' global research resources. Solid results at MFS' three analyst-managed funds reflect positively on the fundamental research that feeds so many of the firm's funds.

Strong long-term records across the firm's suite of funds have damped any pressure to launch into trendy alternatives strategies. For example, the firm hasn't launched into the relatively popular "go-anywhere" offerings that other firms have been experimenting with, as management believes it's difficult to add value with such a wide mandate. In addition, the firm's marketing efforts do not promote star managers or push single products, but they emphasize that MFS is able to offer "investment management for investment managers" and the value of the resources of the firm as a whole. The compensation of the firm's sales team also reflects that approach, as salespeople are encouraged to bring in clients who will own multiple funds rather than just pile assets into a single strategy. Performance of various strategies reflects the firm's strength, especially when the focus on selecting high-quality stocks provided a much needed buffer for its equity funds in 2008's credit crisis, boosting the funds' long-term risk-adjusted results.

Manager Ownership Is Improving
Portfolio managers who invest alongside their fundholders not only show a conviction in their investment approach and portfolios, but also are better able to share in a true fundholder experience as they endure the same tax and cost consequences as their shareholders. Further, Morningstar's research has found that portfolio managers who invest significantly in their funds simply perform better on average, particularly on a risk-adjusted basis.

As of November 2013, 41% of MFS' assets are invested in funds where at least one manager has more than $1 million invested. The firm's ownership level has improved from its review last year, a result of both an increase in assets among funds with high levels of ownership as well as manager David Antonelli's increased ownership in MFS International New Discovery (MIDAX). As of a November 2013 filing, Antonelli now has more than $1 million invested in this fund (admirably, he also invests substantially in the other two funds he runs, albeit not to the $1 million threshold).

Most Funds Have a Reasonable Price Tag
Morningstar's research indicates that a fund's price tag is among the best predictors of its future relative performance. Funds with below-average price tags are likely to outperform typical rivals; those with above-average expense ratios are more likely to underperform.

MFS has some well-priced funds, and 46% of the firm's assets are in funds with Low or Below Average Morningstar Fee Levels. Its larger funds, including MFS Value (MEIAX), MFS Total Return (MSFRX), and MFS Massachusetts Investors Trust (MITTX), stand out for their Low cost structures. In fact, all of its funds with more than $1 billion in assets have at least one share class (and all but one of their oldest share classes) whose Fee Level ranks as Low or Below Average. (Some newer share classes for these funds aren't as competitively priced.)

Meanwhile, the firm's smaller funds, particularly its state-specific municipal-bond funds, are on the pricey side. Overall, the firm's average Morningstar Fee Level comes in at 47, or about average.

Thoughtful Oversight
A mutual fund board's sole purpose is to act as an advocate for fundholders, helping to ensure they are treated fairly and honorably. Only mutual fund directors have a seat at the negotiating table when it comes to hiring mutual fund advisors and setting fees, for example. Most boards of directors take their responsibility seriously, but those that stand out have established a track record of independence and shareholder-friendly practices. MFS' board is one of those boards.

Like all mutual fund boards, MFS' board is majority-independent. Here, just one board member, MFS chairman and CEO Robert Manning, is an interested director. The board has stood out in a couple of areas. As with most boards, the directors are invested alongside shareholders; each member has more than $100,000 in MFS mutual funds. However, the board has adopted and disclosed to shareholders a policy that requires directors to have at least their annual pay invested in the funds within two years. Each director makes more than $250,000 a year--that's typical of boards overseeing similarly sized mutual fund families--so that puts each trustee's financial commitment to the funds well above the SEC's highest ownership-disclosure band ("more than $100,000").

Starting in 2013, a new, firmwide fee breakpoint went into effect, another shareholder-friendly initiative from the fund board. As the firm overall reaches specific asset levels, the vast majority of the firm's funds will receive a break. This should particularly benefit MFS' smaller funds. It also helps ensure that economies of scale realized by the firm overall are passed on to all of its fundholders as opposed to just one or two individual funds. This policy is unusual but not unheard of in the mutual fund industry, and the substance of it remains to be seen. Nonetheless, MFS' board deserves credit for recognizing the highly scalable nature of investment management and the difficulty in quantifying it.

Additional Research
Morningstar provides parent-level research and ratings on more than 200 firms and in-depth stewardship reports on the top-20 firms by assets. Full stewardship text is available to subscribers of Morningstar's software for advisors and institutions: Morningstar Principia®, Morningstar Advisor Workstation(SM), Morningstar Offtice(SM), and Morningstar Direct(SM).

For a list of the open-end funds we cover, click here. http://www.morningstar.com/analyst-research/fund-reports.aspx
For a list of the closed-end funds we cover, click here. http://www.morningstar.com/goto/cef-reports
For a list of the exchange-traded funds we cover, click here. http://www.morningstar.com/analyst-research/etf-reports.aspx
For information on the Morningstar Analyst Ratings, click here. http://corporate.morningstar.com/US/documents/MethodologyDocuments/FactSheets/AnalystRatingforFundsFactSheet.pdf


Kathryn Spica, CFA does not own shares in any of the securities mentioned above.

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