MFS® International Diversification Fund - Quarterly Portfolio Update

Hi, my name is Nick Paul, and I am a co-Portfolio Manager on the MFS International Diversification Fund. Thank you for taking the time to join us for our year-end 2025 review.

So what I thought I would do today is provide a quick recap across non-US equity markets for 2025 at both the asset-class level as well as for the MFS International Diversification Fund.

So let’s first start at the asset-class level. For the broader MSCI All Country World ex-US index, 2025 proved to be one of the best years on record in terms of absolute performance in US dollars, with the index closing the year up 32.4%. In fact, you would have to go all the way back to 2009, coming off of the lows of the Global Financial Crisis, to find a better performing year for international equities than what we just witnessed in 2025.

And for me, what I found most positive is that this strong performance was broad based across styles (so, value, core, and growth), across regions (both developed markets as well as emerging markets) as well as market cap (both large-caps as well as small- and mid-cap stocks), which the International Diversification Fund is uniquely structured to provide clients this level of diversification in a single product offering.

So first by style: as has been the case for several years now in international markets, value took the lead with the MSCI All Country World ex-US Value index up a staggering 39.5% for the year. And while growth stocks outside the US trailed their value counterparts, the MSCI All Country World ex-US Growth index finished the year with a very respective 25.7% return in US dollars.

Now on a regional basis, after many years of anticipation, we finally witnessed some signs of strength coming from emerging markets. For the year, the MSCI Emerging Markets index finished 33.6% higher, outperforming developed non-US, with the MSCI EAFE Iindex up a still very impressive 31.2% for the year.

And finally, by market cap, small- and mid-cap stocks, following years of underperformance, actually faired quite well, with the MSCI All Country World ex-US Small and Mid-Cap Index delivering a 30.1% return in US dollars. In particular, European small- and mid-cap stocks — led by financials, aerospace and defense, and materials — all benefited from optimism surrounding European growth and Germany’s €500 billion fiscal stimulus announcement, had a breakout year, returning 36.3% in 2025. Now despite this strong performance from small- and mid-cap stocks, they still trailed their large cap counterparts, albeit modestly, which closed the year 32.5% higher for 2025.

So from my perspective, the big positive takeaway here was that international stocks were firing on all cylinders in 2025 as we witnessed broad strength across styles, regions, and market cap, and the good news being that at least to start 2026, we are seeing a continuation of this broadening out of performance, with international stocks outperforming the heavily concentrated S&P 500 so far this year, which hopefully bodes well for the year to come. So it was what I like to call a very “healthy” environment for international stocks.

Now turning our attention to the performance of the International Diversification Fund, while the fund had a very strong year from an absolute standpoint, it did underperform the MSCI All Country World ex-US Index for the year. So what was behind this underperformance?

Well painting with a broad brush, while two of the six underlying strategies outperformed their respective benchmarks, it was the underperformance of quality stocks more broadly that was the major driver of underperformance for International Diversification — not just last year, but this low quality outperformance has proved a strong headwind to the strategy really over the last 3 and 5 years as well. And as you can see from the chart here, quality stocks have witnessed an extremely tough stretch over the last 1, 3, and 5 years, as low quality has significantly outperformed high quality, which stands in stark contrast to history, where investing in high-quality businesses has proven a winning approach for investors.

From a factor perspective, value and momentum factors were the standout strongest performers last year, while quality, growth, and low-volatility factors underperformed. Additionally, cyclical stocks significantly outperformed more defensive ones. In fact, the last 12-month period of quality underperformance is one of the worst periods historically. And while I will be the first to say that we understand that the recent period of underperformance has been difficult, we firmly believe that our disciplined, long-term investment approach, which has proved successful over multiple decades and through various market cycles, remains the right approach for navigating the complexities of today’s market environment. And these types of environments — which have favored lower-quality, more cyclical, and economically sensitive stocks — they don’t last forever, and they may be followed by a reversion to fundamentals, where quality and resilience are recognized and rewarded once again. With that, our focus remains on identifying those businesses with clear competitive advantages, healthy balance sheets, and durable growth, trading at what we believe to be attractive valuation, which has proven effective over time.

So as we look forward to 2026, we remain committed to delivering to our clients a well-diversified, quality-focused approach to international investing, and it is our belief that as the market returns to rewarding high-quality businesses, with strong through cycle earnings and free cash flows, the International Diversification Fund should potentially deliver the type of strong relative performance results that our clients have come to expect from the strategy over the long term.

And with that, as always, thank you for your time today and I hope to see all of you again next quarter.

 

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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.

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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