MFS Mid Cap Growth Strategy - Quarterly Portfolio Update

 MFS^® Mid Cap Growth Strategy – Quarterly Update 

Hello, thank you for tuning in to our MFS Midcap Growth quarterly review. My name is Laura Granger, and I am an institutional portfolio manager on the US Growth team.

For the next few minutes, we will discuss what happened in the second quarter, our thoughts on the benchmark Russell Midcap® Growth index rebalance and spend some time on our outlook.

The second quarter delivered a dramatic reversal, with the market displaying remarkable resilience.

We started the quarter with a lot of uncertainty and in the middle of a deep selloff that was exacerbated by the surprising Liberation Day tariff announcements. The index sold off 25% from its February peak. The trend reversed sharply when President Trump announced a 90- day tariff pause on April 9^th. Market sentiment shifted abruptly as confidence in tariff resolution gained momentum. More importantly, first quarter earnings came in stronger than expected. During the quarter, 78% of the S&P 500 companies beat expectations. Estimates trended higher, economic data stabilized and inflation cooled. The Midcap Growth index rallied 33% off its low and ended the quarter up 18.2%, and the year up 9.8%.

The rapid shift in sentiment to a risk-on mentality resulted in high beta outperforming significantly, which you can see on this chart. The highest beta quintile of the index, the left bar, outperformed by thousands of basis points. This type of outsized factor performance is usually short lived, but it was a headwind to portfolio relative returns given our lower beta, high quality profile.

Index concentration has been another headwind for active managers in the asset class. The top 10 index weights totaled 24.5% of the index at the peak versus the long- term average of around 13% to 14%.

Palantir is one reason for the index concentration. With a market cap of $330 billion, trading at the lofty valuation of 62x 2026 EV to sales and 181x 2026 earnings, accounted for over 9% of the index weight at its peak. To put those numbers into perspective, the last time the index was this concentrated was in March of 2000 when JDS Uniphase was 4.5%.

Historically, a valuation of 10x EV/Sales was a strong sell signal. In our opinion, this stock is not a good risk/reward investment for clients and at some point, valuation will matter. Palantir gained close to 55% in the quarter and 73% year to date. As you can see on this pie chart, it accounted over 35% of the index return year to date. In fact, YTD the Russell Midcap® index ex PLTR is up just 6.3%. This was a headwind to our portfolio and most active managers.

The good news is that with the Russell rebalance taking effect on June 30^th, Palantir is out of the index.

Let’s shift focus to the index rebalance, which had a large impact on midcap growth. Just as a reminder, Russell determined the new index construction on April 30^th, two months before the actual rebalance date of June 27^th. At that time, the top 10 weights were expected to decline to around 14% with the exit of Palantir and AppLovin. Also, the new mid/large market cap cut-off was expected to be about $58.5 billion. But the market rallied significantly at that point and the index ended up with top 10 weights at 20.4%. The new largest market cap in the index is Coinbase at $90 billion. So let’s just use Coinbase as an example. On April 30^th Coinbase’s market cap was $51.6 billion, but the stock rallied 70% since that time and now sits at $90 billion.

The good news is there is relief to the name concentration. You can see the details on this next chart. The left side displays the old weights, right side new weights. Palantir and AppLovin had a combined weight close to 12% of the index and are both out. Royal Caribbean is the new top weight at 2.6% but has a $85 billion market cap. In fact, 6 of the new top 10 have a market cap above $60 billion. The last two-month rally in the market had a huge impact on the intended effect of the rebalance.

It is important to note, beginning in 2026, Russell will move to a twice-a-year rebalance schedule. June will be style and market cap, and November will be market cap only. This should help alleviate the market cap creep we are experiencing in midcap and small cap.

There was also a major shift in sector weights, which you can see in the next chart. The weight of information technology declined by over 1100 basis points. As a result, our portfolio went from a large underweight to an overweight. The weight in consumer discretionary increased by over 800 basis points, largely from a big increase in gaming and lodging stocks. As a result, our portfolio moved from a slight underweight to a large underweight. The other notable shift is the increase in industrials, which is primarily due to Howmet moving up in weight in the index to 2.4%.

Finally, a few words on our outlook. With the market reaching new highs, valuations are a bit stretched. However, economic data is stabilizing, inflation is cooling and expectations for earnings growth is positive for many companies. Persistent macro uncertainty will continue to cause volatility, but the upcoming earnings season should provide more insight into how companies will adjust to tariffs. We have not yet seen the full impact of tariffs and some companies will handle it better than others. We are cautiously optimistic given the ongoing macro uncertainties coupled with some of the strong idiosyncratic growth stories we are uncovering. The midcap growth strategy tends to be very idiosyncratic and stock selection is key. We are focused on identifying companies with consistent, above average rate and duration of growth, where the market is underestimating the company’s long-term earnings power. We are finding many exciting opportunities across multiple sectors, including communication services, financials, industrials and consumer and technology.

Thank you for taking the time to listen to our first midcap growth update. Please let us know what would be most helpful for you in future updates. For more detail, please reach out to your MFS representative and have a great day.

 

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The views expressed are those of the speaker 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.

Important Risk Considerations:
The strategy may not achieve its objective and/or you could lose money on your investment.

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, environmental, public health, and other conditions.

Growth: Investments in growth companies can be more sensitive to the company's earnings and more volatile than the stock market in general.

Please see the applicable prospectus for further information on these and other risk considerations.

The portfolio is actively managed, and current holdings may be different.

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