Compelling Culture Key to MFS' Staying Power

Morningstar recently issued a new Stewardship Grade for MFS. The firm's overall grade--which considers corporate culture, fund board quality, fund manager incentives, fees, and regulatory history--is a B. What follows is Morningstar's analysis of the firm's corporate culture. This text, as well as analytical text on the other four Stewardship Grade criteria, is available to subscribers of Morningstar's software for advisors and institutions: Morningstar Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM).

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.

An Investor-Focused Culture Reflects Well on This Firm 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, at 100% for the past year and 94% for the past five-year period.

The firm stands out for its thoughtful approach to succession planning. In September 2014, the firm announced Roberge will join Manning as co-CEO at the start of 2015. The duo is planning a several-year transition phase before Roberge takes over as sole CEO. Manning is just 50 years old, so he potentially still has a long runway to spend as chairman of the firm. In addition, the firm announced promotions for director of equity for North America Kevin Beatty to CIO of global equity and director of fixed income Bill Adams to CIO of global fixed income, signaling the next level of leadership at the firm. Given some of the less-well-planned management transitions that have occurred in the industry recently, it's refreshing to see a firm dedicated to providing transparency to its investors and employees.

One reason the firm has been able to keep turnover low and plan a smooth transition is that it takes a thoughtful approach to hiring. MFS 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 domestic-focused portfolios, a result of MFS' global research resources. Solid long-term results at MFS' three analyst-managed funds reflect positively on the fundamental research that feeds so many of the firm's funds.

While the firm's investment professionals have been central to the firm's history, culture, and success, they and the rest of the company are ultimately accountable to MFS' parent firm, Canadian life insurance company Sun Life, which has owned MFS since 1982. Perhaps a function of MFS' overall strong performance and persistent growth in assets over the past decade, Sun Life seems content to take a mostly hands-off approach, and although the parent company looked to sell MFS in past years, there are no signs it will be letting go of the profitable segment anytime soon. MFS offers a steady revenue stream, and Sun Life has supported the firm during difficult periods such as 2008, when MFS' investment ranks remained relatively stable, even as assets declined. Sun Life's 2011 consolidation of asset management firm McLean Budden with MFS is one example where the parent firm has stepped in. While the merger may have been driven by Sun Life's goals more than by a strategic decision from MFS, it still gave MFS a solid footprint into the Canadian market, an area it had had difficulty penetrating. More so, MFS has indicated it isn't bound to aggressive target growth goals and is able to maintain reasonable expectations with its parent firm. (For example, MFS recently cut its prospective growth rate to 3%-5% from 7%, which didn't raise alarms from Sun Life.)

Realistic growth goals and 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 ventured 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 emphasize the firm as a whole, particularly its global reaches and collaborative approach to investment management. 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.

Some Recent Performance Struggles, but Skill Over the Long Term

Recent performance has been wanting. In calendar-year 2013 and through mid-December of 2014, the majority of the firm's funds have trailed their peer norm, some by a significant degree. For example, small-cap growth fund

Despite some recent performance hiccups, investors have been attracted to the funds' strong long-term performance records, and the firm has bucked the trend of flows moving toward passive investments in recent years, gaining inflows in each of the past five calendar years and for the year to date in 2014. Such growth means that capacity is a concern, and the firm's two largest funds hold several days' worth of trading volume among most of their top holdings. Still, management is managing its growth with aplomb: It has closed eight strategies to new separate accounts or subadvisor arrangements, which closes the valve on large inflows to the strategies. More so, portfolio managers are rewarded primarily on performance rather than asset growth, encouraging them to shutter funds before assets become unwieldy. At $167 billion as of the end of 2013, the firm's institutional business only recently surpassed that of its retail U.S. mutual funds in asset size, although by shuttering some of the institutional flows, the firm's asset breakdown may swing toward retail investors again in the future.

Branching Out That's not to say the firm isn't also expanding its reach. The firm has dipped its toe into the relatively nascent actively managed exchange-traded fund market. MFS subadvises three products from State Street, all large-cap stock offerings. MFS' management chose to use a partnership with State Street rather than launch its own lineup of actively managed ETFs as it is wary of the amount of investor interest in this particular type of product. By acting as a subadvisor, MFS can try out the nuances of managing an actively managed ETF without having to worry about distribution and other related costs. Management sees greater and enduring interest in low-volatility strategies, however, and the firm launched two new low-volatility-focused funds at the end of 2013. Market gyrations in recent years have many investors concerned with finding a way to smooth their portfolio returns, and MFS believes the firm's new funds can add value by picking more defensive-oriented stocks.

The team managing the new low-volatility funds is using a familiar process. The funds are managed by the firm's blended research team, which combines analyst stock ratings with quantitative filters to deliver a product with a specific target, such as low-volatility or high-dividend yield. This type of product has been gaining prominence across the firm and, in addition to managing their own strategies, was also bequeathed a sleeve of allocation fund MFS Total Return MSFRX in April 2013. Roberge sees little overlap between these blended strategies and the firm's bread and butter fundamental strategies, and he believes the former is more scalable as a business. As this area gains prominence at the firm, it will be worth keeping an eye on the strategies' results to see if the team is able to truly add value with its various mandates.

The firm has branched out a little further with the launch of MFS Managed Wealth MNWAX in mid-2014. This long-short equity fund combines equal allocations to three of the firm's equity funds,

Overall, MFS is mostly sticking with its strengths, and the strong long-term performance and tide of inflows is rewarding the firm. As it continues to expand, it will be imperative for it to demonstrate that it isn't losing touch with the strengths it has honed over time nor spreading itself too thin. The firm's current home-grown and investment-focused management provides comfort that it will continue to be a capable steward.

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