Before they were co-managers, Brooks Taylor and Kevin Schmitz teamed up playing doubles tennis in Boston with other MFS Investment Management employees. â€œWe didnâ€™t have the best skills, but we usually did all right,â€ says Taylor. â€œWe knew how to play well together.â€
The duo now favor long hikes over tennis, but their complementary strengths make them a powerful pair at the $11.7 billion MFS Mid Cap Value fund (ticker: MVCAX), which they have co-managed since 2008. Over the past decade, the fund has returned more than 10% a year on average, better than 79% of its mid-cap-value peers. It charges annual fees of 1.07% on its retail shares.
While many value managers hoard cash during bull markets and look for opportunities to buy beaten-down stocks, Taylor and Schmitz prefer to stay fully invested. They lean heavily on the firmâ€™s 25-plus equity analysts to offer their best ideas in their respective sectors.
Roughly two-thirds of the 150-stock portfolio is in high-quality companies that offer the best balance of risk and reward relative to their sector peers on a three- to five-year time horizon. This bucket includes names like tool maker Stanley Black & Decker (SWK), power-management company Eaton (ETN), and global insurance brokerage Arthur J. Gallagher & Co. (AJG).
The remaining third goes to opportunistic investments with low market expectations or where a turnaround is in the works. For example, last June the fund participated in an equity offering for PG&E (PCE) at about 9.5 times forward consensus earningsâ€”about half the valuation of other utilitiesâ€”as a part of its restructuring following devastating wildfires in Northern California caused by its equipment. As an additional plus, Patricia Poppe, the CEO of Michigan utility CMS Energy (CMS)â€”another fund holdingâ€”is taking over as PG&Eâ€™s CEO. â€œWe love change stories,â€ says Schmitz.
MFS Mid Cap Value
Note: Holdings as of Nov. 30. Returns through December 28; five- and 10-year returns are annualized.
Sources: Morngingstar; MFS
The co-managers took very different paths to arrive at MFS. Taylor, 51, grew up in Eastchester, N.Y., where his mother was a teacher and his father, Fred Taylor, was the chief investment officer of U.S. Trust. The younger Taylor studied economics at Yale and worked in investment banking before going to business school at the University of Pennsylvania. He joined MFS in 1996.
Schmitz, 47, grew up in Detroit, where his mother was a nurse and his father worked at General Motors, and investing wasnâ€™t part of the family lexicon. A sixth-grade teacher sparked his passion in investing with lessons in reading the business pages of the newspaper and a mock stock-picking contest. Schmitz didnâ€™t win, but his interest in investing stuck.
â€œI idolized Peter Lynch, and all my friends idolized Isiah Thomas and Michael Jordan,â€ says Schmitz, who got to meet his idol after he was recruited by Fidelity as an undergraduate at the University of Michigan. He joined MFS in 2002.
Whereas Schmitz is very detail-orientedâ€”â€œHeâ€™ll listen to every single conference call of every company we own,â€ says his co-managerâ€”Taylor tends to think more big-picture. He can always be counted on to ask â€œthat question that no one really wants to ask but everyone has on their minds,â€ says Schmitz.
Covid-19 has raised many tough questions, not just about the fate of individual companies but entire sectors. To provide some clarity, the managers created a two-by-two matrix in which the horizontal axis is Covid winners (right) and losers (left), and the vertical axis is secular winners (top) and losers (bottom).
The bottom left quadrant, populated by Covid and secular losers, is an area where they are very selective. â€œThose are industries that have had a difficult time going into Covid, and itâ€™s gotten worse,â€ says Schmitz. â€œThis is where a lot of value traps live.â€ The same goes for the bottom right quadrant, which is composed of companies that are Covid winners but secular losers. â€œThis is where you donâ€™t want to overstay your welcome,â€ he adds.
The upper right quadrant of Covid and secular winners is more attractive, provided valuations are still reasonable. One holding that checks both boxes is Grand Canyon Education (LOPE), a for-profit accredited university with a physical campus in Phoenix and a large and growing virtual student body. â€œOnline education is their bread and butter, and they were doing this successfully before the pandemic,â€ says Schmitz. The fund first invested in late 2019 when the stock was trading around 13 times 2020 consensus earnings, and it has since added to the position. While the company has seen its enrollments increase because of the pandemic, its affordable price tag makes it a secular winner as well.
The final quadrant of Covid losers and secular winners offers the most potential for stock picking now, the managers say. One such company is Wyndham Hotels & Resorts (WH), which they bought in 2019. The stock traded at a significant discount to other hotel chains in part because it didnâ€™t have the same share of business travel. That may work in its favor when demand returns. â€œItâ€™s really well-positioned for family travel,â€ says Taylor, adding that because most of its properties are franchised, the company has the advantage of being asset-light.
Shoemaker Skechers USA (SKX) also fits the category of Covid loser and secular winner. The stock tanked in the early days of the pandemicâ€”people stopped buying shoes, much less wearing themâ€”but the companyâ€™s â€œsqueaky cleanâ€ balance sheet and 20% net cash per share gave the managers the confidence to add to their position, which they initiated in 2019.
The two dominant players, Nike (NKE) and Adidas (ADS.Germany), spend heavily on marketing. Skechers has become the No. 3 athletic shoemaker in the world by focusing on a lower price pointâ€”while indirectly benefiting from its larger competitorsâ€™ global campaigns promoting athletic wear. Skechers stock has yet to recover to its pre-Covid highs, but the managers think it could benefit from a trifecta of expanding valuations, improving margins, and secular growth.