It has been a tough 18 months for growth stocks after a decade of stellar turns. Rising interest rates have weighed heavily on them with non-profitable and unproven businesses being the main casualties of higher discount rates, which have in turn led to multiple compression.
The Russell 1000 Growth index suffered a 27.1% loss measured in US dollars in the year through end of October, its steepest loss since the global financial crisis. The Russell 1000 Value index, in contrast outperformed the growth index by almost 17 percentage points during the same period.
Some asset managers have said that the markets may be finally bottoming out as share prices rally on the expectation that inflation has peaked, although it would take a brave investor to make that call at the moment given that the trajectory of the US economy and the Fed’s tightening cycle remain uncertain.
The change in sentiment has also impacted fund flows for European-domiciled US large-cap growth equity funds. The funds classified in the Morningstar category US large-cap growth equity recorded three consecutive quarters of record outflows, totaling almost $12bn.
Against this backdrop, Jeffrey Schumacher, director of manager research at Morningstar, chose the Morgan Stanley INVF US Growth fund and the MFS Meridian US Concentrated Growth fund for comparison for this week’s head-to-head series.
|MFS Meridian||Morgan Stanley|
|Managers||Jeffrey Constantino, Joseph Skorski||Dennis Lynch|
|Three-year cumulative return||7.33%||2.57%|
|Three-year annualised return||-15.47%||-1.39%|
|Three-year annualised alpha||1.01||-3.93|
|Three-year annualised volatility||22.90||42.89|
|Three-year information ratio||0.13||-0.26|
|Morningstar star rating||****||**|
|Morningstar analyst rating||Bronze||Silver|
|FE Crown fund rating||***||*|
Both funds use compact portfolios, although they have very contrasting investment philosophies. The Morgan Stanley fund looks for companies with defensible business models that dominate their markets or benefit from a strong network effect.
It also eschews some of the top constituents of the Russell 1000 Growth index including Apple, Microsoft, Alphabet and Amazon.com and opts for smaller stocks that have the potential to disrupt industries even if they appear expensive using traditional valuation methods.
As would be expected for any growth fund, it has large weightings in the information technology, healthcare and communication services sector despite the fact that it does not closely track the Russell 1000 Growth index because of the preference for smaller disruptors.
Meanwhile, the MFS Meridian fund looks for companies with deep, durable competitive advantages and healthy balance sheets but won’t pay outsized premiums for them. It is slightly underweight the technology sector compared with the benchmark.
“This portfolio is generally on the conservative side for a growth fund and investors should not expect a lot of young, high-flying stocks here. The managers here will not buy unproven growth, meaning that they may be late to the party and lag more aggressive peers at times, but they won’t blow up because of overexuberance,” said Schumacher.
Generally, the managers take a patient approach to their investments and the current average holding period is over six years, while nearly 30% of the portfolio was first purchased more than a decade ago. Although, it has made some recent punts such as initiating a position in Adobe in April.
|MFS Meridian||Morgan Stanley|
|Information Technology||37.4%||Information Technology||38.14%|
|Consumer discretionary||12.1%||Communication services||16.92%|
|Communication services||10.6%||Consumer discretionary||13.73%|
|Cash and cash equivalents||0.7%||Cash||3.77%|
Top 5 holdings:
|MFS Meridian||Weighting||Morgan Stanley||Weighting|
|Microsoft Corp||n/a||Snowflake||7.86 %|
|Accenture||n/a||The Trade Desk||6.29%|
The Morgan Stanley fund has proved to be volatile with strong showings landing it near the category’s top in 2013, 2015, 2017, 2018, and 2020, while it fell towards the bottom in 2014, 2016, 2019, and 2021. The last couple of years is a case in point as it posted triple-digit returns in 2020 and is down more than 50% this year.
The portfolio’s technology holdings have been hurt by the broad sell-off due to rising interest rates as well as changes to Apple’s privacy guidelines, which weighed on several advertising-dependent holdings such as Pinterest, Snap and Twitter.
That volatility has been underscored by fund flows as investors poured into the strategy in 2020 during its ascent, only then to change course and rush for the exits in 2021. This prompted Morgan Stanley to close the fund to new investors, although it has since reopened.
“Shareholders who have owned MS INVF US Growth since the start of manager Dennis Lynch’s tenure have been rewarded, but they’ve endured some tough stretches,” said Schumacher.
Meanwhile, the MFS Meridian fund has showed the opposite traits. For many years, the managers avoided or underweighted some of the biggest constituents of the Russell 1000 Growth index on valuation concerns, which hurt investors in 2020 and 2021 but explains its outperformance this year.
The strategy is generally unlikely to lead when market exuberance is at its height, but it is generally good at avoiding blowups as well as tending to outperform when growth stocks are less in vogue.
Discrete calendar year performance
The Morgan Stanley fund is headed up by Dennis Lynch, who comes with a solid reputation and a knack for avoiding turnover. He works alongside 24 team members, seven of whom have double-digit tenures.
The team has not seen any departures since 2011 and has been steadily adding to its ranks with the likes of Michael Mauboussin and Dan Callahan joining the asset manager. Lynch has also been growing the analyst team in key sectors including healthcare and technology.
While Lynch’s team a bottom-up approach to investing, it also includes four analysts who focus on big-picture, disruptive changes.
“Dennis Lynch fosters a unique and long-term investment culture that embraces curiosity, flexibility, and self-awareness. He anchors a stable, experienced team and has had success developing and retaining team members,” said Schumacher.
Meanwhile, Jeff Constantino started managing the MFS Meridian fund in July 2017 and was joined by fellow co-manager Joe Skorski two years later.
Constantino started managing the fund’s US-domiciled and broader diversified cousin, MFS Massachusetts Investors Growth Stock, in November 2006 following a six-year stint in equity research on MFS’ central analyst team, while Skorski also began his career on the equity research team.
The research team is one of the strategy’s main selling points as it is backed by approximately 100 fundamental analysts, including 60 equity analysts, spread across eight sector teams. Both managers also have a team of credit analysts at their disposal in case any solvency issues arise as well quantitative analysts to help with risk monitoring.
“MFS Meridian US Concentrated Growth is managed by two capable comanagers taking advantage of a sizeable and adept analyst team,” said Schumacher.
Morningstar awards the Morgan Stanley fund two stars and an analyst rating of silver, while MFS Meridian earns four stars and an analyst rating of bronze.
FE Fund Info gives Morgan Stanley one star and MFS Meridian three stars.
Overall, Schumacher notes the discrepancy between the two analyst ratings.
“Our higher conviction in the team managing MS INVF US Growth and lower fees drive the rating differential. This means that Morningstar’s analysts think that MS INVF US Growth has a greater ability to generate a positive alpha versus the Russell 1000 Growth index over a full market cycle,” he said.
However, he notes that the Morgan Stanley fund is not suitable for all investors given its volatility.
“Investors looking for a more conservative US growth strategy can consider MFS Meridian US Concentrated Growth,” he said.