The Analyst: The drama of mid-caps - they’ve beaten the big boys over 10 years
Friday 13 December 2013
The fortunes of the UK’s largest 100 companies are well publicised. You may note the FTSE 100 always tends to be the quoted index in the financial press and thus investors could be excused for focusing their attention on these corporate behemoths. Yet it is not terribly representative of the UK economy. For starters, the top 20 stocks account for nearly 50 per cent of the entire index and are largely international businesses.
In my view, the UK’s next 250 largest companies provide a much-better guide to the fate of our economy. Interestingly, the FTSE 250 (excluding investment trusts) would have been a superior place to put your money over the last 10 years. Over this period, the index has returned more than double that of the FTSE 100, growing by 270.6 per cent and 114.8 per cent respectively.
There are several dedicated mid-cap funds which have capitalised on this trend. One up-and-coming manager I believe is worthy of a closer look is Chris St John who manages the AXA Framlington UK Mid Cap Fund. The retail version of this fund launched in April 2011 and performance has been admirable so far.
Mr St John has had the opportunity to work closely with Nigel Thomas, manager of the highly successful AXA Framlington UK Select Opportunities Fund. The two managers have a close working relationship, holding debates on those mid-cap stocks not held in the other’s portfolio. Both managers share a similar philosophy, focusing on dividend growth and free cash-flow yields, while also managing money with an absolute-return mentality, taking little notice of the positioning of any benchmark. They are also both keen to follow company management who have been successful in the past. Overall, they seek positive change, be it to a business, through management or within markets. The key difference between the two is the size of company they seek; Mr Thomas does not tend to invest in businesses less than £100m in size.
Mr St John’s approach is relatively risk averse, preferring to run what he describes as a “fairly diverse fund” with around 60 to 80 holdings, and currently owning 71. His investment horizon is typically three to five years. The fund holds a minimum of 70 per cent in FTSE 250-listed companies, which increases to 80 per cent when including stocks similar in size, but do not feature in the index. A maximum of 15 per cent of the portfolio can be invested in the FTSE 100, providing some scope for Mr St John to run his winners as they progress from medium-sized to larger companies.
Mr St John’s investment process combines top-down and bottom-up analysis. He considers wider economic drivers; his current views incorporate themes such as technological change, UK survivorship, customer service and self-help management change. From a bottom-up perspective, Mr St John considers management track record, level of pricing power and high barriers to entry. He is also naturally valuation-aware, with price a key consideration.
There is no hiding the fact that medium-sized companies have outperformed their larger counterparts to a significant degree over the past five years by 126.8 per cent. Despite this, opportunities within mid-caps remain attractive. On average, companies in the FTSE 250 have higher earnings growth potential than most in the top 100. The index also offers greater sector and geographical diversification. It is constantly refreshed with successful and growing smaller companies, while also being a greater beneficiary of merger and acquisition activity. Ironically, there is also declining analyst coverage in this area, which provides more opportunity to uncover anomalies not already recognised by the wider market.
Mr St John has a very credible track record and he is certainly on my list of up-and-coming fund managers to watch. The fund remains nimble at around £50m – an ideal size in my view, providing flexibility to invest in opportunities not available to other well-established funds. At the same time, he has the added advantage of drawing on the tremendous experience of the UK team at AXA Framlington, headed up by George Luckraft and Nigel Thomas.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit hl.co.uk/independent
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