History suggests that there is more money to be made from mid caps. As our data shows, the FTSE 250 index has massively outperformed the FTSE 100 over the last 25 years.
Performance of indices over 25yrs
Source: FE Analytics
Investors are often wary of backing a market that has had a great run, but Chris St John (pictured) – manager of the £16.9m AXA Framlington UK Mid Cap fund – says he is still finding plenty of opportunities in the FTSE 250.
He says identifying investment themes is the best way of making money out of the dynamic mid cap market. St John and co-manager Nigel Thomas take a top-down approach by focusing on major profit drivers and then find the best companies to take advantage of them.
"Similar company profit drivers within the FTSE 250 can appear across sectors. Looking at companies from a thematic point of view, rather than by sector, can help identify these drivers and in turn find stocks that can provide significant investment opportunities," St John said.
He adds that there are four themes he is pursuing at the moment – namely "service, service, service", "UK survivorship", "technology change" and "supply-side constraint".
Here, he highlights four stocks that he believes are in pole position to make money out of these themes.
Spirax-Sarco
For his "service, service, service" theme, he is backing engineering firm Spirax-Sarco due to its impeccable customer-service capabilities.
"Many people underestimate the importance of service, but when a company gets this right, it can add significant value. We look for companies that provide excellent service, wrapped around a strong product offering," he said.
"One example is Spirax-Sarco, which produces boiler and pipeline valves for controlling the flow of steam and industrial fluids."
"For a chemical plant, the capital cost of these controllers is negligible when compared with the capital cost of the plant itself. However, a far more significant sum is the opportunity cost incurred if the plant stops producing because one of these controllers breaks."
"In this event, the speed at which a replacement can be fitted is crucial," he added.
Investors in Spirax-Sarco have been well-rewarded over the years. According to FE Analytics, the stock has returned nearly 700 per cent over the last decade – more than double the amount made by the FTSE 250 index.
Performance of stock vs index over 10yrs
Source: FE Analytics
Despite its long-term performance, there are only six funds in the IMA universe that count it in their top-10.
These include FE Alpha Manager Tim Wood’s McInroy & Wood Smaller Companies fund, and Unicorn Outstanding British Companies, which is run by the FE Alpha Manager duo of Chris Hutchinson and John McClure.
Sports Direct
St John says that Sports Direct is an example of a stock that has managed to capitalise from the downfall of others. Therefore it fits his "UK survivorship" theme.
"There are a number of UK stocks that have benefited from the downturn. A prime example of this is Sports Direct, the market-leading sports retailer."
"Sports Direct has managed to capitalise on the demise of competitors, such as JJB Sports, increasing its market share. We believe that this will in turn allow the company to grow its profit margins over time, thereby helping to fund future expansion into Europe," St John added.
Sports Direct has returned 120.46 per cent since it was listed in August 2007.
However, longer term returns have been hindered by a period of underperformance during its first year. For instance, if an investor had put £1,000 into Sports Direct five years ago, that lump sum would now be worth nearly £8,429.
Nine IMA funds count Sports Direct as a top-10 holding, including FE Alpha Manager Andy Brough’s Schroder UK Mid Cap fund and FE Alpha Manager Crispin Odey's CF Odey Opus fund.
Rightmove
St John says that "technology change" is one of the most important investment themes in the world at the moment and that Rightmove is a great example of a stock that has capitalised on it.
"Rightmove, the property search website, is a company that has profited from the growing use of, or even reliance on, the internet," he explained.
"Rightmove has established a fantastic market position and developed a dominant market share. House buyer and seller preference means that estate agents now risk losing business if they do not use the site, giving Rightmove great pricing power."
"The business has strong cash-flows and a low level of capital expenditure required for expansion."
Thirteen portfolios in both the IMA and closed-ended universes count it as a top-10 holding.
FE Alpha Manager Harry Nimmo is clearly a fan of the company as he has high weightings to it in both his open- and closed-ended Standard Life UK Smaller Companies portfolios and his Global Smaller Companies OEIC.
Ashtead
The final theme St John is playing within his fund is "supply-side constraint" and he highlights UK rental company Ashtead as one that has been able to make the most of a difficult situation.
"Ashtead, the equipment rental group, has taken market share during the economic slowdown," he said.
"It has been able to take advantage of the comparatively weak competitive position of other industry participants, given its strong financial standing and younger fleet."
"We expect the company to benefit from both the cyclical recovery in the US construction market and secular growth as construction companies outsource more of their equipment requirements to hire firms such as Ashtead," he added.
Ashtead has returned more than 5,500 per cent to its shareholders over 10 years. As St John highlighted, its performance has picked up along with the US cyclical recovery.
Since the start of the year, the stock has returned 64.98 per cent while the FTSE 250 index has made 20 per cent.
Performance of stock vs index year-to-date
Source: FE Analytics
Ashtead is by far the most popular of the stocks that St John mentions in regard to his peers.
It crops up in 47 IMA funds' top-10 holdings, two of which – Marlborough Special Situations and Marlborough UK Leading Companies – are managed by FE Alpha Manager Giles Hargreave.
