Mid-caps had driven the UK market last year and managers who had a decent weighting to them outperformed their peers and the FTSE All Share. However, the FTSE 250 has significantly slumped over recent weeks. However Coombs, head of multi asset investments at Rathbones, has been using this period of relative weakness to top up his holdings in the sector as he expects mid-caps to continue to outperform over the medium term.
“There is no doubt they were looking a little over stretched,” Coombs said.
“They had done so well versus large caps and you had to expect that to unwind over the short term. That is what is going on now, but it is healthy and it gives us the chance to top up some of our positions.”
The FTSE 250 had recently broken through its historic record and, according to FE Analytics, the index returned 32.27 per cent in 2013, which was 14 percentage points more than the returns of the FTSE 100.
However, while mid-caps started the year strongly, prices have fallen considerably over recent weeks. That fall means that the FTSE 250 has lost 2 per cent over the last month while the FTSE 100 has delivered a positive return.
Performance of indices over 1 month
Source: FE Analytics
A number of managers had warned that mid and small-caps were looking expensive.
One of the most notable of those was FE Alpha Manager Alex Wright, who specialises in that area of the market. He told FE Trustnet in December last year that the pool of attractively valued companies in that space was shrinking daily.
Toby Ricketts, who heads up various fund of funds at Margetts, was also concerned that various bubbles, like in the FTSE 250, would deflate over the course of 2014.
Coombs agrees that the market had become frothy. “2014 is behaving kind of like we expected it to,” Coombs explained.
“Markets had got a bit ahead of themselves by the end of last year and so we raised quite a lot of cash.”
“Where valuations were, we felt the market was fully valued and we would need stronger earnings and economic growth to really push on, but that clearly hasn’t happened.”
“We needed a time to pause and for investors to re-adjust. We have certainly been using the current sideways movement to tinker with the portfolio. We had come into Q1 with a lot of cash, so we have been pushing that up recently.”
The managers’ high weighting to cash has helped his risk-targeted Rathbone Multi Asset Strategic Growth, Multi Asset Enhanced Growth and Multi Asset Total Return portfolios’ performance this year.
For instance, the FE Alpha Manager’s Rathbone Multi Asset Total Return Portfolio has delivered a positive return so far this year, while global equity markets have lost money.
The major reason why Coombs is bullish on mid-caps is because he wants to generate alpha in his portfolios. He warns that simply tracking the market in the current environment will lead to poor returns.
“One of our core themes this year is that we do think you need to generate more alpha, rather than just beta, because beta is expensive,” Coombs said.
“We have bought more focused portfolios, which has hurt us over the last few weeks with mid and small caps selling off. However, there is no doubt that this is an opportunity, so we have been adding.”
“If I’m looking on a three to five year view, mid and small-caps is where you want to be in a micro and fundamentally-driven market rather than the macro, risk on-risk off driven market which we had been through for three to four years up to the middle of last year.”
Coombs has been buying the Schroder UK Mid Cap Investment Trust, which is headed up by the FE Alpha Manager duo of Andy Brough and Rosemary Banyard.
According to FE Analytics, it has been the best performing portfolio in the IT UK All Companies sector over 10 years with returns of 388.58 per cent but, more importantly, it has beaten its FTSE 250 ex IT benchmark by more than 135 percentage points over that time.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
It has also comfortably beaten the index over rolling one, three, five and seven year periods having only underperformed against its benchmark in two of the last 10 discrete calendar years; which were 2007 and 2009.
The closed-ended fund’s discount has widened following the sell-off. It currently trades on a 3.73 per cent discount to NAV and while that is narrower than its one year historic average, it has traded on a premium at times during the last 12 months, according to data from the AIC.
Schroder UK Mid Cap has gearing of 1 per cent and has ongoing charges, plus a performance fee, of 1.58 per cent.
Coombs admits that he would normally always choose an investment trust over an open-ended fund – especially in the mid-cap space – due to liquidity and as closed-ended managers don’t have to deal with inflows and outflows.
However, he is comfortable using the AXA Framlington UK Mid Cap fund because of its relatively small AUM and has been buying units in it over the last week as well.
The now £71m fund, which is managed by Chris St John, was launched in March 2011. It has performed well over that time and with its returns of 73.8 per cent it has been a top quartile performer in the IMA UK All Companies sector and beaten the FTSE 250 by close to 30 percentage points. It has, however, fallen further than the market over the last month.
Performance of fund vs sector and index since Mar 2011
Source: FE Analytics
The AXA Framlington UK Mid Cap fund’s clean share class has an ongoing charges figure (OCF) of 0.88 per cent.
