“There are fewer opportunities in mid-caps – fewer attractive investments than there were two years ago,” he said.Spencer, manager of the £948m Franklin UK Mid Cap fund, says the narrowing opportunity set has caused him to concentrate his already concentrated portfolio even further.
He points out that in 2012 the fund held 40 stocks and that number has been decreasing ever since. The manager now holds 36 companies in the portfolio.
“There are fewer genuinely attractive opportunities out there,” he said.
“At the start of 2012 we had 40 holdings. That’s been gradually shrinking. We haven’t had more than 40 holdings for two and a half years.”
Given the strong outperformance from small and medium sized companies in the latter part of 2012 and over 2013, Spencer says it makes sense there wouldn’t be as many opportunities out there on a valuation basis alone, but he doesn’t think it’s time to shift into large caps.
In 2012 and 2013 stocks in the mid-cap FTSE 250 index charged ahead, doubling the returns of the blue-chip FTSE 100. However, so far this year mid-cap stocks have only gained 1.97 per cent. The FTSE 100 is up 3.96 per cent, according to FE Analytics.
Year-to-date performance of indices
Source: FE Analytics
But Spencer argues that the FTSE 100’s outperformance is less the fault of company size and more a cyclical shift in the sectors which are finding favour.
He points out that some of the best performance has come from stocks in the tobacco, telecom and pharmaceutical spaces – none of which exist in the FTSE 250.
“Pharma, tobacco, oils, telecoms, mining and banks make up 50 per cent of the FTSE 100, 10 per cent of the FTSE 250 and only 2 per cent of my fund,” he said.
However, Spencer is sticking to his convictions and backing mid-cap housebuilders, retailers and leisure stocks which were hard hit in a Q2 selloff.
“We had stocks that were very badly hit share price wise without obvious reason,” he said. “It was a painful period for domestically exposed stocks.”
The manager said he was also being pinched on the export side, as UK companies were squeezed by the strong pound.
He admits the sell-off hurt the portfolio in the short term, but rather than sell out of positions the manager used the re-rating to top-up a number of existing holdings and buy some new positions at what he considered “finally attractive valuations”.
“We’re quite contrarian and we like doing the opposite to everyone else,” he said. “We topped up housebuilders because we thought we were getting a second bite of the cherry. We also added Booker, which was a stock I wanted for a long time but it looked expensive. It went from £1.80 to £1.30 so we took the opportunity to start a holding at a price we thought was attractive.”
It’s often tough for investors to steel their nerve and hold onto stocks when the share price is hard hit, but Spencer says his conviction comes down to experience.
“I’ve been in the market since 1987 and seen everything that can get thrown at us from a markets perspective. You have to ask ‘is it fundamentally changing the [reasons I bought the company] or a short-term shakeout’,” he said.
The manager adds that being based in Leeds, away from the masses, helps him and the rest of the Franklin UK Equity team step back and take a look at the market, which he says saves them from a lot of “communal thinking”.
The Franklin UK Mid Cap fund has an outstanding track record over the medium and long term, though Spencer admits its performance has lagged the market over the last 12 months.
Over the last eight years since Spencer took over the portfolio, it’s made 194.92 per cent, more than the FTSE 250 ex IT index and more than tripling the returns of the average fund in the IMA UK All Companies sector.
Performance of fund, sector and index since 2006
Source: FE Analytics
Spencer stresses that his fund is a pure mid-cap fund. Every single holding in the portfolio is a constituent of the FTSE 250 index.
“If it goes into the FTSE 100, we will sell it. I’m not messing about in large caps and not fiddling about in small caps,” he said.
This is contrary to a number of other UK mid-cap funds, like the Threadneedle UK Mid 250 and Old Mutual UK Mid Cap, which hold FTSE 100 equipment rental company Ashtead Group in their top holdings.
In the case of the Old Mutual portfolio, Ashtead is the largest holding. The fund also has exposure to Dixons Retail, which is likely to be boosted into the FTSE 100 on the back of the firm's merger with Carphone Warehouse.
While Spencer is allowed to hold up to 20 per cent of his mid-cap fund in FTSE 100 stocks – essentially giving him the ability to ‘run his winners’ – the manager prefers to boot companies out of the portfolio when they hit blue-chip status.
He argues this gives investors real mid-cap exposure and stays true to the process of the portfolio.
Franklin UK Mid Cap has ongoing charges of 0.82 per cent.
