The Investment Association (IA) is considering launching a new UK mid-cap sector with up to 14 dedicated mid-cap funds potentially moved out of the IA UK All Companies sector, FE Trustnet can reveal.
It is well understood that UK funds have been reliant on mid-caps to drive outperformance over the last five years – and dedicated mid-cap funds have been an almost permanent presence in the top quartile of the IA UK All Companies sector.
In a letter to members of the asset manager trade body seen by FE Trustnet, the IA enquired about support for a UK equity mid-cap sector and whether investors and investment advisers would benefit from an additional sector.
“The [sectors] committee has recently been discussing the sub categorisation of the IA UK All Companies sector and whether sector users, particularly consumers and their advisers, would benefit from a UK Equity Mid Cap sector,” it noted.
Members have been asked whether they would join the new sector or would prefer to remain in the broad UK All Companies sector. They have also sought feedback on how the sector should be defined and monitored.
Fund management houses have been given until 9 June to submit their responses to the new sector.
In a statement to FE Trustnet, a spokesperson for the IA said: "The IA continues to review and monitor the sectors across the board to ensure that they work in the best interests of consumers and their advisers and appropriately reflect the wide range of funds the industry has to offer."
Commenting recently, Ryan Hughes, head of fund selection at AJ Bell, said it was important for investors to understand how new sectors are established.
He said: “The IA is effectively the industry managing itself and the sector committees are made up by members of their own firms.”
IA members can put forward proposals for a new sector and if the IA’s sectors committee agrees they will put the sector to members for consultation, said Hughes. If the feedback is positive the trade body can begin implementing a new sector, but the process is led by the fund groups themselves.
A mock-up of the potential mid-cap sector shows that it has outperformed the IA UK All Companies sector by 32.19 percentage points as mid-caps have outperformed their large-cap peers.
Performance of sectors over 5yrs
Source: FE Analytics
FE Trustnet has asked the experts from across the industry for their views on whether it would be beneficial for investors.
Hughes said there was a strong argument for the huge IA UK All Companies sector – home to 264 funds and assets of £169.5bn – to be rationalised.
“I don’t know why it hasn’t happened. Why should a whole group of mid-cap funds be sat in there?” he asked.
“The reason they have sat in there and no one has done anything about it is because it’s been the place to be for so long and they’ve looked great.”
“The mid-cap funds themselves haven’t been clamouring for their own sector because they’ve been the stand-out funds in the All Companies sector so why would they want to separate themselves out and be compared against each other,” the analyst added.
Indeed, as the below table shows, the dedicated mid-cap funds have experienced an extraordinary level of success over the past half-decade.
Source: FE Analytics
Over the last five years all eligible mid-cap funds are in the top quartile of the IA UK All Companies sector while only one fund (Schroder UK Mid 250) drops into the second quartile over a three-year-period.
The worst performing mid-cap fund over the last decade has been the Aberdeen UK Mid Cap Equity fund, which has returned 102.63 per cent (10.46 percentage points lower than the FTSE 250) yet it is in the top quartile of the IA UK All Companies sector over the period.
“It has been beneficial for them to be compared against a load of large-cap stuff that they have outperformed,” Hughes said.
“But I think for fund buyer’s purposes would there be an advantage to them being split out? Absolutely. There is enough of them, it is well established, people understand it, you can now buy passives that track it and the market has evolved so it is therefore fair that it is a sector.”
Hughes added that while mid-cap funds haven’t been clamouring for their own sector because they’ve been the standouts in the UK All Companies sector, now could be the time for this change to happen.
He said: “I am sure that if mid-caps start doing very badly against large-cap they will be asking for it themselves because their quartile rankings will look so poor against everyone else.”
Last year, mid-caps struggled for the first calendar year since 2011, underperforming their large cap peers by 12.41 percentage points in 2016.
Performance of indices over 5 calendar years
Source: FE Analytics
Charles Younes, research manager at FE Invest, said: “Last year the mid-cap funds were compared to large-cap funds which had exposure to international equities and by definition they did pretty well while the mid-caps couldn’t invest in those companies.
“I think it’s good for them to have their own sector and not to be compared to funds that have the flexibility to move across the market cap.
“If you want to remove those managers it’s fine – it will be a very small sector with only 14 funds but why not?”
However, Younes said the boundaries should be stringent, with a clear target outlined in the same vein as the All Companies sectors.
He said: “For me the best way is to have a clear definition. Your target has to be the FTSE 250 and you have to be 90 per cent invested in the mid-cap space like they typically enforce in sectors such as European equities or Japanese equities.
“You can have 5 per cent allocation to cash and a bit away from mid-caps but 90 per cent needs to be in the mid-cap space. It’s better than having a vague or not very clear definition.”
Ben Willis, investment manager at Whitechurch Securities, added that he too is positive about the idea for the creation of a UK mid-cap sector.
He said: “I think that could work – we have a small cap universe, so it would make sense for a mid-cap sector too – there must be enough funds. It would certainly provide a more pertinent sector benchmark to use in conjunction with the FTSE Mid 250.”
However, not all advisers were as keen on the idea. Mike Deverell, partner and investment manager at Equilibrium, said: “I don’t think a specific mid cap sector would be worthwhile.
“It’s an arbitrary term as it is defined in different ways – does it mean just the FTSE 250 or is it defined by company size?
“There is little significance of a stock being the 101st biggest in the UK and therefore outside the top 100.”
Deverell added: “I think generally the sectors are imperfect but they are just a starting point for research.
“A good adviser should then be digging into why the fund has outperformed and working out if that is sustainable, due to a strong process, or perhaps just luck. This should always include market cap exposure.”