Mid-caps have been the biggest beneficiary of improving domestic confidence in the UK in recent times, with the FTSE 250 index up 51.09 per cent over a two year period. This puts it well ahead of the FTSE 100. They’ve had a weaker period of late however, with lower-than-expected earnings growth leading to big falls from a number of mid-cap stocks on high P/E (price-to-earnings) multiples.
Worries over further shocks and cheaper valuations in the FTSE 100 index has led a number of managers to abandon their mid-cap overweights, but Barnett (pictured) thinks investors are wrong to tar all mid-caps with the same brush.
“We’re still positioned in them. It’s a 250 stock index, and so to generalise that all companies in the index are overvalued is ridiculous, in the same way as saying all of the companies in the FTSE 100 are cheap,” the manager said.
Performance of indices over 2yrs
Source: FE Analytics
“You need to be vigilant as in any part of the market, but it’s a big generalisation.”
Barnett believes that overall there is more value in large caps at the moment, which is why they dominate the top-10 of his Invesco Perpetual UK Strategic Income fund. He has recently taken charge of the much larger Invesco Perpetual Income and High Income funds and increased his mid-cap exposure in them, but all of his major positions remain in large caps.
He highlights mid-cap financials as perhaps the most attractive area in the FTSE 250 index at the moment, and would be tempted to add to his exposure if they are caught up in any mass sell-off.
“I have maintained my financials exposure and am happy to maintain it,” he said. “Potentially if they are weak because of certain perceptions of overvaluation, it could be appealing to add [to my positions.]”
This is not to say that he likes banks however, preferring companies in the financial services, asset management and insurance sectors. Hiscox, Beazley and Lancashire are among his favourite stocks.
He also holds FTSE 100 company L&G across his three open-ended portfolios, which he bought into significantly following the post-Budget sell-off earlier this year.
Outside of financials, he has a major position in Thomas Cook, which has been one of his biggest value adders for the top-performing fund in recent years.
Performance of fund, sector and index over 3yrs
Source: FE Analytics
Barnett’s comments are supported by an even more bullish Mark Slater, who told FE Trustnet last week that he expects the FTSE 250 to maintain its dominance in the performance stakes relative to the FTSE 100.
He has used the recent falls in the index to buy housebuilder Bellway and specialist financial services company Close Brothers – among others.
Other managers have taken money out of mid-caps, including JOHCM UK Equity Income’s Clive Beagles and Standard Life UK Equity Income Unconstrained’s Thomas Moore. Both have benefited significantly from their mid-cap exposure in recent years.
It’s possible to get exposure to UK mid-caps via funds in the IMA UK Equity Income sector and IMA UK All Companies sector that have a bias towards the FTSE 250. These include the likes of Invesco Perpetual UK Strategic Income, or if you are willing to take on more exposure, Marlborough Multi Cap Income or Unicorn UK Income.
Even more adventurous investors could go for a UK mid cap tracker such as HSBC FTSE 250 Index, or an actively managed fund like Schroder UK Mid 250 or Neptune UK Mid Cap, headed up by FE Alpha Managers Andy Brough and Mark Martin, respectively.
Rob Gleeson and his FE Research team favour the Neptune fund, selecting it as their only UK mid-cap portfolio in the FE Select 100.
“The portfolio is split into three groups: recovery, which is focused on companies that should do well if economic conditions improve; structural growth, which focuses on sectors such as healthcare that are growing despite a sluggish overall economy; and self-help stories, which consist mainly of struggling companies the manager believes have the potential to turn things around,” the team explained.
“By keeping at least 20 per cent of the fund in each group, manager Mark Martin aims to ensure he can perform regardless of economic conditions.”
Performance of fund, sector and index since launch
Source: FE Analytics
“Martin clearly has skill in identifying valuation opportunities in the mid and small-cap area. This, along with the silo approach, is the key to the stability of the fund and offers a lower-risk method of accessing a traditionally high-risk part of the UK market.”
The team points out that the fund should be bought with a time horizon of at least seven years, as its investment universe and style can often go out of favour for extended periods.
“Like the first two and a half years of the fund’s existence, there may be long periods when this value-oriented investment style will not perform as well, and investors should be prepared for this,” they said.
Commenting more broadly on the UK market, Barnett doubts that it will perform anywhere near as well in the foreseeable future as it has since the 2008 financial crisis.
“The stock market is on the expensive side of fair value,” he said. “It is up with events – certainly not bubble territory, but I think we can expect it to go sideways for a period of time.”
FE Trustnet will look at funds with a proven ability to outperform in sideways markets in an upcoming series.
“The big risk is the lack of earnings growth,” Barnett continued. “There is going to be some price vulnerability when expected profits are not fulfilled.”
“Other big issues are tapering in the States. We’ve been what effect that QE has had on asset prices and the absence of it could have the reverse effect.”
Barnett also points to slowing growth in China and growing geopolitical risks – namely the tensions in Iraq – as reasons to be wary.
He continues to view healthcare and tobacco as the two standout value areas in the FTSE 100. Glaxo, Astra, Imperial Tobacco and Reynolds American are top-10 holdings in Invesco Perpetual Income, High Income and UK Strategic Income.
“They have the characteristics of companies I want to own,” he said. “They are good value in the current market, given their ability to deliver growing, sustainable dividends.”
The manager adds that he doesn’t expect interest rates to rise this year, in spite of Mark Carney’s comments earlier this month.
