UK funds focusing on FTSE 250 stocks have had a very painful few days following last week’s Brexit result. 
A Leave victory at the polls was always likely to cause volatility for mid-caps, but given the market wasn’t expecting such a result on Thursday, some of the share price falls within the index have been severe.
The reasons for that are twofold. The first relates to currency: not only does a weaker sterling naturally benefit FTSE 100 companies (which tend to have more international exposure) more so than in the FTSE 250, but given the latter index is more domestically-orientated, the added import cost could well hurt some well of its constituents.
The second revolves around the outlook for the UK economy. Many fear that Brexit will spark a so-called DIY recession, which again would put pressure on many mid-caps given their earnings are dependent on domestic economic growth.
According to FE Analytics, for example, the average IA UK mid cap fund is down a hefty 12.32 per cent since the Leave vote was announced. That compares to a 5.62 per cent loss from the FTSE 100 and a 7.41 per cent loss the IA UK All Companies sector.
Performance of UK mid cap funds since Brexit vote
Source: FE Analytics
There are quite a range of performances within that sub-sector, though.
Investors in the Old Mutual UK Mid Cap fund, for instance, are sitting on a 15.5 per cent loss since Friday while Neptune UK Mid Cap fund has managed to limit losses to 7.58 per cent.
The major frustration for investors is that uncertainty is expected to remain for the foreseeable future. While UK equities have rallied back so far this morning, very few expect a bull market as comments from UK politicians, members of the EU and central bankers along with economic data points are likely to cause violent price swings over the coming weeks and months.
The other point worth bearing in mind, on the other hand, is that investing is supposed to be a long-term game. Therefore, should investors use this volatility and uncertainty to pick up discounted assets or is this an excuse to trim holdings and look for other opportunities outside the UK mid-cap space?
Data from Hargreaves Lansdown suggests many investors sit in the former camp, after 80 per cent of all transactions on its platform on Friday were purchases. Indeed, all 10 of the most bought shares that day were in companies that are closely tied to the UK economy.
Ten most bought stocks on Hargreaves Lansdown on Brexit Friday
Source: Hargreaves Lansdown
“Private investors continue to buy into the market, with banks and house builders proving to be the most popular purchases,” Laith Khalaf, senior analyst at Hargreaves Lansdown, said.
“Adventurous investors with a long-time horizon might consider starting to drip feed money into the market, but they’ll need to hold onto their hats as it’s likely to be a choppy ride.”
Given the FTSE 250 index is down 14 per cent in price terms since Friday, Sharon Bentley-Hamlyn – fund manager at Aubrey Capital Management – the FTSE 250 now looks like a very interesting hunting ground.
“The FTSE 250 is trading on a 12-month forward P/E ratio of 14.6 times for 31 per cent estimated EPS growth, which looks very healthy and inexpensive in terms of price earnings to growth ratios, even if growth materialises at a slightly lower level,” Bentley-Hamlyn said.
FE Alpha Manager Mark Martin, whose £605m fund has been the best performing FTSE 250-benchmarked portfolio since the EU referendum, says that investors shouldn’t get carried away by the falls and urges a selective approach at this point in time.
“It is too early to talk about valuations as markets are extremely volatile at present, and sell-side earnings revisions have yet to take hold,” Martin said.
“However, where we have seen share price falls in spite of likely currency-related earnings upgrades, our analysis suggests that there are clear opportunities for small and mid-cap investors with a medium to long-term time horizon. This includes potential strategic buyers, especially from the US given the relative strength of the US dollar.”
“One cannot ignore the obvious impact Brexit and the uncertainty around it will have on consumer confidence and GDP growth, but for active stock pickers there are many quality companies whose price falls are likely to overstate the impact on their fundamentals.”
Martin launched the Neptune UK Mid Cap fund in December 2008.
According to FE Analytics, not only has it been a top decile performer in the IA UK All Companies and comfortably beaten its benchmark over that time, the fund has also been one of the best in its peer group at protecting capital (as shown by its downside capture ratio, maximum drawdown and Sharpe ratio) despite its focus on FTSE 250 stocks.
Performance of fund versus sector and index since launch
Source: FE Analytics
Martin attributes this return profile to his three silo approach whereby he holds at least 20 per cent in economic recovery, structural growth and corporate turnaround stocks in an attempt to shield investors against potential market falls.
It is due to his approach, therefore, that he believes his fund will hold up again if the FTSE 250 goes through another painful period thanks to Brexit.
“The uncertainty created by a referendum on Brexit has already weighed on investor sentiment in the run-up, acting as a drag on mid-caps in particular given that the FTSE 250 is more geared into the domestic economy than the FTSE 100,” Martin said.
“It is, however, important to remember that the mid-cap index derives more than 50 per cent of earnings overseas and furthermore that we have deliberately positioned the Neptune UK Mid Cap fund to be more exposed to overseas earnings than its benchmark.”
“Many of our holdings, particularly in the healthcare and industrials sectors, actually stand to benefit from the weakness in sterling through currency-related earnings upgrades.”
