The shortage of UK housing, the wealthy and aging population and the recovery in global industrial production are the three key themes UK mid-cap investors should keep their eye on if they want to maximise gains this year, according to Franklin Templeton’s Paul Spencer (pictured). 
The FE Alpha Manager, who heads up the £918m Franklin UK Mid Cap fund, is also underweight real estate, travel & leisure and support services, with zero per cent weightings in pub stocks or physical betting shops.
Overall though, he says there is a wealth of opportunities in the UK mid-cap space presenting themselves through valuation anomalies, despite the fact the FTSE 250 index is trading on a “fully-valued” prospective price/earnings (P/E) ratio of 15 times.
Performance of indices since start of data
Source: FE Analytics
“We have a portfolio full of balance sheet strength which creates optionality in terms of capital allocation, so the management teams that we’re invested in have significant options to enhance shareholder value through capex, acquisitions, dividends and buybacks,” Spencer said.
“We have companies which I think can comfortably generate 10 per cent-plus returns without really stretching the imagination too much in terms of operational delivery, and that is enhanced in certain instances through significant buybacks and special dividends, which are really helping the TSR [total shareholder return] of the portfolio.”
In terms of sector overweights, the manager currently holds an additional 5.9 per cent in chemicals, 5.4 per cent in financial services and 3.5 per cent in media relative to its FTSE 250 benchmark.
However, he says the largest overweight is due to two significant individual positions in chemicals and personal care business Elementis and polymer solutions supplier Victrex, as opposed being to an overall sector bet.
“Our financial services [exposure], which we’re overweight by 5.4 per cent, is very diverse – we have Ashmore, Close Brothers, Intermediate Capital, IG Group, Rathbones, so there are really very different drivers among those stocks and I don’t mind being overweight that space given the great diversity of opportunities we have,” Spencer explained.
“Within media, one or two stocks of the stocks are probably misclassified. Zoopla I really don’t think is a media stock. We also hold Euromoney which I would probably classify as a financial or other.”
While he says his underweight in support services is insignificant because of the broad range of companies in the market area, Spencer says his underweights in travel & leisure as well as real estate investment trusts are active positions.
Franklin UK Mid Cap is 4 per cent underweight the former and 3.4 per cent underweight the latter compared to its benchmark.
“We don’t own any of the pub stocks, transport stocks or UK-based gambling stocks; real estate we’re quite significantly underweight,” he continued.
While Spencer and the team adopt a bottom-up stock selection process and maintain a high-conviction, low turnover portfolio, there are three main overarching themes they are deliberately maximising their exposure to. One of these themes is the UK’s ageing and wealthy UK population.
“We’re trying to pick up services there through companies such as Spire Healthcare the private hospital operator, McCarthy & Stone the assisted living developer and Homeserve, whose customer base is typically more elderly and are more are concerned about plumbing and drainage issues in the home,” the manager continued.
“We also have exposure to wealth management firms such as Rathbones and [financial institution] JRP Group is a play on this is well. They have quite a significant equity release business within their portfolio of operations.”
While Spencer is negative on REITs, he is playing the shortage of UK housing through Bellway, McCarthy & Stone and brick-making business Ibstock.
He says Ibstock, which is a market leader in its field, is a particularly attractive alternative to holding more than one housebuilder for those looking to benefit from the housing shortage.
“There is a very robust supply/demand situation within Ibstock at the moment, it’s extremely well invested and the asset base is very modern. We have a key way there to play increased housing production in the UK,” he explained.
“If you don’t want to call which housebuilder will do best of all, owning Ibstock is a really good way of playing underlying demand for an increase of bricks in the UK. It also has 20 per cent of its sales in the US which we think should be a positive over the next couple of years.”
When it comes to playing the global recovery in industrial production, Spencer has holdings in the aforementioned stocks Victrex and Elementis as well as IMI (Intermolecular) and BBA Aviation Flight Support. The latter two holdings partially rely on revenue from the US, which the portfolio has a bias to within its 50 per cent overseas revenue weighting.
“Against a background where, in fairness, the market is fairly fully-valued on a prospective P/E for the FTSE 250 of about 15 times, I think you can still find plenty of examples within our portfolio of companies that can generate significantly higher total shareholder returns,” Spencer concluded.
“I think we have some positions in stocks that will do really well over the coming years.”
Franklin UK Mid Cap is in the top quartile for its total returns over three, five and 10 years. Over the last decade, it has outperformed its benchmark and average peer by 65.7 and 113.81 percentage points respectively with a total return of 181.18 per cent, which is the seventh-highest return in the sector.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
The fund has a clean ongoing charges figure of 0.82 per cent and yields 2.63 per cent.