Best in Class: Mid caps good for long term

Best in Class: Mid caps good for long term

After a long period of outperformance, mid caps began the year on the back foot, with falls far outpacing those seen for some larger stockmarket peers. Is this the start of a reversal in fortunes, or is now the time to make a good value buy?

Over the past year, FTSE 250 returns still beat those of the FTSE 100, albeit both are in negative territory, at -4.7 per cent and -13.8 per cent respectively. So far this year, however, the renewed sell-off has seen the FTSE 250 lose 11 per cent to the FTSE 100’s 8.8 per cent fall.

A re-rating of many of the bigger name mid caps, such as Just Eat, Victrex and Rightmove, has been partly prompted by concerns the sector has become expensive.

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Many of the domestic drivers that boosted mid-cap returns throughout 2015 – such as low mortgage rates, falling oil prices, and lower gas and electricity prices, which have driven up consumers’ disposable income –look set to continue at least into the first half of 2016.

With the FTSE 250 index heavily weighted to non-bank financials, consumer services and industrials, it should continue to benefit from increased spending at home.

But a major storm cloud is looming for equities in general, and perhaps mid caps in particular – Britain’s upcoming referendum on whether to leave the European Union.

If there were a Brexit, it could be a catalyst for large-cap outperformance, at least in the short term.

Given around 75 per cent of FTSE 100 revenues are generated outside the UK, these companies would benefit more from any sterling depreciation, as their overseas earnings would get a boost.

However, while some polls may suggest it’s a close call, the bookies still firmly believe we will stay in the EU. Of the two options, at this stage I’d still follow the money.

Overall, there are some great UK companies in the mid-cap bracket and it is a diverse, dynamic area of the market where specialist fund managers can take their investment focus in plenty of promising directions.

In the shorter term, there’s a good chance we may continue to see increased volatility and underperformance in large caps. If I were investing today for the long term, I’d still happily bet on mid-caps.

The Franklin UK Mid Cap fund, for example, aims to outperform the FTSE 250 (excluding investment trusts) over a three- to five-year time frame. Paul Spencer has delivered impressive returns, both relative and absolute, during his tenure as fund manager since February 2006.

Mr Spencer manages a high-conviction portfolio, comprising just 37 stocks at the end of December 2015.

Understanding the risks associated with individual companies is vital in this space – even more so with such a concentrated number of holdings. The fund carries more stock-specific risk than its benchmark and is subsequently more volatile, but the manager has proven expertise in identifying high-quality companies.

His approach focuses on free cash flow and balance-sheet strength to help determine if a stock can deliver sufficient value over time.

This is a pure mid-cap fund and Mr Spencer is disciplined when it comes to investment decisions – selling companies that enter the FTSE 100 and never buying stocks in the FTSE Small Cap index, regardless of the opportunity.