UKOct 31 2016

Fund Review: Royal London UK Mid Cap Growth

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Fund Review: Royal London UK Mid Cap Growth

This £367m fund seeks capital growth over the medium to long term, which manager Derek Mitchell views as five to seven years, and invests in FTSE 250 companies with the aim of outperforming the benchmark.

Mr Mitchell acknowledges his approach to selecting stocks for his portfolio is different to most in that his starting point is top-down, rather than bottom-up. He explains: “It’s about building a picture of what is happening at the top-down level, rather than going straight to picking companies, and what is having the greatest impact on the markets at any one time. Once I am sure in my mind as to what is going on, the focus [will be] on those parts of the market that will have the biggest positive influence on whatever’s happening at the top-down level.”

The manager notes the market is currently focusing on whether the bull market in bonds has come to an end, and the potential implications this will have on equity markets and sectors. He says: “The focus for the past few weeks has been on the bond proxy consumer staples and they’ve certainly performed very well. I think their outperformance could start to be questioned, and that’s the sort of thing where top-down will have an impact on my sector and therefore stock selection.”

Mr Mitchell has a preference for cash-generative firms in terms of the holdings he chooses, meaning cashflow is a key fundamental. “We look for companies that use that cashflow to generate good growth and earnings and a dividend,” he says.

The manager has recently been adding to existing holdings, rather than initiating new positions in the portfolio. An example is aviation services firm BBA, where a positive meeting with management prompted him to add to the firm. He explains: “BBA transformed itself through an acquisition of one of its main competitors and there was a big worry at the time that it had bitten off more than it could chew. It took a lot more debt on to finance this deal and there was a worry that this would be a struggle for BBA. But we’ve had a positive meeting with the management that very much reassured us in terms of the speed at which they could pay down that debt, and as a result we added to our holding.”

The fund sits at the riskier end of the risk-reward spectrum at level six out of a possible seven, while an ongoing charges figure of 0.75 per cent applies to the M-accumulation clean share class.

The fund has outperformed its sector over the longer term, with the M share class delivering 111 per cent in the five years to October 21 2016. The IA UK All Companies sector returned an average of 69.3 per cent in the same period, while the FTSE 250 index gained 100 per cent.

But Mr Mitchell admits it has been “a bit of a struggle” to match the benchmark over the past year. Data from FE Analytics reveals the fund generated a modest 0.3 per cent in the 12 months, while the peer group averaged 9.6 per cent and the index was up 8.3 per cent. “I think that our exposure to consumer areas going into the referendum was, in retrospect, too high,” he says. 

He notes that retailers have suffered in the wake of the vote as many of them source goods in US dollars. “The fall in sterling has raised questions as to whether the retailers will be able to pass on the increased costs [to customers]. We saw this rear its head in the press recently with Tesco and Unilever. The input costs for [the suppliers] has increased and they want to put the prices up, but you can understand why some of the retailers are reticent [and] feel they might not be able to pass on the costs.”

The manager highlights Zoopla, Dechra Pharmaceuticals and Melrose Industries – all of which have made acquisitions recently – as holdings that have boosted the fund’s performance.

He adds: “We have reduced exposure to consumer areas, and reduced some weightings to the bond proxies I mentioned. So [we are] taking money out of utilities and putting it to work in selected names across the fund that I believe will continue to perform well. I’m not expecting a great pick-up in growth. I think the reports we’re hearing from the US third-quarter earnings season would certainly point that way. It’s still very much a struggle for industrial companies.”