Andy Brough's schroder mid-250 fund has outperformed by avoiding insolvent companies and by anticipating future trends
Even though large cap stocks tend to rally first in a market recovery, it is fundamentals that drive share prices over the long term, Andy Brough, manager of the Schroder Mid 250 fund, said.
Brough has managed the Mid 250 since its launch on 15 November 1999 and last month it was upgraded by Standard & Poor's from an AA rating to an AAA rating.
If the market recovers, what will happen with small and mid cap companies?
Large caps always recover first. People always tend to look at large companies first but this does not last too long because things only stay up if there is a valid reason for them going up in the first place. If there is a war tomorrow and the market falls, the large companies would be the ones to fall first. If there is no war tomorrow and peace breaks out, large companies will go up first. However, at the end of the day fundamentals will out.
What is your average holding length of a stock?
It depends. If something shoots through and goes into the FTSE 100 we will sell it. Our holdings simply reflect where we see growth at any one time. In the past growth has come from the housebuilding sector and it is now broadening out to pharmaceuticals and other sectors.
How quickly can you sell a stock?
Liquidity problems only exist if everyone is trying to do the same thing, so half the skill is trying to identify things ahead of other people. Getting out and trimming telecommunications stocks before the end was key and that is how we approach all sectors, be they consumer or any other.
How much money do you run in total now at Schroders? How much can you run before it becomes a problem?
In the small and mid cap team in the UK we run around £2.25bn in retail and institutional money, with the fund itself at around £340m. I feel comfortable running up to £1bn in the fund. You have to be ahead of the curve and buying things before other people and this gets difficult when it exceeds this amount.
What are the main dangers of investing in the mid-250 area?
Holders of Independent Insurance, Independent Energy and SFI will tell you that mid-cap stocks can go bust and holders of Railtrack narrowly escaped with their shirts. We never held these stocks, nor did we hold Marconi or Energis, so while running this fund no hard lessons have had to be learnt so far. The lessons we have learnt have come from running small-cap money.
Who are your peers and should there be a mid-cap sector created?
Ashton Bradbury at Old Mutual is my main peer. There needs to be a few more funds before a mid-cap sector is created but it's a good idea. At the moment there are 81 funds in the small cap sector and there are only three mid-cap funds, our fund, Bradbury's Old Mutual UK Select Mid Cap Fund and BWD UK Mid Cap Growth, so there do need to be a few more funds yet.
What are the key questions an intermediary should ask a mid cap manager to ascertain whether they are good or not?
How is the portfolio moved around? At any one time a mid-cap should have exposure to what is going on in the economy.
In the tech boom the fund was heavily technology-orientated and in the value boom it was heavily value-orientated.
A lot of companies only perform when they are in the FTSE 250 and can't hack it when they break into the FTSE 100. Another question to ask is whether the manager held any of the stocks that went bust.
What are your long-term ambitions? Do you have any desire to run a hedge fund?
The only hedge I have been looking at is the one in my garden that needs cutting. My ambition long-term is to just carry on managing the fund.
How would you describe your investment process?
We use a unique method of slotting companies into three categories, A, B and C, depending on what investment opportunities they offer. The most important characteristic of the 'A' companies is that demand exceeds supply for their products. Usually you'll find these companies in new growth industries which have high barriers to entry. Essentially these companies can produce superior margins and will tend to grow regardless of the economic cycle. Obviously, this is the preferred area of investment.
The 'B' companies do have good growth prospects but also tend to have a number of competitors. This means that share prices are prone to fluctuation and investment timing is key. We take advantage of these stocks when their valuations are attractive.
The 'C' companies operate in industries that are in long-term decline and show little growth prospect and, therefore, are not that attractive. The thing you have to remember is the constituents of these categories are not static.
For example, 'A' companies can become 'B' companies when more competitors arrive on the scene. Those who survive the competitive pressures and inevitable consolidation will eventually become 'C' companies.
What do companies have to demonstrate for them to be included in the portfolio?
Organic growth is the key. Acquisitions are high risk. Cash generation and strong balance sheets are important as well.
How many holdings are there in the fund?
At present there are 78 in the fund and our target holding is 65 to 70. We run between 3% and 5% cash and at present are running at 4%. This reflects the strong inflows to the fund at present, running at around £500,000 a day at the moment.
What are the overweight and underweight positions in the fund at present?
We are overweight in transport, due to the fact they are not building any more ports; defence stocks; housebuilders; contractors; and leisure and gaming stocks. We are still underweight in telecoms.
However, this is an area we are constantly monitoring and we recently bought Xansa, an IT contractor, at 40p, as new management has come in and refocused the business. We are always looking at this area of the market and are not averse to it but at the end of the day you have to go where you think you make your clients money. That could be in tech, transport, housebuilding or anything.
Is the recent market rally we have seen since 9 October sustainable?
Companies need to show that this rally is coming through into their profits and some of the recent results have not been too bad. So the key to if it can be sustained is whether the numbers keep coming through.
FUND MANAGER: Andy Brough
Joined Price Waterhouse in 1983 where he qualified as a chartered accountant, after a degree in economics.
Joined Schroders in 1987 as a UK Equity Fund Manager, becoming co-head of the UK Small Cap Team.
Currently co-head of the Pan European Small Cap Team at Schroders
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