The frAA rated £200m Dresdner Mid-Cap Trust, launched in 1974, has been managed by Derek Lygo since ...
The frAA rated £200m Dresdner Mid-Cap Trust, launched in 1974, has been managed by Derek Lygo since July 1997. The fund is ranked sixth of 234 funds, offer to bid, over three years to 31 May in the UK All Companies sector, and seventh of 285 funds over one year. The performance has, however, fallen over the short term, with the fund ranked 299 of 300 funds in the All Companies Sector, on a bid to bid basis over three months.
Jenne Mannion talks with Lygo about the fund's high exposure to technology stocks at the time of the correction and the process of constructing the funds.
How do you define a mid-cap company and how do you select the stocks?
Mid-cap companies have a market capitalisation band of £230m to £3bn and are anything within the FTSE 250 index. The first thing we do is strip out the 30 or so investment trusts in the mid 250. That leaves us with a 220 stocks.
The house style at Dresdner RCM is bottom up stock picking, therefore the best stocks basically find their way into the fund through a screening process. We screen stocks on three criteria, valuation, growth potential and quality. Through that screening process, every company has to meet all three criteria. About half the 220 mid-cap stocks get excluded, as they fall short of one of these criteria. If a stock is growing at less than say 10% a year, it is not very interesting. If it is on a P/E of 150, that is too expensive. Also if the company has an overstretched balance sheet or bad management it will also be excluded. So by doing that screening process I am left with an investable universe of about 110 stocks, from which I pick about 80.
Is 80 companies your standard amount of individual holdings then?
At the moment we have slightly more than 80 companies.
This is a result of changes in the FTSE index, whereby some smaller companies have entered the mid-cap universe and others, which were in the mid-cap, have ascended into the FTSE 100. At the moment I am holding both NSB and Alphameric. Both of these stocks are interesting, both involved in the provision of IT products and services to the retail industry.
Now I consider that I don't need both and I'm thinking of concentrating on just Alphameric, and taking money out of NSB, so there is a sort of rationalisation process to come. The maximum stock position at any given time will be 5%.
How has the mid-cap mandate left you restricted to investing in certain sectors?
In my investable universe there are three main areas that cannot be invested in. These are the big pharmaceuticals, banks and oil companies, as most of these fit within the FTSE 100. There are, however, other ways of playing the oil sector via exploration and production.
Likewise, while I cannot invest in big drug companies, there are some exciting mid-cap biotechnology companies. These are actually growing at a much faster rate than the big drug stocks, so I believe these are preferable for the growth investor.
You have very strong performance over one year and three years, but this has fallen over three months. What is the reason for this?
The short-term underperformance of the fund is a result of my high exposure to technology at the time of the correction in that market. Technology is our biggest over weighting in the fund and represents 26%, versus a benchmark of 6.6%. The correction in this sector has hurt us, but the fund is actually bouncing very strongly at the moment.
The peak in technology came at around the time of the index changes. That meant I bought into the less liquid smaller companies at the index change over, and sold the more liquid stocks. In the general sell-off in technology stocks, the smaller, less liquid ones, were hit much harder.
Those smaller stocks are now providing the biggest bounce so I expect that they will continue to recover a lot of that lost ground.
Did you make any changes to the portfolio based on what is happening in technology?
No I didn't, and I'm quite pleased that no changes were made. Obviously one has to have conviction, but also you cannot just totally ignore market perception.
However, I felt the sell-off in technology shares was mainly due to valuation concerns. There was also a lot of negative sentiment surrounding dot.com companies, which I tend not to invest in. That had a knock-on effect on all technology shares and I believe they will stabilise and start to go up again in due course. There are indications that this is already starting to happen.
Would you sell these companies even if you expected they still had strong potential?
I would tend to hold onto them for as long as possible but in the end I would sell them because this is a mid-cap fund.
The encouraging thing is that when you lose the bigger companies into the FTSE 100, there are still good opportunities among the smaller stocks. There were exciting growth media companies coming into my investable universe at the bottom end, to replace the big ones that had gone into the FTSE at the top end. This really has been the story over the last three years.
Apart from index driven changes, are you taking any strong bets at a sector level?
The most consistent bet has been the overweighting in technology issues and there are a number of companies that have niche positions in the market that I have been holding for quite some time.
One of the most interesting things at the moment is to look at the possibility of the interest rate cycle peaking and sterling weakening. What that would mean is I would have to take a closer look at cyclical companies and general industrials, and look to add to those holdings. To a certain extent I have been building up in that area in anticipation of sterling weakness.
We are underweight financials and over-weighting telecoms and media, and biased towards information technology. We are currently adding to industrials
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