The Schroders Mid 250 has been a popular choice for investors, but its size is raising some concerns. Kira Nickerson reports
There was a time when a fund that invested solely in UK mid cap stocks would have seemed a little specialist. However, after years of outperformance by the small to mid-cap end of the market the area has garnered more attention and, while considered growth-oriented, is more mainstream today than ever before. Highlighting this is the size of Schroders' Mid 250 portfolio, managed by Andy Brough, which at close to £3bn rivals some of the broader portfolios in the UK All Companies sector and is the only one of its type to be multi-billion in asset size.
Launched at the height of the technology boom and at a time when small caps were soaring, the fund appeared to be in for a bumpy ride as equity markets in general fell back significantly less than five months after the fund went on offer. Yet its cumulative performance figures still show strong positive growth. Over five years to 11 June the fund is ranked third out of a peer group of 221, with returns of 144.9%, before charges. Over the cumulative three years to the same end date the portfolio has done just as well, ranking sixth out of 256 funds based on gains of 101.2%, bid to bid, according to Morningstar data. This compared to the three-year average gain in the UK All Companies sector of 64.1%.
According to FTSE data over five years to the end of March 2007, the mid 250 gained just over 89% while over 10 years, which includes the bear market downturn 2000-2003, the index rose 155.44%. However, while the fund was top quartile in the three months to 21 May, it has since suffered from fears of a market sell-off, falling to the bottom of the sector in the three months to 25 June, ranking 295 out of 309. This has raised questions about whether the strong performance of mid caps has come to an end.
The £2.94bn Schroder fund invests 95% in the FTSE mid 250 area of the market, with the remainder invested in cash and some small cap positions, although these tend to be from stocks which have fallen back in size rather than Brough purposely seeking them out as potential holdings outside his main stock universe. If a stock moves up into the FTSE 100, Brough will sell his holding, but the same does not work in reverse; Brough will hold on to the position if he feels the company is going to come back.
Starting to cause some concern among investors, though, is the fund's growing size, bringing up the inevitable questions of when the group plans to limit investments and how much further can it grow before it hampers Brough's style. While portfolios with broader mandates talk of liquidity concerns it's no surprise there would be concerns with a mid-cap portfolio. Representing some 15% of the UK equity market by market capitalisation, the mid 250 comprises of the 101 to 350 of the country's largest companies. While not as liquid as large cap stocks, many mid-caps have billion pound market caps, meaning the liquidity issues within this index are not quite the same as investing in Aim or small cap stocks.
Responding to the typical questions brought on by the size of the fund, Brough says: "The fund is large but we are used to running large amounts of money. To maintain the record of strong performance, we keep the number of holdings under control, resulting in a very high conviction portfolio. If we find a good story like Wetherspoon, or support services companies like Babcock or WS Atkins, for example, we'll back it significantly. The fund's size also means we can build significant stakes in companies and can effect changes such as a takeover, or a change of management if things start going badly."
That said the fund is currently at the top end of its historic range of holdings at just under 90. The liquidity concerns and size of the fund though are not pushing Brough to increase the tail of the fund, which other managers have done to aid with the size of the portfolio, nor are they forcing him to look more towards the top, larger end of the mid 250 index.
He notes: "Again, if we find a good story then we will take the biggest possible position we can. As the fund gets bigger, we will maintain our high conviction approach and ensure the number of holdings remains under control.
"The fund is still more naturally skewed toward the lower end of the index, where we see better value. But that doesn't mean we don't play the larger end - we bought Daily Mail & General Trust at £6 and sold at £8 when it went back into the FTSE as we did with Whitbread which fell into the mid 250 at £11 a share and went back into the FTSE100 at £17 a share."
Mid 250 stocks have had their appeal over recent years due to the opportunities they are perceived to feature. Pro-mid cap investors often cite the appeal that springs from the fact that mid caps can still feature strong growth attributes but with greater maturity than smaller companies, while the index as a whole is broader in nature with less concentration than that found in the FTSE 100. Stocks in this area of the market are also perceived to still be under researched, despite their recent popularity.
But with mid caps having performed so well for so long, many commentators in the market believe their time is now over - which could spell difficulties for funds such as the Schroders vehicle. Unsurprisingly Brough disagrees, commenting: "There are certainly some large caps at the moment that offer pretty good value. The thing is you are always going to see more exaggerated moves among the mid caps just by function of the size of the companies. There also tend to be more pricing inefficiencies to exploit the further down the market you go: the smaller a company is, the less well followed it tends to be."
He says there are always opportunities to exploit within this index as there are a number of constituent changes throughout the year, sparking new ideas. Brough notes a lot of the stocks that were in the 250 when he launched the fund are no longer present with 50-60 changes each year.
Also pushing up the popularity and investment interest in this area of the market is the fact that mid caps are typical target of private equity or merger activity. With private equity flush at the moment, mid caps continue to play a role, despite the fact that a lot of the press attention has focused on such activity in the large cap arena, which has been less common. But to Brough the continued activity from private equity is no great thing for the market as a whole, calling it a disaster waiting to happen. He adds: "I just hope the managers have made enough in fees before it happens. In the meantime my door is always open if they want to keep paying attractive prices for the share in companies we own."
Despite the changing environment and the perceived constraints of a large fund, Brough says his process and style on the portfolio are not changing. "We construct the portfolio purely on a company-by-company basis. We still look for attractive companies that are operating in pockets of inflation, just as we did in 1999 when the fund was launched. These companies can continue raising their prices because demand is strong and this means better profits and attractive long-term returns for investors," he says n
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