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Mark Dampier: UK Mid caps offer scope for growth

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The fortunes of the UK’s largest 100 companies are well publicised, with the FTSE 100 tending to be the quoted index in the financial press.

Thus, investors could be excused for focusing their attention on these corporate behemoths. 

Yet they are not very representative of the UK economy. For starters, the top 20 stocks account for nearly 50 per cent of the entire index and are largely international businesses.

In my view, the UK’s next 250 largest companies provide a much better guide to the fate of our economy. Interestingly, the FTSE 250 (excluding investment trusts) would have been a superior place to put your money over the past decade. During this period the index returned more than double that of the FTSE 100, growing by 270.6 per cent compared with 114.8 per cent for the FTSE 100.

Several dedicated mid-cap funds have capitalised on this trend. One up and coming manager I believe is worthy of a closer look is Chris St John, who manages the Axa Framlington UK Mid Cap fund. The retail version of this fund launched in April 2011 and performance has so far been admirable.

St John has had the opportunity to work closely with Nigel Thomas, manager of the highly successful Axa Framlington UK Select Opportunities fund. The two managers have formed a close working relationship, holding debates on those mid-cap stocks not held in the other’s portfolio.

Both managers share a similar philosophy, focusing on dividend growth and free cashflow yields while also managing money with an absolute return mentality, taking little notice of the positioning of any benchmark. They are also both keen to follow company managers who have been successful in the past. Overall, they seek positive change, be it to a business, through management or within markets.

Typically, there is around a 30 per cent overlap between the two managers’ funds. The key difference between the two individuals is the size of company they seek; Thomas does not tend to invest in businesses which are worth less than £100m.

St John’s approach is relatively risk-averse, preferring to run what he calls a “fairly diverse fund” with around 60 to 80 holdings, and currently owning 71. His investment horizon is typically three to five years.

The fund holds a minimum of 70 per cent in FTSE 250-listed companies, which increases to 80 per cent when including stocks similar in size but not featured in the index. A maximum of 15 per cent of the portfolio can be invested in the FTSE 100, providing some scope for St John to run his winners as they progress from medium-sized to larger companies.

St John’s investment process combines top-down and bottom-up analysis. He considers wider economic drivers and his current views incorporate themes such as technological change, UK survivorship, customer service and self-help management change.

From a bottom-up perspective, St John considers management track record, level of pricing power and high barriers to entry. He is also naturally valuation-aware, with price being a key consideration.

There is no hiding the fact that medium-sized companies have outperformed their large counterparts to a significant degree over the past five years, outperforming by 126.8 per cent.

Despite this, in my view, opportunities within mid-caps remain attractive. On average, companies in the FTSE 250 have higher earnings growth potential than most in the top 100. The FTSE 250 also offers greater sector and geographical diversification. It is a dynamic universe, constantly being refreshed with successful and growing smaller companies while also being a greater beneficiary of merger and acquisition activity.

Ironically, there is also declining analyst coverage in this area of the market, which provides more opportunity to uncover anomalies not already recognised by the wider market.

St John has a very credible track record relative to the competition and he is on my list of up-and-coming fund managers to watch. The fund remains nimble at around £50m – an ideal size providing flexibility to invest in opportunities not available to other well-established funds. 

Furthermore, St John has the added advantage of drawing on the tremendous experience of the UK team at Axa Framlington, headed by George Luckraft and Nigel Thomas.

Mark Dampier is head of research at Hargreaves Lansdown

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