Threadneedle’s Simon Haines has run the group’s UK mid 250 fund for six years, during which his favoured part of the market only under-performed blue chips in 2008.
His investment approach begins with a basic sweep of the market to eliminate stocks deemed unattractive on a long-term basis, such as companies in structural decline. This slims down the potential universe to around 100, which Haines sifts further by considering quality, potential upgrades to consensus earnings and the possibility of re-rating.
Looking back to 2008, Threadneedle was taking a cautious approach and was unable to marry up several positive company meetings with an environment rapidly turning against leverage.
Haines says: “Many firms failed to recognise that cheap sources of capital would not be around forever and suffered in the market sell-off. This led us into safety-first parts of the market such as utilities and support services, largely on a top-down view, and saw the fund substantially outperform the index over 2008.”
This continued into the first quarter of 2009 but Haines says the second part of the year was tougher as the market’s quality threshold dropped in the broad post-March rally.
Last year, the mid 250 index comfortably beat the FTSE 100 again, with the best alpha-generating calls its overweight positions in oil and gas, both exploration and production, and general industrials. Both bets were driven by Haines’ positive view on global growth and economic recovery.
Elsewhere, the manager’s move into housebuilders last year is yet to be rewarded but he expects the sector’s strong valuation argument to come though this year.
The manager also suffered from an underweight position in media stocks, which have since benefited from positive global growth trends, and recently bought into B2B player Informa to capture this.
Over his six years on the fund, Haines highlights 2008 as a solitary period of mid-cap underperformance, largely due to the area’s perceived domestic focus as the UK economy declined.
He says: “Mid-cap balance sheets are now strong and most of the overleverage has washed out, with factors such as M&A activity serving as an ongoing support for the market.”
“In sectors such as industrials, cash-rich buyers from the US are circling the market and we expect this to broaden out in 2011 as so many companies held fire on capex spending in recent years. Buying another company is an instantly gratifying way of catching up on years of lost capex.”
More generally, Haines says mid 250 companies will typically grow faster than blue chips as they are coming from a lower base. He highlights several mid-caps capable of doubling revenue in three to five years whereas few FTSE 100 names could achieve this.
An overweight position in industrials such as Weir Group has played into the strong theme of companies benefitting from overseas earnings – especially in emerging markets – and he is typically light in more domestic mid-caps.
However, he feels caution is warranted as inflation grows in China, for example, and says exposure to European and US earnings may come into vogue once again.
“We remain overweight industrial and oil services but are looking at how far these stocks are discounting an ongoing aggressive economic recovery,” says Haines.
“This year is shaping up to be a tough one for UK consumers but it is important to analyse how much of that is already reflected in share prices, with these areas of the market now underowned.”
In recent months, Haines has taken profits in some of his more successful industrial and oil stocks, such as Weir Group and Wood Group, as he believes their ratings already factor in substantial future earnings upgrades.
He says: “We have been looking at various ways of playing the economic recovery in cheaper parts of the market such as software. Many of these companies also fit in with our Western exposure theme and we feel the US could surprise on the upside in 2011.”
Stocks such as Informa also meet the criteria and the company sells more into the US than Asia. Haines says such stocks are cheaper at this point in the cycle than they have been before, while industrials look more expensive.