The funds moving into mid caps and small caps

UK shares have staged a fierce rebound, at least on the face of things. 

The FTSE 100 is up by more than a fifth over the space of 12 months and sits on a return of almost 80% over five years. Active funds including Temple Bar Ord have reaped big rewards in this period.

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And yet the recovery has been an uneven one. Yes, blue-chip shares and classic “value” sectors such as financials have done well, and have led a wider recovery.

But companies further down the market cap spectrum have yet to enjoy such a big rebound, with mid-cap shares in particular lagging the FTSE 100.

The optimists among us might hope for more positive returns from mid-cap shares. 

While they can have a slightly more domestic focus than the FTSE 100 at another moment of uncertainty for the UK economy, they offer lower starting valuations that adventurous investors might take advantage of.  

Source: FE Analytics. Past performance is not a guide to future performance.

Such valuations have opened the door to fresh merger and acquisition activity in the FTSE 250, with sweetener maker Tate & Lyle recently receiving a bid offer from US rival Ingredion Inc at 595p per share. 

Meanwhile, private hospital group Spire Healthcare Group received an offer from one its biggest shareholders this month. Such activity, if continued, offers a boost for the portfolios with exposure here.

What is mid cap, anyway?

Active funds often tend to differentiate themselves from the relevant tracker in distinct ways. 

A global or US equity fund will often have less exposure in the Magnificent Seven shares, to give one example, while in the UK plenty of funds will have a greater focus on small and mid-cap shares than the FTSE All-Share.

A decent number of “generalist” UK equity funds are certainly taking a punt on the mid-cap space and we have identified a few notable examples. 

However, it’s worth noting that subjective measures are at play here. 

There is no exact definition of a mid-cap share, for one: some put it down as a company with a market cap of between £2 billion and £10 billion, while it’s notable that the market cap for Balfour Beatty, the top constituent of the FTSE 250, comes to around £3.8 billion. 

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UK fund managers also tend to approach their disclosure about such preferences differently: some will say how much of the portfolio is in a given index such as the FTSE 100 or FTSE 250, some will break it down by large or mid-cap exposure, while others will separate companies in terms of what market cap range they fall into. Some funds simply don’t disclose such details at all.

Putting that aside, some funds do have a clear preference for mid-cap exposure. These might be an interesting addition to, say, a large-cap focused fund or a FTSE 100 tracker.

The funds betting on mid caps

Out of the funds in the Investment Association (IA) and the Association of Investment Companies (AIC)’s UK All Companies and UK Equity Income sectors, we do see portfolios of different types with big allocations to the mid-cap sector.

One name that is quite consistent on this front is Mercantile Ord, a trust with a dedicated small and mid-cap focus. Some 81.3% of the portfolio comes with a market cap of between £1 billion and £10 billion and top holdings include the likes of Serco Group and Balfour Beatty. 

The fund has a big allocation to financials, which make up around 27.6% of the portfolio, with holdings including Plus500 Ltd, ICG and IG Group Holdings. Industrials also account for around a quarter of the fund.

If Mercantile has a specific focus on this part of the market, funds with a broader remit have also taken a liking to mid caps, if less prominently. 

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Aberdeen Equity Income Trust, which has enjoyed a strong run of performance in the last year or so, states a 40.9% allocation to FTSE 250 companies. 

Of the fund’s biggest overweight positions versus the FTSE All-Share at the end of March, FTSE 250 constituents include Chesnara, TP ICAP GROUP, Drax Group and Galliford Try Holdings.

However, the team’s biggest moves in March tended to be sector-focused, with the manager initiating a holding in Norwegian-listed oil and gas business BlueNord, buying into Glencore, exiting a position in AstraZeneca and reducing exposure to Energean, which suspended some of its operations in response to conflict in Iran.

The income play

With small and mid-cap shares competing with the FTSE 100 on the dividend front recently, we do see some other yield-focused funds delving into the FTSE 250. 

A big chunk of the Montanaro UK Income GBP fund is tied up in companies with a market cap of between £1 billion and £10 billion, while Merchants Trust Ord has a 37.8% allocation to the FTSE 250.

Montanaro as a firm has tended to exhibit a preference for companies further down the market cap spectrum as discussed in a recent episode of our On The Money podcast, and the 10-point checklist detailed there outlines the sort of company they might back.

Merchants’ move into the mid-cap space is a more recent development, with manager Simon Gergel telling us the space had grown more attractively valued, and that the team was backing names here with “good yields and attractive fundamentals”. That has included buying companies such as RS Group and Mony Group.

Value too

We see similarly sized mid-cap allocations in JOHCM UK Equity Income IP GBP Inc and value funds Polar Capital UK Value Opports I Acc and Man Undervalued Assets Profl Acc C.

Henry Dixon, who works on both Man Undervalued Assets and its sister fund Man Income Professional Inc D, recently talked of how he was seeing particular value in small and mid-cap shares via sectors such as financials.

We do meanwhile see a combination of other names with exposure. 

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IFSL Evenlode Income B Inc, which has tended to follow more of a total return approach than some of its equity income rivals and backs a handful of names also favoured by Nick Train, has around a third of its portfolio in mid-cap shares, as does IFSL Marlborough Special Sits A Acc and the value-minded Fidelity Special Situations W Acc. 

Do bear in mind with Evenlode Income that for new investors there’s a 5% initial charge due to the fund being “soft closed”.

A fund with more of a quality focus, Liontrust Special Situations I Acc, also runs a decent allocation here.

It’s worth remembering that dedicated mid-cap funds do exist although most active names have lagged behind the FTSE 250 over a five-year stretch. Schroder UK Mid 250 Z Acc leads with a 31% return, while the troubled Jupiter UK Mid Cap I GBP Acc has lost around 30%.