Analysis: Schroders fund finds opportunities in US mid caps

Global financial markets were weighed down by the uncertainty around the outcome of the US presidential elections for the latter half of 2016. Then, the shock: Donald Trump’s victory.

US equity markets have been on a high ever since, with the S&P 500 index gaining almost 5 per cent in US dollar terms. Even rising inflation and the threat of further increases in interest rates have not been able to dampen the rally.

The optimism seems to have spread to the International Monetary Fund,which revised its growth forecasts for the US up 0.1 percentage points to 2.3 per cent for 2017 and 0.4 percentage points to 2.5 per cent for 2018 compared with a lacklustre 1.6 per cent in 2016.

Investor sentiment has been buoyed by Trump’s promises of tax cuts, increased infrastructure spending, kick-starting domestic production and creating more jobs. A Republican-dominated Congress will ensure most of what he has promised in terms of tax cuts and spending is fairly straightforward. While the effect of tax cuts can be felt straightaway, infrastructure spending will only boost the economy in the longer term.

But a protectionist trade agenda and aggressive foreign policy are more likely to add to uncertainty in the markets in the coming months, so volatility is set to increase.

That said, the silver lining of Trump’s anti-globalisation rhetoric has been the outperformance of small- and mid-cap companies, where around 82 per cent of revenues are domestically generated. Analysts believe they are set to gain further and outperform their large-cap peers.

One fund highly favoured in the IA North America sector is the £1.8bn Schroders US Mid-Cap fund, headed by Jenny Jones since April 2005. Jones is an FE alpha manager who has maintained a consistently high score over rising and falling markets.

Jones and her team of analysts select medium-sized US-listed companies based on fundamental research. The team believes smaller companies are typically at the early stages of their expansion and under-researched compared with their larger peers, hence offering greater scope for outperformance.


KeyfactsThe investment approach focuses on three types of companies: mispriced growth, for those with a valuation that underestimates future growth potential; steady Eddies, for those with stable and predictable earnings that provide a defensive ballast; and turnarounds, which are typically distressed or out of favour but have recovery potential. The first two types account for about 90 per cent of the portfolio, which normally consists of around 120 holdings.

Given stock selection is based on such strong fundamental research, it is no surprise the fund has been in the first quartile over three, five and 10 years, consistently outperforming its benchmark and the IA North America sector over the same periods.

With respect to the effect Trump’s policies might have, Jones believes that, while most of the goals are likely to be fulfilled, they seem to be fully priced in. In addition, since the stocks in the fund are held with a three-year view in mind, its positioning is unlikely to change in the short term.

According to FE’s research team, the defensive properties built into the fund through the steady Eddies should continue to limit losses in falling markets, while the underlying focus on strong companies with promising growth prospects should capture a large portion of market gains. UK investors should bear in mind, however, that since it does not hedge currency exposure, returns can be heavily influenced by movements in the US dollar.

The fund is best suited for those looking for exposure to the US domestic economy, who are willing to buy and hold for at least seven years and who want to limit their exposure when markets fall. It sits in the FE Invest Approved list, has an OCF of 0.91 per cent and an FE Risk Score of around 103 currently (zero being cash and the FTSE 100 being 100).

Namrata Nanda is institutional marketing manager at FE