Franklin Templeton’s Paul Spencer: Where next for mid caps?

Post Brexit the FTSE 250 saw a sharp fall and the index plunged against the FTSE 100 as mid-cap domestic stocks bore the brunt of the knee-jerk reaction to the referendum result. However, this dip proved short lived and a lot has happened in a year with the FTSE 250 hitting unprecedented highs of 20,000 for the first time.

TOWIE – The Only Way Is Equities

Looking across the market, it is fair to say that equity valuations are currently quite full. That said, they continue to provide some of the best risk-based returns in the market, and if this low interest rate, low inflation environment keeps up, we are likely to see a continued justification of these higher ratings.

As the post-referendum environment highlighted, the mid-cap and large-cap indexes are so very different in their make-up that their performance should never really correlate, other than by pure coincidence. The FTSE 250 is a much broader, more diversified index and doesn’t have those mega-cap sectors which take up big chunks of the FTSE 100, like oil, mining, and banking.

In terms of their respective performances, the FTSE 250 has outpaced the FTSE 100 significantly over the last 10 years. This is mainly down to the sectoral and structural exposures you can access via mid-caps – a key advantage, because by definition, the FTSE 250 is where you will find those faster growing, dynamic, and more innovative companies. These structural reasons remain intact and should continue to drive mid-cap outperformance longer-term.

Investing in themes for the long term

In order to gain access to structural growth themes in our mid-cap portfolio, we are focusing on key trends that we see materialising over the long term. These include an ageing, wealthy population, the shortage of UK housing and a recovery in global industrial production.

Companies such as private hospital operator Spire Healthcare, assisted living firm McCarthy & Stone and HomeServe, are all well placed to capitalise on the trend of catering to an older demographic. In addition, wealth management business Rathbone and equity release provider JRP Group have a customer base who are concerned about retirement income planning.

A number of stocks that will benefit from efforts to address the UK housing shortage, like Ibstock, Bellway and McCarthy & Stone, also show potential.

We are tapping into companies that should benefit from a recovery in global industrial production, especially in the US. Indeed, if Trump can engender stronger growth, companies that have exposure to US industrial production should do particularly well. As such, stocks such as Bodycote, Victrex and Elementis, given their US-centric focus in production facilities and end markets, should do well.

You don’t need a crystal ball

The last 12 months have been punctuated by huge political and economic uncertainty and this may continue. Our approach is focused on ensuring we have a robust enough investment discipline to cope with these black swan events. In mid-caps, as long as you are investing in companies that are well-financed, have strong management teams, and are in a robust economic position then you should be able to ride out the volatility that plagues an uncertain geo-political landscape.

External factors will always have an impact on share prices from time to time (sometimes for obvious reasons, sometimes not), but by investing in mid-cap companies with strong long-term fundamentals investors are likely to benefit from the upside as they develop and grow.

Paul Spencer is portfolio manager on the Franklin UK Mid Cap fund