Allianz Dresdner Asset Management says UK mid-caps are likely to outperform large-caps this year, because of higher earnings growth and the effects of US dollar falls and potential interest-rate rises. The expectation of double-digit growth in UK mid-cap stocks this year comes after significant outperformance over large-caps last year, which closed the valuation gap between the two. Trevor Green, manager of the Allianz Dresdner UK Growth and UK Mid Cap funds, says US interest rates are key to the outlook for UK mid-caps. “If you look at previous periods before and after a rise in US interest rates, it is interesting to note that UK mid-caps perform very well in the months prior to a US rate rise – and this outperformance tends to continue for a few months after such a rise,” he says. “There is no reason to sell ahead of a rate rise, and any expected change later in the year should not have significant impact on the UK mid-caps, although a surprise rise in the next three or four months would do.” The falling dollar will have most impact on the UK large-caps rather than mid-caps, with 25% of FTSE 100 companies earning more than a third of their revenues in the US, according to Thomson Financial/Datastream in October. UK mid-caps, however, have little dollar exposure, says Green (pictured). Although UK mid-caps are less markedly undervalued than in 2003, earnings growth forecasts are now 59% higher for the FTSE 250 than for the FTSE 100. “This disparity is not reflected fully in relative valuations at the moment,” Green says. GlaxoSmithKline and two large-cap oil companies have disappointed in their results recently, the manager points out, while the FTSE 250 is focused on recovery, for example in media and engineering, and companies have delivered on their earlier earnings forecasts. Green holds 30% of his UK Growth fund in mid-caps, compared with a benchmark weighting of 12% as, even when he likes a sector, he tends to prefer the smaller players. In the mid-cap fund he is wary of housebuilders but keen on software and speciality financials.