Buy into UK mid-cap stocks' recovery with this investment trust

The FTSE 250 index of mid-caps has done very well over the past quarter-century. As Anthony Lynch, manager of the Mercantile Investment Trust, noted in February, “the FTSE 250 Index of mid-cap companies has not only trounced the FTSE 100 since 1995 but has also beaten the S&P 500 Index over the same period”.

In the last five years, however, the 11.6% return of the FTSE 250 has lagged the FTSE 100’s 15.5%. So this could be a rare opportunity to buy mid-caps at bargain prices. The £195m Schroder UK Mid Cap Fund (LSE: SCP) is on a 15% discount to net asset value (NAV). Admittedly, the performance of the £1.9bn Mercantile Trust has been 15% better over the last five years, but Mercantile trades on a discount of 10% and the ten-year numbers favour SCP.

The Heineken index

Andy Brough has co-managed the trust since it moved to Schroders in 2000. For the first ten years, it also invested in small caps but then focused on the 194 companies in the FTSE 250 that are not investment companies. “I think of it as the Heineken index,” he says, “as it gets refreshed like no other. Lots of changes make it an exciting universe.” Brough relishes being able to invest both in recovery stocks that fall out of the FTSE 100 and growth stocks that are coming up. “Our aim is to find companies that will make it into the FTSE 100 but to leave before the party ends.”

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He has no regrets about having to sell shares that get there. “Getting into the FTSE 100 is often as good as it gets. Companies strain to be promoted and then can’t do much.”

For example, Sports Direct’s share price fell from 880p to 260p while in the blue-chip index. In 2009, Brough filled the portfolio with housebuilders, all but three of which were subsequently promoted. This gets him through the challenge of knowing when to sell a share, “one of the hardest things to do as a fund manager”.

Brough is not an out-and-out growth investor: “It is rare to have companies in the portfolio with no or negligible revenues.” Tech sector investments include Computacenter, the IT services business, and SDL, the largely-automated translation services company.

But “technology is also intrinsic to the success of other companies in the portfolio, such as Dunelm, Pets at Home, and Man Group, a fund management group that processes 2.5 billion bits of data a day”.

The pick of the pubs

These holdings sit alongside “old economy” ones such as Safestore, the self-storage group, and JD Wetherspoon, the pub company that founder Tim Martin named after the geography master who told him he would amount to nothing.

Brough subscribed to its recent fundraising because “if it can’t survive, no pub chain can. It has spent all its time since coming to the market buying back the equity it floated, so you know that things are tough when they actually issue it.”

As far as the macroeconomic backdrop is concerned, he is cautiously optimistic. “There is a line of sight on the exit from pandemic lockdown, but two-metre social distancing doesn’t work economically” (the World Health Organisation recommends one metre). He also worries about “who will pay the bill, the fraying of obedience as people return to work and the paradox of thrift as increased saving results in lower demand”.

The post-pandemic world will throw up threats as well as opportunities for businesses: “If they need less space and rent has become an optional payment, what does that mean for property values and banks?” Emergence from the 2009 crisis paved the way for five years of exceptional performance by mid-caps in general and SCP in particular. The opportunity now may prove as good.