If you are feeling optimistic about UK companies now that interest rates appear to have peaked, the FTSE 250 is a natural place to hunt for opportunities. It is trading on a cheap price/earnings (PE) ratio of 10.8 times forecast earnings for the next year, pretty much the same as the FTSE 100.
In good times, mid-caps can be an attractive sweet spot, less volatile than small-caps, with more potential for growth than large-caps. They rallied hard at the end of 2023, but still have a lot of underperformance to make up for, with the FTSE 250 ex Investment Companies index down 0.6 per cent in the three years to 12 February, compared with a 29.7 per cent gain for the FTSE 100.
Investment trusts make for a compelling way to gain exposure to the sector, thanks to their discounts to net asset value (NAV) – although, as ever, those discounts could widen as well as narrow.
While there is no shortage of investment trusts with some allocation to UK mid-caps, there are only three dedicated plays, and one of these is soon to disappear.
JPMorgan Mid Cap (JMF) is due to merge with JPMorgan UK Smaller Companies Investment Trust (JMI) this month. That leaves Mercantile Investment Trust (MRC), also run by JPMorgan Asset Management, and Schroder UK Mid Cap (SCP). The former is the biggest and has the best long-term track record over the past decade. Mercantile’s managers look for quality companies to deliver long-term growth, and thanks to a focus on cash flows they have been able to grow the trust’s dividends for a decade in a row.
The trust is overweight technology, which helped its returns in the first half of 2023, as well as industrials and consumer discretionary. Top holdings as at the 2023 year-end 2023 were fund manager Intermediate Capital (ICP), housebuilder Bellway (BWY) and IT company Softcat (SCT). Mercantile’s managers Guy Anderson and Anthony Lynch say the short-term outlook looks uncertain and favour companies with pricing power and strong balance sheets. But they also note low valuations offer an attractive entry point, and the trust’s gearing level is comparatively bullish at 13 per cent, the highest in the AIC UK all-companies sector.
Schroder UK Mid Cap is a smaller trust with a concentrated portfolio of 51 holdings, currently weighted towards industrials. The managers aiming to find a balance between “disruptors'' and more established companies. The trust doesn't explicitly target dividend growth but has typically delivered this over the long term, and as of 12 February offered the highest yield of all UK equity trusts at 3.7 per cent. Performance has been weak in the past month, but is still looking solid in the medium term. It is also the cheaper option at a discount to NAV of 13.9 per cent, against 11.7 per cent for Mercantile.
As ever, just because something is cheap it does not mean that it will perform well. But for investors who like the case for unloved UK mid-caps, these two trusts are a good place to start looking.
