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'Mid cap' investors take fright in build-up to Brexit vote
Guy Anderson, manager of the Mercantile investment trust, admits he is worried over the impact of 'Brexit' uncertainty on medium-sized companies.
Guy Anderson, manager of the Mercantile (MRC ) investment trust, admits he is worried over the impact of the upcoming referendum on the UK's European Union membership on the medium-sized companies he focuses on.
Mercantile is one of three investment trusts to focus on the 'mid cap' companies that make up the FTSE 250. Those companies have performed much better than their blue-chip rivals over the last three years, but the tables have turned so far in 2016.
One of the reasons for that is the uncertainty created by the looming 'Brexit' vote. Anderson argues some investors are using mid caps as a proxy for Brexit uncertainty, due to their greater domestic focus and apparent vulnerability.
Can't watch now? Read my script
Daniel Grote: Hello, I’m joined today by Guy Anderson, who is manager of the Mercantile investment trust. Mercantile is one of only three investment trusts that has a focus predominantly on the medium-sized, or mid-cap companies that are found in the FTSE 250.
Now Guy, I wanted to start by asking you about your cash positioning. You’ve got a little bit in there, I think it’s around 4%. It’s not a huge amount, but maybe a bit more cautious than some other investment trusts. Does that show a little bit of nervousness about where markets are going to go?
Guy Anderson: Sure, it’s a very good question. So we as an investment trust, clearly we have the option to go geared or into net cash, and historically we have used that. So two years we were running north of 10% geared. We took the decision in the middle of 2014 to bring that back to a fully invested level because we thought the market had rerated sufficiently, that further gains from that point needed to be driven by earnings growth rather than continued rerating, and that’s really been our potion since then. We have actually been running as you said around 4% net cash through the first part of this year and the end of last year, and we’re pretty comfortable with that level. Clearly there are a large number of risks around, and I’m sure we will talk about some of those, and we still feel that further market progress will require delivery of earnings growth.
DG: You talk about the way the market has progressed, and the FTSE 250 over the last few years, and certainly last year, had a very good performance, particularly when you compare it to the FTSE 100. How sustainable is that? You mention earnings needing to come through – do you think that is likely to happen or is there some vulnerability there?
GA: I think one of the key differences in the recent period, so last year for instance, is the difference in the sector make-up of the FTSE 100 versus the FTSE 250. Clearly the FTSE 100 is very resource focused, resources and financials, the FTSE 250 is a far broader mix of sectors. And if we think to the earnings progression last year, earnings in the FTSE 100 fell around 17% last year whereas in the FTSE 250 they were down around 3%. So clearly a stark difference in the growth profiles and that is really the key driver in the performance difference. So it hasn’t been driven by the FTSE 250 rerating ahead of the FTSE 100 for example.
DG: You mentioned some of the beaten-up sectors of the FTSE 100, largely the commodities sector, but industrials as well, certainly the blue-chip industrials, I’m thinking of companies like Rolls-Royce, haven’t done very well. But in your trust, industrials are one of the big portions of the fund. Do you think there is a difference between mid cap industrials and big industrials?
GA: So I don’t think there’s a structural difference between the companies but when we look at industrials it is a hugely heterogeneous sector for the mid cap end of the market. So the industrials would include, for instance, around 40% of that industrials exposure is in the support services sector, which is in itself very mixed. So you could have at one end Howden Joinery, a distributor of building materials, at the other end you’ve got a Ricardo, which is an engineering consultancy business. So it is a really varied make-up.
DG: And one of the holdings which used to be one of your flagship industrial holdings was DCC. That’s now gone from the trust as it has entered the FTSE 100. This issue around stocks gaining promotion to the blue chip index – is that a frustration that you then have to sell them, or does it actually impose some kind of valuation discipline in that you are selling stocks that have done really well.
GA: One of the things we always want to ensure with Mercantile is that we don’t suffer some sort of size drift. We don’t want to suddenly wake up one morning and find that we’re 20% invested in the FTSE 100, because our investors are investing in us for mid and small cap exposure, so we will stick to that. Having said that, we don’t force ourselves to sell positions the day they are promoted to the FTSE 100 and we tend to allow ourselves an 18 to 24-month window in which to finesse that exit.
DG: Berkeley is another that has drifted down the list of holdings as it has entered the FTSE 100. With house builders generally, they have obviously been on a great run, and there are lots that populate the FTSE 250. Do you think they are becoming too expensive and that momentum is going to slow, or is there further to run?
GA: We clearly think there is further to run. We’ve got around 8% of the portfolio in consumer goods at the moment and around 6% of that is in house builders. We clearly have a positive stance.
DG: I guess one of the risks for house builders, and for mid cap stocks generally, where there is more of a domestic focus than among the FTSE 100, is Brexit, and all the uncertainties that are going to build as we approach the referendum. How worried are you about it?
GA: Clearly, quite worried. So, the FTSE 250, as everyone knows, around 50% of the revenue is sourced domestically versus around 20% for the FTSE 100, which means at the moment I think a lot of people are using it as sort of a proxy, a Brexit hedge, if you will. So that may be having implications at the moment, and for the next few months. What we care about more is clearly the longer term potential.
If the bookies are to be believed, chances are, 70% probability we remain in, at which point I would expect some of the recent underperformance of the mid cap market to unwind, relative to the large cap market. If we do vote to leave, I think equity risk premia across the market, and I think it would be across the UK but also across Europe, will increase, there will be volatility because of the uncertainty that creates. Clearly what the long term outcome is, I wouldn’t try to comment on.
DG: Guy, thanks a lot for your time.
GA: Great, thank you.