Mercantile 16 February 2022
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Mercantile. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
The Mercantile Investment Trust (MRC) is focussed on identifying future market leaders in the UK, that is mid and small-sized companies outside of the FTSE 100 Index that could potentially grow into some of the UK’s largest companies and deliver long term capital appreciation for shareholders. As discussed in Portfolio, the lead manager Guy Anderson focusses his efforts on the mid-cap space, his relatively concentrated portfolio of c. 75 – 80 holdings being largely drawn from stocks in the FTSE 250 Index. Although better established than very small companies, Guy believes these stocks are often still underappreciated due to thin broker coverage and inertia in the market’s understanding of a company’s business model and market positioning. Taking advantage of these opportunities, Guy has delivered substantial outperformance over the last five years primarily via stock selection, as discussed in Performance. The trust also aims to deliver long term dividend growth ahead of inflation and currently pays a yield of 2.5%, which we think could be attractive for a capital growth-orientated, mid-cap strategy (see Dividend).
Guy has the flexibility to ‘run his winners’ and hold onto stocks that he believes still have growth potential even after migrating to the FTSE 100. The flexibility to hold larger companies is why MRC resides in the AIC UK All Companies sector, where with total assets of c. £2.2bn it is the largest trust. The benefits of economies of scale mean MRC is noticeably less expensive to hold than peers, with an OCF of 0.48%. The scale of MRC has also allowed the board to provide Guy with expanded, cost-effective borrowing facilities to deploy at his discretion (see Gearing).
The UK mid-cap space has been rewarding to investors, the FTSE 250 outperforming the FTSE 100 by c. 4% p.a. over the last three decades. Why this is the case is a matter of debate. Arguably the combination of the growth potential of smaller companies plus the ‘junk’ filter of a company having to hit critical mass to reach mid-cap status is a sweet spot for investors.
If an investor wants exposure to UK mid-caps, they could buy a tracker like the iShares FTSE 250 UCITS ETF, which has an OCF of 0.40%. For 0.08% more p.a. (i.e. 8p per £100 invested p.a.), an investor could buy MRC instead and receive multiple benefits. Firstly, Guy is an experienced, active manager supported by a well-established and resourced team with a track record of adding value primarily via stock selection (a statistically more robust source of excess returns than large bets on sectors or style rotations, see Performance). Secondly, long term returns can be enhanced via the use of cost-effective Gearing. Thirdly, the opportunity set is wider, Guy being able to access good prospects outside of the FTSE 250, both smaller companies that have yet to achieve mid-cap status plus holding onto portfolio winners that have migrated to the FTSE 100 (a position an index tracker would be forced to sell). As a final kicker, MRC currently has a higher income yield than the ETF, and the dividends are supported by ample revenue reserves.
|Strong long-term performance track record enhanced by stock selection rather than large ‘macro’ bets
|Allocation to FTSE 100 may not suit investors looking for pure mid-cap exposure
|Large and liquid trust, with low management fees
|Gearing can exacerbate downside (as well as amplify upside)
|Experienced team with significant depth of analytical resources
|Scale and approach preclude exposure to opportunities in smallest UK stocks