Schroder UK Mid Cap Fund 28 November 2019

Schroder UK Mid Cap (SCP) is a FTSE 250 ex-IT focused trust. Managed by Andrew Brough and Jean Roche, the trust focuses on mid caps, exiting companies when they are promoted to the large-cap FTSE 100 index.

Andrew and Jean construct a portfolio from what they deem the best opportunities in a universe of c.190 companies (the FTSE 250, minus other investment trusts). The focus of the managers is very much on bottom-up stock analysis, seeking to identify two positive categories and one negative category of stocks: 1) long-term growth opportunities, 2) cyclical opportunities and 3) stocks to avoid.

Long-term growth opportunities will comprise the majority of the portfolio, usually around 60%. These are typically high-quality companies with strong competitive positions in industries subject to structural growth trends. Cyclical opportunities are likely to be more vulnerable to changes in the economic cycle; the managers are seeking companies in sectors where they believe improved capital discipline and allocation across the sector can drive increased pricing power and improved profitability for companies within it, or companies that have internal catalysts to improve these issues. The managers are relatively ambivalent with regards investment style, with a focus on the operational performance and prospects of the underlying companies, and how this will translate to pricing power.

Recent returns have remained strong, outperforming the sector and benchmark index, but the trust remains at a discount of c.-14.3% (as of 19/11/19), with ongoing political uncertainty seemingly a factor in depressing sentiment towards this area. The managers note global fund manager surveys continue to suggest that international investors hold lower than average exposure to the UK as a whole, but that they believe there are a significant number of attractive opportunities available at present.

The current dividend yield of c.2.9% is well covered, with revenue reserves in excess of the previous financial year’s dividend.

SCP continues to be managed in line with a strategy that has historically generated outperformance over the longer term. Andrew and Jean believe that negative global sentiment towards the UK market and economy as a whole does not tally with the actual economic data, which could make this an interesting entry point. Should UK growth remain reasonable, and political risks abate, the greater domestic revenue generation within the portfolio could lead to outperformance, whilst providing a tailwind to the UK market as a whole.

The discount on SCP has proven a reasonable barometer of sentiment towards the UK as a whole, and mid caps in particular. The current discount level does not suggest we are at capitulation-style levels of sentiment, but certainly suggests there is a significant amount of negativity already discounted in the share price. Historically, drawdowns have tended to be slightly greater than the wider market, though this is to be expected given the mid-cap focus.

Given the trust’s mid-cap focus and manager’s strong track record through stock picking, for investors bullish on the UK we believe SCP is likely to offer superior upside potential should UK equity markets start to recover their poise.