299. Expert insights into the FTSE 250

[Music] welcome back to the investing on the go podcast brought to you by Fun caliber we're focusing on the F250 this week discussing not only the challenges it's faced in recent years but the potential for m&a activity and investment opportunities in the midcap sector for the year ahead I'm Chris S and today we're joined by Chris singen manager of the elite a framton UK midap fund Chris once again thank you for joining us pleasure let's start with the basics for those who perhaps don't know too much about the fund obviously this operates in sort of as the name suggest mid cap sector which is sort of hunting around the footy 250 so for those that perhaps aren't as familiar with the market could you just start off with an overview of the the types of companies that make the index and some you know give us some idea of some of the companies that reside in the footy 250 uh yes of course I can yeah um yeah the footsy 250 which is um yeah commonly referred to as the UK midcap space uh is made up of those companies in the all share that go from company 101 to company 350 by value so anything in the footsie 100 sits above at the footsie 250 and then essentially the small cap sits below it um it's rebased quarterly so the index itself changes on a quarterly basis the companies at the top of the index will get promoted up to the footy 100 companies get demoted from the footy 100 and companies move in and out at the bottom end of the index uh as well in terms of size of company um there's a slightly unusual one at the top of the footy 250 at the moment which is Carnival the cruise uh Liner Company holiday company that's actually valued at 16 billion but um because it has a relatively low free float it doesn't actually make up a particularly big part of the index so so if you're looking for the sort of the the the sort of upward and and the top and bottom bands I would ignore that one um the largest company in the index is investing currently which is nearly five billion market cap and at the bottom end of the index the smallest company uh is Trax eurobox Reit which is a uh it's a real estate investment trust and that's valued at a little over 400 million so there's a very very broad spread of businesses within this index and it's made up of companies that people on this call will will know and perhaps a number of companies that people won't know so within the 250 itself uh companies that you may recognize include EasyJet uh train line uh Gregs The Bakers dun Elm uh but there are also many companies that you perhaps haven't heard of that have um you know Market leading positions in the in what they do they're very well known in the UK and on a global basis you know companies like root talk which is an engineer btes uh which is a value added reseller of uh amongst other things Microsoft software coats which is a company that manufactures and sells thread so I suspect there's some coats thread in the clothing you're wearing at the moment actually holds it all together so a great array of businesses domestically and international some you'd have heard of some you won't um just want to go a bit deeper on that obviously you've got the footsy 100 and that's got a whole host of Behemoth in there and it's very internationalized a lot of the earnings there are drive from overseas that that's not so much the case with midcap could you maybe just talk to us about some of the differences between the companies in the the 100 to the 250 and and how that affects performance for example the the fact that they're perhaps not as internationalized although they are still to a reasonable degree as the 5100 yeah it's interesting when I when I see people I've seen people over the years people view the Foy 250 as a very domestic UK index uh 54% currently of the turnover that's generated in the footy 250 is generated inside the UK and so 46% is actually um generated from uh markets outside of the UK so it it's a very varied index um and does have significant exposure to um International uh businesses it it you're right it is very different to the footy 100 um certainly in terms of its makeup the the footsy 100 has much bigger Holdings and some what I would call some of these older more Capital intensive perhaps more environmentally harmful businesses um you know mining U that sits with basic materials big oil and gas companies um Telco lesso now um and healthc Care consumer staples are also very big and Consumer Staples is made up of the fmcg companies and um and the tobacco companies as well that's very different the UK uh footy 250 index is has much more consumer discretionary more Industrials more financials more real estate so you can get the feel just by those sectors that you've got more exposure to the UK economy in the footsy 250 index the the other quite big difference I think is is the concentration of the index the footy 250 is a much broader spread of businesses in terms of what they do but also valuation as well the Tom top 10 stocks in the 250 represent 16% by value whereas the footsy 100 about half of the index by value is in the top 10 stocks with the largest stock in the footy 100 being around 9% which I think at the moment is Astro zenica um whereas in the footy 250 the largest company in the index is around uh 2% so so there are uh a lot of differences um the UK um in terms of performance given the uh higher UK economic exposure in the 250 and and by that really we're talking about house builders you know retailers pubs restaurants property those companies by definition are more sensitive to interest rates uh to uh the UK economic output generally uh the levels of employment or unemployment in the UK and the level of disposable income as well uh so when interest rates are are moving in the way they have in in an upward direction that has put um quite a bit of pressure on a number of um a number of the UK domestic businesses um International uh businesses within the index as as we talked about earlier there's a number of companies that that that people won't have um uh won't have heard of um but the companies I mentioned you know a company like Road talk for example is a very established International Company um it has you know multiple offices very close to its end markets IT Supplies uh water industry oil and gas and so when particularly when you look at oil and gas companies and where they operate uh rot talk has a very very strong presence there um and that will and those companies should at least theoretically behave a lot more like the international companies from a stock uh price performance uh very similar to the footy 100 um just just quickly before we move on to that do do you find that um when you look at stock selection that you tend to have a preference for companies that are perhaps more internationalized in their earnings versus those that are domestic I think over my career on balance yes um because I've typically been overweight Industrials uh overweight software as well and underweight uh property companies um and um I'd say for the majority of the time underwe consumer discretionary as well so the answer to the question I think would have to be yes um but that's more an output rather than an input even you know within that there have been plenty of companies that um have been winners in the UK um which are exposed purely to you know the UK economy and really when you're investing and when you're doing it from a bottom up perspective and meeting a lot of company management teams it it's not really quite as simple as trying to you know is alloca perhaps to a different sector on the basis of you know whether it's domestic or International on the basis of say what's happening to to to UK interest rates for example there there are masses of nuances when you get down to the stock level um and you know circumstances competitive environment can can change a lot um and that can give companies you know an opportunity to flourish even in markets that are relatively difficult um you know marks and Spencer is a good good example of that uh where it's seing its supply side you know it's a business that's been sort of eternally under restructure and this side it really this time it really feels as though there is some um uh sort of momentum uh to the recovery and that it's not only because of what management are doing to the business itself um but because of what you've seen on the supply side of the competitive landscape companies like Asda Morrison's on the supermarket side um being heavily leveraged businesses struggling to invest and make their store fit for purpose and S and similarly on the clothing side you've seen a lot of capacity coming out through um the receivership of uh you know companies like Arcadia for example so it you do need to look at these businesses in the environment that they're operating yes over time I think I have had more exposure to International markets than domestic but that does not mean that there aren't fantastic opportunities within the UK well well let's go straight into the environment obviously there are sort of long and shortterm pressures on the UK there's a lot of poor sentiment with regards to it but then by the same token valuations look attractive I mean perhaps let's look at the 250 on its own and just sort of explain the push pull factors around it are you finding a lot of opportunities are they at the top end are things dropping in from the footy 100 that perhaps you're finding attractive just talk talk about the as a basket where the opportunities are are they wholesale or not um yeah there are a lot of opportunities around at the moment you know this is an asset class that you know when we were talking you know we talk about performance of this area and you know the last couple of years have been um very very difficult uh the footy 250 up to the end of December 2023 the footsy 250 index excluding investment trusts was actually down 10.3% whereas the footy 100 was up 133% you know that is a a dramatic uh difference a 23% difference in the performance of those two indices over two years this has been a very very unusual period um if you look back historically for 10 20 or 30 years pre-co or 40 years the annualized return of this thought of the market was around 10 to 11% but actually over the last 10 years because of the effects of covid I think because of the effects of the inflationary pressures we've seen because of the extreme movements in interest rates the annualized return over the last 10 years of this part of the market it's only been 4.4% so it's been a very very unusual part in uh um events in the footy 250 space and even if you take it back you know longer you you can see this ongoing compounding effect of returns and total returns in the footy 250 Place uh space and did you go back to uh December 99 it's quite a dramatic outperformance of 250 Total return versus not only the footy 100 but almost also msci world so historically this has been a place of great interest now I suppose the question could be asked well is this a place going forwards of interest and I would say from a company specific perspective absolutely uh we still have broadly the same number of companies to look at um this is within the index and you know we can to some degree go outside of the index in this fund as well and there are many drivers that are around today uh that perhaps haven't been historically um which are affording companies a great um great opportunity whether that's technological disruption uh I talked about Supply sides um changes with a company like M&S um similarly they're strong getting stronger we're seeing companies taking a lot of market share at the moment those companies with high levels of service uh in very strong positions companies that can differentiate through Service uh are seeing increased sales numbers in terms of the services that they sell um so from from a company bottomup perspective there is plenty to be excited about and plenty of Interest I think because of what we've seen from a performance perspective and yes that is compounded by the outflows you've seen from the UK Market the footsy 250 space has been left looking very cheap in the context of its own uh history certainly it it currently trades on a forward P of 11.7 and so would need to move up around 20% to be in line with its long run average that was gonna be my my question quickly you mentioned that the sort of 20% uplift needed to be in line with that long-term average you you sort of focus on high quality companies and you know Financial Z in terms of management and sustained profitability is there ever a point where um price alone becomes a catalyst potentially investing in a company yeah no not price not price alone no no no they we you invest in businesses on the basis of the fundamentals I'm looking for those companies that can grow uh compound increase their economic output over for time valuation is important pillar in that you know we go back to to the framlington days and nothing has changed we view ourselves as GARP investors which has sort of come back into Vogue in about the last sort of three or four months but you know growth at a reasonable price so valuation is important but it is not the main driver of any investment decision just following on to that we we talked a little bit there about the the Dynamics of the market Etc but um just sort of Beneath The Sur could you maybe talk to us about how companies look on a corporate level just in terms of their balance sheets and a bit of insight into the market there yes uh if if you look back at the history of the midcap space um the Fantastic sort of compounding earnings that you've seen have been driven by uh sorry the compounding returns you've seen and compounding dividend income has been driven by compounding earnings growth what you haven't seen in the midcap space over a prolonged period is um uh companies gearing up their balance sheets to for example buyback stock which you have seen in some International markets balance sheet strength in the UK is um I think a highlight at the moment it is something that we've always focused on when investing uh if you're going to invest in equities which we view as high risk you know you are the least preferred creditor in the insolvency act a strong balance sheet is very important so management decisions are are are made on the basis of and thinking uh at the front of their mind with Equity holders in their mind and not with the debt holders as an observation balance sheets are strong um and when I look at the fund itself the balance sheets within the fund are an average stronger than the market now what what that that is important when you're an equity holder because it gives management teams optionality um and when we're looking to invest we do talk to companies about their Capital allocation policy and we we've increasingly seen companies have a much more formalized Capital allocation policy over time so you know that Capital allocation is dividends is bolt-on Acquisitions and increasingly we've seen share BuyBacks within the midcap space so over 50% of the midcap funds the companies in there by value are buying their own shares back they're not gearing the balance sheet up to do it this is out of surplus free cash flow uh and I think is that is just reflective of companies that are in a very strong position with a lot of optionality and Ju Just quickly as well obviously the fund has the midcap the name and most of the areas is focused on our midcap but you also have the ability to invest in some smaller companies and also allow companies in the midat space to grow into larger firms is that a constant theme just just give us a bit of insight into that as well please um yeah so yes it is a midcap fund I think you should view it as a sort of core midcap fund but can invest up to 15% in the uh footsie 100 the reason that was put into place is so that if companies get promoted up to the footy 100 we're not a forc seller of those stocks so I can run companies into the footy 100 um a compan like we group would be an example of a business that that's come through the 250 and promoted up the footy 100 we mentioned I mentioned Marks and Spencers earlier that um um you know that may well be heading back at some point Point um so we not a full sell income is get promoted and similarly uh sorry we have to have a there has to be a minimum of 70% of the fund in footsy 250 index stocks that number is around 80% at the moment uh so that does leave a balance that can be invested elsewhere and and that is the part of the fund that might end up in the small cap space but I think to for us to invest in small cap stocks that need to have a reasonable chance of getting into the midcap um so you know we might find a very interesting company at 100 million market cap which might go to 150 you know that's still a long way from being in the 250 so that's the sort of business that we go to the small Cap Fund but but there are other fund there you know reason you know a holding that we took not that long ago trust pilot that was in the small cap space and that is subsequently being promoted up to the 250 okay and just again on the outlook for UK equities I mean A lot's been made of m&a do you expect UK companies to be continually targeted this year or do do you feel that that might slow down yes I do yeah I think they'll continue to be targeted uh last year there was a lot of m&a in the mid and small cap space um it didn't get huge um uh coverage in in the Press because the the average market cap was comparatively small um but there were uh plenty of deals and I would expect the that to continue the you know valuations are attracted balance sheets are strong these companies have got great Market positions um interest rates look like they're peaked or falling so there's some clarity and stability stability in terms of those companies that are looking to make Acquisitions from a from their own funding perspective and I think that is all a very uh positive backdrop for continued m&a it'll just be a shame to see even more UK companies being taken off either off the markets or bought by bigger corporations yeah and and and just lastly maybe just give us a snapshot of the positioning of the fund at the moment do you have certain you have a bottom up sort of focus do you have a sort of do you have any sectors you're particular interested in just just give us a bit of a a view of the composition of the fund at present yeah the the the I don't tend to we don't tend to allocate from a uh from a sector specific point of view what we're interested in is the is the sort of corporate drivers of the underlying um of the underlying company so it ends up becoming very stock specific so so the sector over underweights are actually an output of the process rather than targeting any particular areas um but to answer the question we are overweight in uh technology that is an area where we found some uh very interesting uh uh businesses that have you know incredibly long um you know growth Horizons that are attractively valued um Industrials we spoke about that was an therea where overweight as well um and within that there's there's a great array of businesses um you know we group we mentioned which um sells into to to mining now um chem ring is within there which is um uh a defense business with a with a particularly interesting uh cyber business called Rog um ashed is still in there which is which is an example of a footy 100 company that's been oted which is a toall high business exposed principally to the uh to the US so so that is um you know those areas we are uh certainly um overweight um and then we actually remain underweight financials um and real estate and those have been um and consumer discretionary as well those have been very much long-term underweights but are are certainly less underweight than they were um started adding some additional Holdings in the um in the more sort of uh sort of consumer discretionary uh and real estate space about six uh six old months ago on on the basis of of extreme valuation as much as anything and just quickly you mentioned the tech side there I mean people perhaps don't associate Tech so much with the UK particularly in large C also maybe in Med C is it something that's always been present or is it a growing presence in the UK Market in your segment no it's always been here I mean there's a the combination of companies it's a slightly odd sector in the UK in that there are those companies that I would say are out andout technology companies which are you know providing technology for other businesses to make them more efficient and effective and there are quite a few companies in there that are are using technology to differentiate themselves um so a business like autot Trader which people will know that that started its life um uh uh offline as a magazine now a completely online business people I'm sure people would have gone on and had a look at the um autot Trader website that actually sits within technology now you could sit and debate whether that is a technology company or not but it's certainly a business that has used technology to build a very very strong Market position with strong competitive Moes around it um but but but you probably wouldn't call that um an out andout technology company so real mix Chris thanks for joining us once again on the podcast pleasure thanks for having me this fund's flexibility to invest in the footsy 100 and small cap space lets the manager run winners and invest early in strong growth stories for more information on the ax of framington UK midcap fund visit fund caliber.com and don't forget to subscribe to the investing on thego podcast available wherever you get your podcasts please remember we've been discussing individual companies to bring investing to life for you it's not a recommendation to buy or sell the fund may or may may not still hold these companies at the time of listening Elite ratings are based on fun Calibur research methodology and are the opinion of fun calibur's research team only