250. Why the FTSE 250 is great for active investors and long-term growth

[Music] welcome back to the investing on the go podcast brought to you by Fun caliber staying with the UK equities theme and to celebrate our 250th episode we're focusing in on the UK midcap Market or the Fitzy 250 today's guest tells us more about why UK midcap stocks can offer investors The Best of Both Worlds more excitement than their larger peers in the footsie 100 but without many of the risks associated with the UK's smallest names I'm Darius with dma today I'm delighted to be joined by Abby Glenny who is the fund manager on the abdine UK midcap Equity Fund Abby good morning hi Darius thanks for having me no thank you for the time so look um let's start off with your asset class I think hopefully most of our listeners will be familiar with the footsy 100 the large cap index in the UK um but maybe slightly less familiar with the uh midcap the footy 250 could you tell us a little bit about it and um you know the types of companies that are in that index and that you look at sure so yeah I think everyone's you know usually pretty aware about FY 100 I think that the thing that I sort of characterize is that large percentages of f00 are sort of what I would call slightly older economy um sector so if you think about some of the energy resources Health Care Staples um and actually if I sort of broaden those a bit you've probably got you know a good bit over half of that index is in those sort of sectors whereas yeah what I find about this 52 250 midcap spaces it's much more dynamic in terms of those newer economy type sectors so you know things like media technology a lot of actually new Support Services type businesses um so I think that makes it quite an attractive place to invest and also particularly if you're looking through a cycle so you know without a doubt 500 therefore has times that is very attractive and you 2022 is definitely one of those if you take longer term approach you it's much more sector diverse I think you've got much more growth Dynamics through that whole Space um it's also you know I think it's big enough and Broad enough so by definition by the name you've got 250 companies even if you take out the um sort of Investment Trust and look at that index you I think you still got a broad enough range and the thing that actually we think is quite important as well is if um the aim index so you know for people who don't really know aim that well I would just say look it has massively improved over the past 10 or 15 years in terms of quality of business governance you know these are properly profitable dividend paying strong businesses where a lot of them are actually in the market cap space of equivalent to FY 250 so for instance in our midcap fund we would s of sustainably have 25 to 30% of our funds in the aim index and big they're the bigger companies of name aren't they yeah absolutely that probably would be big enough to be in the midcap index were they on the full Landon listing yeah so we look at I mean we probably look at the sort of biggest 100 companies in AIM um but yeah I mean the I don't know at the moment but you know sometimes some of the top companies are probably touching on the market cap range of 00 even so yeah yeah there's some proper businesses in there and the other thing about the midcap index is the foot is 75% or thereabouts of its earnings come from overseas what sort of rough ratio is that then on the midcap yeah so midcap is 5050 basically yeah and I think you're right probably is even gone slightly above that I think the people almost don't think about sometimes is you are taking an inherent FX bet in f00 that you you maybe don't think you're taking by buying you know a UK index um whereas I would say you once again sometimes it's positives and sometimes it's negatives in some terms of overseas earnings um but you you through a cycle are really taking more of a bet on the actual company underlying fundamentals I would say in the midcap space so let's just dig in then a little bit deeper um what makes this midcap these 250 companies the next big as 250 what makes them attractive um for an investment case yeah so I think there's a few things I think they offer actually a lot of the things that people like more about the small cap space so they offer a lot of the growth Dynamics um that a lot of investors are looking for particularly if you're taking a sort of longer term approach and just that opportunity um you one of the things we like about businesses for instance is um where they can expand into adjacency so that might be a new division a new product a new geography and and actually within that midcap space when you're taking that decision it's it's big enough often that it actually impacts the whole business if that makes sense you can you can shift around the business and really grow dynamically um so like that we like that also there are um when we think about the sort of risk of the midcaps space you know actually we think due to the diversity of it um you know some some investors are slightly cautious about investing in small cap space you know the midap we gives a lot of the growth opportunities but with a lower risk Dynamic um and actually the liquidity is all right as well so you know this is definitely something that's been more of an investor focused if we think about the last five years or so mid midcap liquidity um is is pretty good particularly I think if you're willing to sort of invest in businesses for the medium term um the other thing is like people are often have quite a negative view about has the UK being unattractive to invest in for the last 20 years and I think if you look at the large cap space the number would sort of maybe suggest that um but actually you get midcap I think over the last 20 years has generated Twice The Return of large cap and actually I think it's generate better returns than S&P 500 and like msci aqu so I think people forget actually what a good return um Universe UK midcap has been yeah I think you're absolutely right I investors in midcap have have have done very well when maybe the large cap index you know has been fairly yeah sideways if nothing else yeah I think one of the other things maybe D as well is that like that's just looking at an index level but I think one of the interesting things well is that you know these companies are generally less well covered than large capat businesses you know in terms of the number of sside analysts looking at them I think there's more sort of information asymmetry and opportunity to really add value so particularly for a sort of active fund manager I think the opportunity in midcap is really quite attractive to to try and outperform and you can also be quite um you don't really have to be that Benchmark aware um you know obviously that comes into play in ter RIS Dynamics and things but it's very different to 500 where you've got some really large positions that you really have to have a view on all of these and actually even if you're negative on them you maybe still have to own some of it you know just to be quite underweight the midcap space is just very very Broad in terms of you know percentages um of the different Holdings so lots of opportunity for an active fund manager to to add Alpha over and above the sort of returns that the index has given um another part of this your style of investing is to run your winners um and you know that means you're buying companies when they're relatively small as they sort of get bigger and show that dynamism potentially for growth that you've talked about could you give us an example of a stock that you bought that was quite small maybe and that the one that you've sort of run into you know being larger okay yeah so you're right there's a we do have a sort of run your winners mentality and I would say if I look at our midcap fund there's probably different buckets of that so there's some buckets that we' sort of consistently held you know strong positions of um so I would pull out things like for instance midwich which is a value ad reseller in sort of audio visual equipment um increasingly um Diversified in terms of geography um things like Hollywood Bowl we've held pretty consistently temping bowling operator things like gamma Communications um and actually all of those we would have bought as IPOs but perhaps that would have been in our small cat fund you know originally when they fresh listed and we've held those throughout and they're now you know pretty sizable sort of um midcap names there's are those and actually some of these have been in existence and we've held them for a lot longer though where we've held them in some form for a long time but actually because of portfolio construction because of how our process works uh We've either come in and out of these businesses or position sizes have sort of significantly changed every year so um things like Telecom plus you know we've probably owned um for you know maybe 15 years in in sort of some form but not owned at all times uh CBS the pet veter business as well um you know we we had exited that after we thought the investment case didn't really fit our process anymore and then I think we bought that back in 2021 um be other on Gregs is a good example H you know everyone knows Gregs absolutely we've had that for a long long time um but yeah similarly the investment case has sort of come and gone during different periods and I think that's where our process allows us to believe in though some of these things for the long term but also gives us a really good judgment of when we should sort of step away from that for periods well maybe it's almost as if we'd planned this but that's a nice segue then into the process and a big part of a midcap and the small cap um funds that that that you're associated with has something called The Matrix at uh as part of its process maybe for our listeners you could um describe what it is that the Matrix does and how that helps you um to to to to pick and potentially avoid stocks as well sure so I mean the Matrix is essentially a stock screening tool um and this is sort of been in-house developed and I think maybe what's different to um what other funds might might look at in terms of screening tools is that you we've used exactly the same screening tool for 25 years was um you there have been minor changes but essentially we've looked at broadly the same factors over all that period with broadly the same weightings um and we do also continue to look at whether those factors are still the most relevant and so there have been a few changes over that sort of 25 year period yeah and how we would use it I guess two main ways would be the Matrix is really useful for stock screening but also for prolar construction so for our whole invest we can look at what is the Matrix telling us about that stock and it'll give us a a numerical score and we can also look at what all the factors individually are saying um and you know essentially we are looking constantly and this gets updated twice a week so it's live data we're looking at what stock are screening well you know should we be paying more attention should we be going doing the fundamental research on so you know it's only a stage in our process but is quite an important one um I think then portfolio construction so we also are constantly challenging ourselves on the existing portfolios of looking at you know which stocks are not scoring well and that's the ones we're constantly challenging ourselves on in terms of you know part of our cell discipline um and I think it's really good because it also um I think this is an this is an industry where particularly if you're long-term shareholders of things you can become quite emotionally attached to businesses and actually The Matrix has no emotional attachments to stock so it's really good at you know making you sort of neutral in that way and also creating sort of Team Challenge and debate because it's very obvious for anyone you know why do you still believe in this stock you know it's been scoring weekly for a while Etc um so an improving Matrix score of things you potentially look at and a reducing Matrix scores if if you hold it at least it causes you to think and and and revisit yeah absolutely and that's it you know we're not running Quant funds but it's a really disciplined part of our process I think it provides a lot of consistency as well through um through the cycle um I think one of the things that's really useful about the Matrix for us is that the the factors are are fit around our investment process so they are quality growth momentum and we do have two of the 12 factors are valuation factors so you know if you believe in our process you absolutely have to believe in the Matrix and because it's blinded um but I think the thing that's quite interesting about it in periods um like we see at the moment and we've had a lot of these discussions with clients is that our processes you know we don't change through a cyc but what is flexible is what is screening as quality growth momentum so that's where the Matrix helps you to stay aware of where companies or sectors which might not have been you know your most traditional stocks maybe you've never held them before or maybe they're in a sector you don't typically own that much of actually those are becoming quality growth momentum in what is maybe a different economic environment and you mentioned some of the factors there sort of earnings upgrades momentum does does the Matrix take any account of balance sheet or is that just a separate piece of work you do on stocks that look interesting yeah so we have two quality factors so balance sheet comes into both of those so one is the choicely score um which is like a a composition actually of lots of different underlying Financial metrics also Zed score um so Z scores the thing about Z score switch quite different is that it tends to be very important in a small um number of periods so people often either really care about Z scores or they don't care at all it's a little bit binary so we've seen that through the last 18 months or so in terms of when people actually worry about balance sheets and companies going bus that becomes quite important um but a lot of the other quality factors we would look at in terms of like Revenue visibility recurring Revenue in contracts cash generation you know improving margins those are all things that come more into our our fundamental research than they perhaps do in The Matrix thank you so look maybe then just to finish up if we could talk about a couple of your largest stocks um why you like them at the moment and what maybe some of their sort of growth characteristics are okay so maybe I mean one that we've held for quite a while which is still one of the biggest stocks in the portfolio would be keyword studio and you know for people who don't know it it is essentially the the global leader in outsourced services for video game companies so you know their typical customers are all your big old big AAA games developers as well as maybe some you know smaller uh Indie type developers and what I've seen with this business is it has really expanded into adjacencies that I talked about before so this business is truly Global in nature but also what I've seen them do is since I since I first invested in this which would have been maybe 20 2017 probably um I've seen them really invest in terms of the number of different Services as well that they offer you know these guys can help with games development artwork they can help with customer support um all sorts of Dynamics and what's what's important about that is the cross- selling opportunity that they have Within These big customers um is a business which is very driven by organic growth but also does complimentary Acquisitions um and for us that's really important because you know we don't mind businesses which are acquisitive in nature to some degree but we really want to always see that supported by organic growth so you're not just buying growth um and I think the type of Acquisitions that keywords do actually really like because H they're either very clear skill sets or they're really actually about acquiring people people so it's it's a difficult industry to to grow people because it it's actually quite competitive in nature and a lot of these um particularly in the games development side they like to work almost as independent yeah and key becomes a really good home for them because I think there's a really strong culture but they also let the sort of um particularly the studios nature of parts of the business really Drive their their sort of own culture and retain that um so I think they've got a really good balance in that and management have show they can sort of execute um on that strongly so it's a really high return business good margins H really sensible about their balance sheet leverage as well um and also it's a in a growth industry you know which I think people are gaming for sure aren't they yeah and I think one of the things people got wrong about keywords is that when we saw um the the covid Boost of some of the the sort of AAA games because people were selling more because people were at home gaming and everyone sort of thought keywords would be a CO beneficiary and actually I think a lot of that is on a lag cycle for them and they're much more um much more balanced I guess so you know the potential benefit was actually going to come later when those companies had you know great profits and continued to invest in their business and what I like about keywords compared to um perhaps some other video game businesses is you're not making a bet on a game's particular game success or failure you know so they really spread across all sorts of games by all sorts of developers and maybe then just a headline stock when you've already touched on Greg's a sort of High Street name that people will know is that just a shop roll out the more shops they have the more profitable they are or is it product where is their their growth coming from yeah so I mean Gregs is really quite mixed in terms of actually their their growth Dynamics and I think that's quite important as well because they they also they do need to drive growth because they definitely have cost inflation um at the moment and probably the they've had different periods of cost inflation but this is an environment where actually there's a lot of different cost lines are all showing inflation like other businesses have um but what we've seen about Gregs is really that sort of ability to innovate I think one of the things if I compare Gregs now to five years ago the product Innovation and also the social media marketing Innovation I think are very very impressive um and if you compare that to peers I mean we're also seeing at the moment that you know their value for money proposition is really resonating with clients um well I think one of the things that there been there's a lot of debate about Gregs in terms of what happens you know in a consumer squeeze and actually it's it's quite hard to judge so do people perhaps trade down to Gregs which is a benefit or actually do people trade away from Gregs you know and and but at the end of the day what I think we've learned is that people are on the move and that is your your typical Greg's customer is yes you could buy all the ingredients and make a a lunch at home and take it with you actually the cost benefit in terms of wastage and products isn't actually that big and it's the the ease and the fruitful that is really important um I think on the back of that they've really innovated in their state as well so behind the scenes you know the bits that we don't see in terms of marketing distribution um um I think that's been really Innovative I think they've also got a store rolling um particularly um I think we've seen them really step away from just being sort of city center High Street location so actually it's your retail Parks your industrial sites it's where you live and we've seen that I would say over a number of years so actually at covid I think what people badly misjudged was that it would be very driven by just City centers Yeah by Time by by that period they'd really um broaden their site locations a lot more um and I think that's one of the things that we had a really interesting discussion with them two weeks ago actually about it which is Gregs can make lots of different sites in lots of the different locations work so it's not like a cookie cutter approach and it makes them really flexible in terms of the type of space that they can go for um the landlords they can work with because you know one site for instance they might want to have you know a big seating area they might want to have a full service offering you know in other sites they can have something um that's different for that audience and I think they really starting to sweat those assets more as well so sure you know in future years I'm sure lots of us will be going for our dinner in in Gregs and we always said before Co who knew people would pay for a Greg's delivery but they absolutely do Abby that's really really interesting thank you so much for taking the time to talk just not just about some of the stock examples but the whole asset class in general a and UK midcap Equity is a high conviction strategy which invests in medium-sized companies for the long term it invests in businesses when they are well established but still have a long run way of growth potential for more information on the aine UK midcap Equity Fund visit fund caliber.com and don't forget to subscribe to the investing on Theo 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 not still hold these 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