The pros and cons of investing in UK mid-caps

UK mid-cap stocks can offer investors the best of both worlds: More excitement than their larger cousins but without many of the risks associated with smaller names.

That’s because although these medium-sized companies are generally well-established in their sectors with strong customer bases, they usually have plenty of growth potential. This makes them a great option for anyone wanting exposure to proven stocks that can still develop their business models and surprise on the upside.

Here we look at the various pros and cons of this area, as well as highlighting three funds investing in mid-caps that could be worth considering.

Pros of investing in UK mid-caps

UK Mid-caps are seen as an exciting, vibrant part of the London Stock Exchange, with many such businesses being found in the FTSE 250 index. This index contains the next biggest 150 companies outside the FTSE 100, which is the blue-chip list of UK-listed global giants such as BP, Shell, and GlaxoSmithKline. Mid-caps can be found in a wide array of sectors, including healthcare, information technology, consumer discretionary, financials, utilities, and real estate and there will be some household names as well as companies you may not have heard of.

Cons of investing in UK mid-caps

There are always risks associated with individual companies. Even well-established businesses in thriving sectors can hit bad patches for a variety of reasons. For example, the sectors in which they operate may have fallen out of favour or profits may have been hit by economic factors such as rising inflation. Ventures that are going through a growth phase may also find it challenging to expand into new markets or attract extra customers for their products. Some UK mid-caps have a big domestic focus to their business, so are more reliant on the health of the UK economy and consumer.

Are mid-caps right for you?

Whether having exposure to mid-caps is appropriate will depend on your investment objectives, attitude to risk, and existing holdings in your portfolio. The volatile nature of this area means putting your money – and faith – into a fund specialising in mid-cap names can make more sense than buying individual stocks. The good news is there are plenty of funds investing in UK mid-cap stocks so take your time to research what’s available and the track records of the managers in charge.

Mid-cap fund suggestions

To give you some food for thought, we’ve picked out three funds with exposure to the UK mid-cap area that are definitely worth considering.

AXA Framlington UK Mid Cap

Our first suggestion is the AXA Framlington UK Mid Cap fund, which has been run for more than a decade by Chris St John. The aim of the fund is to provide long-term capital growth and it will have at least 70% of its assets in medium-sized companies.

These names are chosen on the basis of their financial status, the quality of the management at the helm, expected profitability, and prospects for growth. Spirent Communications, a UK-based telecoms testing company, is currently the largest position in the portfolio with a 2.89% weighting*. This is marginally ahead of the 2.88% position of Spectris, the supplier of precision instruments and controls*. Dunelm, the home furnishings retailer, is the third largest with 2.72%*.

Looking ahead, Chris says there is “Increasingly tangible evidence that inflation has peaked and with it interest rate expectations.” He believes the UK stock market remains attractively valued and says that “with inflation expectations peaking, global growth slowing, and the cost of debt stabilising, the environment for our investment style is improving.”

abrdn UK Mid Cap Equity

The next portfolio worth a look at is Abby Glennie’s abrdn UK Mid Cap Equity fund, which embraces a high conviction strategy of investing in medium-sized companies. Its performance target is to achieve the return of the FTSE 250 (ex-investment trusts) index plus 3% per annum over rolling three year periods.

Stocks chosen for the portfolio are usually well established with a “range of high quality characteristics” that operate in growing markets and display positive business momentum. Idea generation starts with a ‘matrix screen’ that highlights the strongest quality, growth, and momentum stocks in the investment universe. This provides a list for the team to research in-depth.

The fund currently has 49 holdings that hail from a variety of sectors, including information technology, consumer discretionary, and financials*. Given its bias to growth, the fund typically has an overweight to technology and an underweight to industrials and real estate. Telecom Plus has the largest stock weighting in the portfolio of 4.4%*. This company is a British multi-utility supplier of gas, electricity, home insurance, landline, broadband, and mobile services. Keywords Studios, the Dublin-based video game services provider, is the next biggest on 4.1%, followed by the 4% in Kainos, the software company*.

IFSL Marlborough Multi Cap Growth

The IFSL Marlborough Multi Cap Growth fund is a great choice if you want more diluted exposure to mid-caps. Richard Hallett, who has managed the portfolio for 17 years, invests in small, medium, and large UK companies. He has an unconstrained approach and focuses on leading UK companies that have sustainable competitive advantages over their rivals. These could be in the form of superior business models, higher quality management teams, better products, and more impressive research & development capabilities.

Just under 40% of the portfolio is currently invested in medium sized companies*. This is the largest exposure in the portfolio. Mega cap names make up 29.2% of the fund, with small cap names weighing in with 14.5% and large caps with 10.7%*. While many of the largest stock positions are in FTSE 100 names, there are still plenty of mid-cap companies. These include Genus, the animal genetics company*.

In his most recent update, Richard insisted he felt optimistic about the prospects for relative
performance. “Our investment process remains unchanged,” he wrote. “We continue to focus on identifying companies that have pricing power and an ability to invest and grow, despite a difficult macroeconomic backdrop.”

*Source: fund factsheet, 31 December 2022

_{Photo by Kai Gradert on Unsplash}