Old Mutual UK Select Mid Cap Fund research update

Mid-caps comprise the 250 largest quoted companies outside the FTSE 100. They represent a dynamic range of businesses operating both at home and abroad, and they have frequently outperformed the largest UK companies.

What has driven this outperformance? One reason is the FTSE 100 is dominated by a narrow range of sectors and a handful of very large companies, whereas mid-caps are more diverse. For, instance, interesting areas such as engineering and technology are more widely represented. Mid-cap firms are also smaller and more nimble, so they can frequently capitalise on new areas of growth quickly. This can enable them to increase their profits at a faster rate if things go well, though the risks are typically higher and they are more volatile than larger, more established companies.

Mid-caps are generally less well researched and understood than larger firms, so they offer expert stock pickers more opportunity to find undervalued companies with exciting potential - perhaps even the FTSE 100 companies of tomorrow. Accurate information is important in this analysis, and one team we believe excel in researching mid cap and smaller companies is at Old Mutual.

Richard Watts, manager of the Old Mutual UK Select Mid Cap Fund, is a key member of the team. He is keen to use the full breadth of the mid cap market by combining more internationally exposed areas such as technology, with more UK-centric stocks such as asset managers. For instance, in the expectation of improving markets he holds shares in Aberdeen, F&C and Investec.

There is also domestic exposure through house builders such as Barrett Developments, Taylor Wimpey and Persimmon. These have all performed well over the past few months but Richard Watts believes there is further to go. Pubs and restaurant companies such as Greene King and Spirit also feature, as well as certain retailers like Debenhams.

This domestic exposure might concern those worried about the outlook for the UK economy. However, Richard Watts is more sanguine. Whilst he expects a challenging, low-growth environment, he believes valuations still reflect very low expectations, and these areas could enjoy better returns than more expensive shares exposed to global growth.

One trend Richard Watts also hopes to see improving is in mergers and acquisitions. Whilst there has been a trickle over the past year, a much-anticipated pick up has not yet been forthcoming. He holds a number of companies he believes may eventually be bid for at higher prices such as Man Group and Invensys. It should be noted this is a concentrated portfolio meaning each holding has a meaningful impact on performance, which also increases risk.

The recent performance of the fund has been encouraging. Over the past year the fund has risen by 28.6% versus 26% for its benchmark index, the FTSE Mid 250 Total Return (excluding Investment Trusts), and 20.6% for the sector, although past performance is no guide to the future.*

Past performance is not a guide to future returns. *Source: Lipper 01/02/2012 to 01/02/2013.

We continue to favour the Old Mutual team for exposure to this part of the UK market so the fund remains on the Wealth 150 list of our favourite funds across the major sectors.