Anjli Shah: Global mid-caps: why now?
Anjli Shah, co-manager of the $50m Aberdeen Standard Investments (ASI) Global Mid-Cap Fund, discusses opportunities within the global mid-cap sector and why it remains an interesting investment proposition.
Measured by the MSCI World Index, mid-caps have outperformed their larger peers by around 10% over the past 12 months, and significantly outperformed large caps over the longer term.
By investing in mid-caps investors have access to a diverse group of companies, many of which are industry leaders in niche market segments. Additionally, these currently trade significantly below their historic valuation relative to their large-cap equivalents. As such, the ASI global mid-cap investment managers believe the asset class can be an attractive complement to a large-cap-focused equity approach.
Furthermore, an active approach towards investing in mid-cap stocks has the potential to add significant additional value over the long term. The market often systematically underestimates the rate and sustainability of returns that high quality companies, with attractive growth and business momentum characteristics, can deliver over the long term.
Mid-caps offer many of the same attributes of fast-growing small-caps, but with less volatile returns. We feel that companies in this sector typically dominate their respective niches, operate in attractive industries, are not dependent on external factors to succeed, have strong and stable management teams and attractive environmental, social and governance (ESG) credentials. We believe that these rare businesses that exhibit such highly desirable traits will not be subject to “mean reversion” in their earnings growth, as predicted by most traditional investment theorists and is why we think investors should consider an allocation to the asset class as part of their wider investment portfolio.
It is widely accepted that over long time periods smaller companies (small & mid) outperform their larger peers, but for this additional return investors need to take on higher levels of risk. ASI’s experience is that the perception of risk in smaller companies is often far higher than reality, with the differential between the two lower than many expect, and that at an index level, an active approach has the potential to not only deliver a higher return but also lower levels of risk. The Fund only invests in certain companies (profitable, strong balance sheets, defendable competitive advantage, good mgmt. teams) and avoid other companies (early stage, loss making, highly cyclical), which the managers believe not only helps to generate higher returns, but also helps to reduce risk. Further information and charts are available upon request.
The ASI Global Mid-Cap Fund looks to achieve growth by investing in shares of mid-cap companies listed on global stock exchanges. Stock selection has been the biggest contributor of performance accounting for 76% of the equity returns (1 year to end April 2021). Performance has been enhanced by holding stocks that have benefitted from the home improvement trend. This has morphed into “home-as-a-sanctuary”, a key structural theme within the ASI Global Mid-Cap Equity Fund.
An example of such an investment is Generac +201% (Note: since fund inception i.e. 22 April 2020 to current price today, performance is in absolute terms, source is Bloomberg) a US-listed stock which manufactures home standby generators and is the market leader with 75% share in the residential segment. It’s company’s generators run off natural gas rather than diesel and are therefore more environmentally friendly.
Generac has consistently reported strong, better-than-expected results with management recently commenting they can’t make them fast enough to keep up with the level of demand. With <5% of US homes penetrated (and even less internationally) at present, there is a significant runway for growth. The company is also moving into clean energy solutions such as solar invertors and battery storage. The Stock is one of ASI Global Mid-Cap Fund’s small cap graduates. It was first held in ASI’s Global Small Cap Fund before graduating to the mid-cap index and becoming investable for the Fund when it launched.
Finnish-listed Kesko, the leading supermarket and building & technical trade business in Northern Europe, has proved to be defensive during Covid and has continued to take market share. The company’s strong trading figures have been driven by healthy construction and DIY trends in the Nordic regions. Even as Covid-related restrictions have eased, this trend has not reversed with returns of +24% since 1 January 2021.
Pool Corp is the world’s largest distributor of swimming pool supplies and related products. As the sole nationwide distributor in the US, it has substantial scale advantage. Pool Corp has enjoyed robust sales growth during the pandemic, reflecting demand from stuck-at-home pool owners. With the company generating 60% of its revenues from maintenance, contractors have reported record backlogs for pool renovations and new pool construction, which has helped give visibility to Pool Corp’s 2021 growth prospects. Returns have been 89% over the past 12-months.
Looking ahead, global equities could trend higher as continued coronavirus vaccine rollouts worldwide raise the probability of more populations achieving herd immunity at a quicker pace in 2021, especially in developed nations. This, in turn, will allow more countries to expand commercial activities and ramp up international trade, as well as travel. Improving economic data combined with wide-reaching fiscal stimulus in the US and Europe will likely lead to an extended period of economic expansion.
Indeed, the Organisation for Economic Co-operation and Development (OECD) raised its GDP forecast for the year. However, supply chain disruptions caused by inventory shortages and geopolitical tensions could threaten to derail the recovery. The US and its allies have targeted China with sanctions related to human rights abuses, and the latter has responded in kind.”
From a portfolio perspective, we closely scrutinise how companies are coping with the transitionary phase as more economies reopen for business. We feel comfortable with the underlying operating performance and growth prospects of portfolio companies, particularly as medium-to-long structural trends have accelerated and as the ongoing economic recovery provides an additional cyclical kicker.
Taking into account the recent stabilisation in bond yields, reducing factor risk and the relative valuation of cyclical stocks, we believe the next leg of outperformance will be driven by fundamental factors.
In a world of disruptive change, fundamental analysis-based stock-picking strategies remain at our core. We believe that our process with a focus on quality, the long-term and clear aversion to loss-making businesses remains well positioned to continue to do relatively well in what may continue to be highly volatile markets over the coming months.