Making the most of mid caps

Katen Patel, portfolio manager, discusses the importance of considering domestic versus international exposure in UK mid caps.

Go to the profile of Katen Patel
Mar 26, 2018

In 2017, stocks with higher domestic exposure continued to underperform their international peers, in aggregate. This trend, which began in 2016, has been driven by a drop in sterling and the weakness of UK consumer spending, which has been hit by negative real wage growth.

With the Santa rally having been more than wiped out and many domestic stocks continuing to remain on low valuations, Katen Patel—portfolio manager for the JPMorgan Mid Cap Investment Trust—asks if it’s time to revisit those areas of the mid cap market that are most sensitive to domestic growth?

Weak consumer and higher input costs

The current UK consumer outlook is supported by a strong labour market, with unemployment at multi decade lows. However, wage growth remains elusive and consumer confidence is still very much in the doldrums. Some market commentators expect inflationary headwinds to reduce from here, which could turn wage growth positive, but the outlook for UK monetary policy remains incredibly uncertain and will likely remain that way as we head through the Brexit process.

The possibility of another general election further clouds the picture. The market has started to price in a higher probability of two interest rate increases this year, potentially putting further pressure on the UK consumer, although we should keep in mind that rates will remain significantly lower relative to history.


JPMorgan Mid Cap Investment Trust plc

The sterling rally of 5% at the start of the year is helpful for companies whose cost base is partly in dollars, which includes many of the retailers. However, a lot of these companies hedge their currency requirements a number of months out, so they won’t see the benefit for some time. Meanwhile, they will continue to suffer from higher factory gate costs caused by sterling’s weakness over the last 18 months or so. This can either be passed on to consumers where the power of the brand and product is strong enough (for example, JD Sports or Fevertree)1, otherwise it can result in squeezed margins and potential profit warnings.

Profit warnings hit retailers

As highlighted in a recent article on The UK Edge by one of my colleagues (Timothy Lewis – Your stylish guide to UK markets), a recent2 Ernst & Young report on profit warnings noted that in the FTSE industrial sector (which has higher international exposure) profit warnings are at their lowest for six years, whereas in the domestically-focused general retailers sector, profit warnings are at their highest since the financial crisis. In the last few months alone we have seen profit warnings from the likes of Card Factory, Dixons Carphone and Debenhams1. It now also appears that the new owners of Homebase are suffering losses.

This all suggests to me that many of these domestic companies are cheap for a good reason: namely, the earnings element of the price-to-earnings ratio cannot be relied upon. I am, therefore, still mindful of increasing exposure to companies that are dependent on a strong UK economy given the uncertain outlook and continue to favour stocks with exposure to the global economy, where the picture remains much more rosy.

Selectivity is key

Fortunately, there is a plethora of both international earners and domestic earners within the FTSE 250 Index. As active managers, we can be selective in terms of what we own in the portfolio. Therefore, the Mid Cap Investment Trust is currently overweight international earners compared to the benchmark, although we do have selective domestic exposure in sectors that we feel have structural growth drivers supporting them, such as the UK housebuilders and the UK challenger banks.

In recent weeks we have seen strong trading statements from a number of our large internationally exposed names, such as Electrocomponents, Fenner, FDM and SSP. This portfolio positioning was put in place immediately after the Europe referendum result and has benefitted performance significantly since, with a total fund return of 63%, compared to the benchmark return of 37% to the end of January 2018 (Bloomberg data from 27 June 2016 to 28 February 2018)3.

Most importantly for investors, although there is undoubtedly volatility coming through, the mid cap universe offers investment opportunities whatever the economic and market backdrop.

Katen Patel is a portfolio manager for the JPMorgan Mid-Cap Investment Trust plc. Read more >


JPMorgan Mid Cap Investment Trust plc

Unless otherwise stated, all data is sourced from Bloomberg as at 15 February 2018. Past performance is not a guide to the future and you may not get back the full amount invested.

1The companies above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell. 2Q4 2017. 3The trust is an actively managed portfolio. Holdings, sector weights, allocations and leverage, as applicable, are subject to change at the discretion of the investment manager without notice.

JPMorgan Mid Cap Investment Trust plc 

Investment Objective: Aims to achieve capital growth from investing in medium sized UK listed companies, by outperformance of the FTSE Mid 250 Index. The company will predominantly invest in quoted companies from the FTSE Mid 250 Index, although, where appropriate, it may invest in quoted UK companies outside of this index as well as companies quoted on the Alternative Investment Market which is the London Stock Exchange market for smaller, growing companies. The company has the ability to use borrowing to gear the portfolio within the range of 5% net cash to 25% geared in normal market conditions. Risks: External factors may cause an entire asset class to decline in value. Prices and values of all shares or all bonds could decline at the same time, or fluctuate in response to the performance of individual companies and general market conditions. This trust may utilise gearing (borrowing) which will exaggerate market movements both up and down. This trust invests in smaller companies which may increase its risk profile. The share price may trade at a discount to the Net Asset Value of the company. The single market in which the Trust primarily invests, in this case the UK, may be subject to particular political and economic risks and, as a result, the trust may be more volatile than more broadly diversified trusts. Companies listed on AIM tend to be smaller and early stage companies and may carry greater risks than an investment in a company with a full listing on the London Stock Exchange.

For Professional Clients only – not for Retail use or distribution. This is a marketing communication and as such the views contained herein are not to be taken as advice or a recommendation to buy or sell any investment or interest thereto. Reliance upon information in this material is at the sole discretion of the reader. Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. The results of such research are being made available as additional information and do not necessarily reflect the views of J.P. Morgan Asset Management. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are, unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Changes in exchange rates may have an adverse effect on the value, price or income of the products or underlying overseas investments. Past performance and yield are not a reliable indicator of current and future results. There is no guarantee that any forecast made will come to pass. Furthermore, whilst it is the intention to achieve the investment objective of the investment products, there can be no assurance that those objectives will be met. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. To the extent permitted by applicable law, we may record telephone calls and monitor electronic communications to comply with our legal and regulatory obligations and internal policies. Personal data will be collected, stored and processed by J.P. Morgan Asset Management in accordance with our EMEA Privacy Policy Investment is subject to documentation which is comprised of the Prospectus, Key Investor Information Document (KIID) and either the Supplementary Information Document (SID) or Key Features/Terms and Condition, copies of which can be obtained free of charge from JPMorgan Asset Management (UK) Limited. This communication is issued by JPMorgan Asset Management (UK) Limited, which is authorised and regulated in the UK by the Financial Conduct Authority. Registered in England No: 01161446. Registered address: 25 Bank Street, Canary Wharf, London E14 5JP. 0903c02a820c02b5

Go to the profile of Katen Patel

Katen Patel

Fund Manager, J.P. Morgan Asset Management

Katen Patel is portfolio manager of the JPMorgan Mid Cap and JPMorgan Smaller Companies Investment Trusts, as well as the JPM UK Smaller Companies Fund within J.P. Morgan Asset Management's UK Equity team.


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John 8 months ago