Over the last six months, we have seen some of these risks begin to play out. As the global credit crisis unfolded, fuelled by the sub-prime meltdown in the U.S., two things happened. Investors started to seek safety in the perceived stability of large caps, and the easy credit that had helped fuel the
M&A boom dried up. Against that backdrop, large-cap oriented funds in the UK All Companies sector substantially outperformed their peers that were more focused on mid- and small-cap companies. To be more specific, the top twenty offerings in the six months ended 31 December had an average market cap just of £10.6 billiion, whilst the bottom twenty averaged just £2 billion.
Zeroing in on mid-cap focused funds, however, there was significant differentiation with regards to their ability to withstand the meltdown. The top performers from 1 July through 31 December 2007 were Threadneedle UK Mid 250, which was up 1.7%, followed by Rensburg UK Mid-Cap Growth (down 3.6%) and Old Mutual UK Select Mid-Cap (down 3.5%). Among the notable laggards, Andy Brough's £2.7 billion Schroder UK Mid 250 struggled to a 9% loss.
Although six months is far too short a term to mean much, such a downdraft can give you a clear idea of the risks inherent in a portfolio. In Brough's case, he held some exposure to troubled lender Paragon Group at the end of June and also had a smattering of property related companies. Whilst it's unclear how long he held those positions for, they would have clipped the fund if retained. In contrast, Ashton Bradbury had limited exposure to these areas, and also let cash run up to 10% of assets, which could have accounted for some of the fund's resilience.
We had already begun to worry about Brough's fund a bit--not because of its recent malaise, but because the fund's performance relative to the FTSE 250 ex IT has tailed off in the longer-term as assets have grown. It's not clear if the extra liquidity demands generated by the fund's size are giving Brough any problems, but it merits keeping an eye on. For that reason, we're more partial at this time to Bradbury's Old Mutual offering and the Rensburg fund, but it should be said that we remain leery of mid-caps. Although their valuations have come in relative to large-caps, they are still high by historic standards on a relative basis. Moreover, the volatile market conditions that led investors to favour large-caps don't show any sign of abating in the near-term, which could put more selling pressure on mid-caps. We don't think outright sales are in order--such market timing attempts are a good way to get whipsawed, but we do believe it's a good time to make sure your mid-cap exposure didn't get out of step with your risk tolerance during their run-up.
A version of this article previously appeared in Investment Adviser, Financial Times Ltd.
