Fund in focus: Merian UK Mid Cap
Posted by Liz Rees in Fund and industry updates category on 12 Jun 19
The Merian UK Mid Cap
fund aims to grow capital from a concentrated portfolio of 40-60 companies, of which around 75% will be from the FTSE 250 (excluding Investment Trusts) index.
The remainder are drawn predominantly from the FTSE Small Cap Index or the top end of the Alternative Investment Market (AIM). Holdings which enter the FTSE 100 may be retained and the fund is permitted up to hold up to 10% in unlisted companies.
Richard Watts has been at the helm since January 2009. Merian’s mid & small cap team of nine professionals is the largest in its field, and each of the five fund managers and four analysts has specific research responsibilities. They typically conduct over 300 company meetings every year.
The team also has an in-house data analyst who helps them make their own forecasts and produces valuable insights on trends, particularly in the retail sector.
Senior managers at Merian Global Investors led a buyout from Old Mutual in autumn 2018, and most employees have a stake in the business.
Investment philosophy & process
The core philosophy is to capture under-appreciated growth. Watts combines a broad economic outlook with detailed company analysis. He has a flexible approach and adapts the portfolio for the stage of the economic cycle.
The team meet regularly with large-cap colleagues to monitor and discuss key economic indicators. They also draw on external research. This economic and market analysis helps them form a view about which sectors are likely to outperform and underperform.
When researching companies, they are looking for them to meet at least one of three criteria; sustained above average earnings growth, the likelihood of earnings upgrades or the potential to re-rate. If the relevant characteristic is no longer present, the shares are sold.
The process also involves rigorous research to identify companies which are trading at a discount to their intrinsic value. As a result, Watts may invest in some highly rated businesses if he believes they are capable of delivering results over and above expectations.
The broad themes that Watts targets are: structural growth, global economic sensitivity and generic UK cyclicals. Presently, there is a skew to the former and favoured sectors are support services, IT software, online retail and financial services.
Top holdings offering structural growth potential include online fashion retailer Boohoo.com and automation software company Blue Prism. Exposure to global economic sensitivity is provided by plant hirer Ashtead while domestic cyclicals include house builder Taylor Wimpey.
The unconstrained approach means there are no set limits on the size of active positions although individual weightings will usually be less than 4%. Nevertheless, Watts will go close to the regulatory maximum of 10% for companies in which he has greatest conviction; Boohoo was 9.6% at the end of April.
Recognising the trend for companies to stay private for longer, Watts holds a few unquoted businesses of a reasonable size. However, Merian recently launched a specialist Investment Trust (a structure more suited to less liquid stocks) in this space and, going forward, the UK Mid Cap fund will obtain exposure via the trust (Merian Chrysalis Investment Trust).
Watts has outperformed the benchmark FTSE Mid Cap (ex IT) Index during his tenure. From 1 January 2009 to 31st May 2019 the fund delivered a total return of 378% compared with 308% for the index and 170% for the IA UK All Companies Sector.
Watts has beaten the benchmark in eight of the past 10 years. 2018 was a rare poor year, after an exceptionally strong 2017. To date in 2019, the relative performance has been strong as secular growth businesses rebounded.
Watts is fairly relaxed on the outlook for the UK economy. Although activity has softened, he notes that employment and wage inflation remain strong, while government finances are in very good shape. He considers the risk of an imminent recession to be low.
Furthermore, Watts believes that in the case of a soft Brexit, or indeed no Brexit at all, mid-cap companies could re-rate meaningfully given the reasonable valuations and past record of superior earnings growth.
We hold this team in high regard and Watts has proved excellent at stock-picking over the long-term, although this is no guide to the future. It should be noted, however, that the high conviction positions which have driven performance can produce greater volatility in the short-term.
A long-standing preference for structural growth has served Watts well in a low-growth, low-inflation environment and we are reassured by the fact that the fund can be flexible to suit changing market conditions. Morningstar awards it a silver rating.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Nothing in this article is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment.