Investors spooked by the recent sell-off in technology stocks need to understand that some parts of the market are still doing very well – this is not an all-sector global market slump.

While the US tech-heavy Nasdaq index is down about 6% year to date, we’ve seen the FTSE 350 oil and gas sector rise by nearly 17% over the same timeframe, the UK’s banking sector is up by 15% and the tobacco sector has increased by 13% in value since the start of January.

There has been a market rotation away from expensive tech stocks where the big corporate profits will be made many years from now, with investors now preferring cheaper stocks where good profits are already being made today, known as value stocks.

The UK is one of the best places to find value stocks because the market in general trades on a lower valuation than places such as the US. Not only can you find more attractively valued stocks on the London Stock Exchange, often you’ll find further bargains in
the investment trust space where shares can sometimes trade below the value of a company’s assets.

Investment trust Schroder UK Mid Cap Fund (SCP) is a great example as its shares trade at an 8.3% discount to net asset value. Effectively that means you can buy a portfolio of UK stocks for less than you would pay to buy them individually.

The scale of the discount is quite surprising when you consider the Schroder trust invests in liquid stocks, focusing on the FTSE 250 index of mid-cap names. Its track record is also very good, with the trust’s total return (share price gains/losses and dividends) outperforming the FTSE 250 index on a one, three, five and 10-year basis.

BEST IDEAS

Jean Roche took over as lead manager of the trust from veteran fund manager Andy Brough in January 2021. The latter continues to act as co-manager.

In a presentation on Schroders’ website, she says: ‘We are active investors aiming to invest in around 50 stocks, which represent the best mid-cap ideas. We aim to invest in these companies at the sweet spot in their growth path’.

Roche believes the mid cap index acts as an incubator. In essence, companies in the FTSE 250 in general will have already developed a strong market position. As they continue to grow the most successful eventually compete for a place in the FTSE 100 index. FTSE 250 stocks typically display faster growth rates than those in the FTSE 100.

INVESTMENT PROCESS

Roche and Brough look for well-managed resilient companies with a leadership team driving a long-term vision capable of generating solid cash flow returns.

Given that big winners are ‘often born out of innovation’ Roche is attracted to companies that are challenging the status quo and recognises that the FTSE 250 has a strong record of containing businesses which have created successful disruption.

Examples include Auto Trader (AUTO) and Rightmove (RMV) which have fundamentally changed the way their sectors operate, and both stocks have gone on to join the FTSE 100 as they continued to grow.

Assessing the sustainability of growth over the long term is another key element in the investment process. This involves examining the scope of the sector to grow and the potential threat from incumbents.

Roche also likes companies which can react to and capitalise from change. In particular, she advocates a corporate culture that enables fresh and innovative thinking.

M&A SWEETSPOT

The renewed demand for UK-quoted companies from large and experienced buyers is noteworthy. Mid cap companies have been at the centre of takeover interest from private equity firms and there is a sense that the M&A spree we saw last year will continue into 2022.

According to Roche, ‘It’s always helpful to observe what the corporate and private equity sectors are doing since we share their long-term mentality. It seems to me these bidders are currently thinking UK shares are cheap.’

WHAT’S IN THE PORTFOLIO?

Investors buying shares in Schroder UK Mid Cap are getting exposure to various sectors including industrials, consumer discretionary, financials, real estate and healthcare.

At the end of November, key holdings included Diploma (DPLM) which distributes parts to help keep factories running smoothly as well as products for the healthcare industry. Cushions to curtains retailer Dunelm (DNLM) is also a big position for the trust, and on 12 January it said full-year pre-tax profit would be materially ahead of expectations.

Investors shouldn’t expect everything in the portfolio to be doing well at the same time, with key holding Games Workshop (GAW) among the stocks to have disappointed the market in recent months. Yet that’s the beauty of investment trusts – they can provide instant diversification, so when a few holdings aren’t doing well, there are hopefully lots of other holdings to cushion this blow and drive overall performance.

Admittedly some of the holdings in the trust are tech companies and their shares are likely to have been caught up in the sector sell-off this year. These include Computacenter (CCC) which is a highly profitable business today, yet its shares have been dragged down by investors selling anything to do with technology.

Furthermore, some of the portfolio holdings are not necessarily cheap, so this isn’t a pure value-led investment trust in the way you might describe Temple Bar Investment Trust (TMPL) or Aurora Investment Trust (ARR), for example.

Even though Schroder UK Mid Cap pays dividends, investors should consider any income as a bonus rather than a core reason to own the shares. In the year to 30 September 2021, the trust paid 14.8p in dividends which equates to a 2.2% yield.

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