79. Why the FTSE 250 is more international than you may think

[Music] hello and welcome to the investing on Theo podcast I'm Juliet schooling L and today I'm joined by Chris singen manager of the elite rated ax of framlington UK midcap fund hi Chris um you invest mainly in the UK's mediumsized companies those in the footsie 250 which is uh commonly thought of as being very domestically focused is this true today or or is that a miscon conception uh it's true to some degree but I personally I view it as a misconception I think most people view the fc250 index and so the midcap uh section of the market as very much a UK domestic facing group of businesses in reality about half of the income the turnover generated by these businesses actually is generated from outside of the United Kingdom so there are lots of domestic companies yes but there are also lots of International companies as well uh serving markets out in uh you know Far East Asia uh the US and across Europe as well and this sort of midcap area um has been sort of shunned a bit since the brexit vote hasn't it over worries about you know the eventual Deal or No Deal uh and now Corona virus on top of that um but the performance hasn't actually been as bad I think as a lot of people think the footsie 250s sort of rotated hasn't it between sort of outperforming large and small caps and underperforming them um why why is this um and how has your fund sort of managed to outperform uh yeah it's it's interesting um actually if you look over the last three and five years um the footsy 250 in aggregate has actually outperform uh the footsy AllShare however you're right within that there's been some years where performance has been very different uh 2016 is the most extreme example of that and that really saw the impact of uh the brexit vote which surprised the market and really what happened at that time was uh Banks uh assumed that the UK economy would go immediately into recession would be a significant uh significant contraction in GDP and Sterling weakened considerably as well at that point now on the base of what we've just said around sentiment and yes the F250 is more exposed to the UK economy than International that had a profound effect on the index itself so we saw we saw a dramatic fall in Sterling an expectation that the UK economy would contract and as a consequence of that the footsy 250 is an index fell quite precipitously certainly a very different performance to the 00 which is made up of more International companies companies orbe it 30% of the all share is actually made up of UK earnings itself so Sterling had a big impact that surprise uh brexit result had a big impact uh as well now it hasn't been One Way by any stretch of the imagination as I said three to five three and five years the midcap is up form the FY AllShare uh and that has been driven I think principally uh once again because of the uh Superior growth in earnings and economic output you see from footsy 250 uh companies themselves it's also worth bearing in mind the footy 100 and the all share by extension uh is made up or is is dominated by a few very big sectors oil Pharmaceuticals tobacco banks for example so when you see significant movements in the oil price it disproportionately affects the footy 100 and therefore all share relative to the footy 250 in terms of out performance or how how the fund has performed relative to the to the index uh that has all come about because or PR predominantly come about because of stock picking um and the effect of stock picking so companies like decra Pharmaceuticals which supplies Veterinary products uh future which is a media business Renta kill which some of you may have heard of before which is in a pest control business they've all been good compounding companies that have increased their economic output over this time and so yeah so the outperformance has come through stock picking since the fund was launched in March uh 2011 um before fees the fund is outperform the by 96% cumulatively and of that 81% has come from stop picking well that's great news great news for for our our investors um and uh you also invest in some aim Holdings don't you um yeah what is it that you you like about this particular part of the market yes there lots of misconceptions about aim I I think um things have changed a lot since say the tech uh and doom boom for example when a lot of the index was made up of loss making businesses um a lot of very early stage companies in technology area and similarly some very early stage pre-revenue Capital intensive businesses in the mining area were also very well represented if you look at the index the aim index now um its cumulative market capitalization is nearly 100 billion pounds uh and there are 187 companies at the last count with a market capitalization of more than 100 million pound and in fact 18 companies have a market capitalization of more than1 billion pounds so that you know these are profitable businesses and that would put them actually into the footsy 250 were they to move from aim to the full list so companies like Fever Tree uh boohoo which uh both companies which people may well have heard of and and companies like Breeden which is an aggregate producer uh uh kinen in healthcare which per wouldn't have heard of those businesses all have Market capitalizations of over 1 billion pounds so there are lots of uh profitable growing businesses apply exactly the same investment philosophy and process to aim as I would for a fully listed business but outside of these wellestablished businesses with with significant market capitalization there are also lots of interesting Innovative businesses and I think if you focus just on the AllShare then you miss out on the opportunities that are there so if if you think about computer game companies in lockdown uh and as as an industry that has taken masses and masses out globally out of its distribution cost by um Distributing games digitally that is an area of the market that has done well over lockdown has seen significant growth in in demand and as an industry uh it is certainly growing and compounding and it is much more represent Ed in AIM that it is on the main list there also other great Innovative companies within Tech within technology within healthare we have holding in a company called creedal you know these are businesses that really are on the on the on the on the Forefront of Technology very big end markets uh well capitalized interesting technology uh and and really do have a very interesting future ahead of them yeah you I mean you mentioned uh boohoo and fever treat there which probably names our listeners are familiar with um how long have you held them um I've held both those SS not for a great deal of time um uh I've bought them within the last two years uh so taking advantage of stock market Falls I mean there've been companies I've followed uh for a long time or both of them since float uh so I've used Market pullback as an opportunity to add to add uh to to to buy the Holdings and add to them as well a as I've which which is typical of me I I'm a long-term investor my investment Horizon is three to five years but my average holding period at the moment is around seven years so I'm very happy to be patient with these businesses let them develop and in my mind I don't mind you know if the market capitalization expands but to my mind the risk reward has actually improved in the favor of the equity holder then I'm happy to buy at a later date rather than necessarily taking all the risk of buying these companies at flat yeah and um what's your outlook for UK companies over the next sort of year 18 months um with this extraordinary situation we find ourselves in you know we've been just been told that the economy's contracted about 20% uh how concerned are you about this and and you know the uh brexit ongoing brexit negotiations well yeah it is it is concerning and to to discount it and ignore it would be would be um Reckless to say the least I as a general observation um you know we are seeing a severe economic contraction in the UK and in fact globally um as a direct result of uh the impact of lockdown um essentially governments have put their economies and and if you look at the UK it's absolutely true here the government has effectively put the economy uh to sleep on a temporary basis um people have been asked to stay at home uh come companies have uh effectively uh shut up shop in many cases if you think about companies in the eye of the storm companies like in the Leisure industry restaurants and pubs they've not been able to open for a while so you've seen this extraordinary situation where companies have seen dramatic Falls in their turnover as a consequence of direct action to contain the virus now there has been a response on the other side side uh from central banks from governments and from Banks themselves who've all worked hard uh to my mind to protect the productive capacity of the United Kingdom and our economy and this has all been about when the when the virus broke when lockdown was put into place you saw extreme effect on the cash flow of businesses so what you've seen is a a a liquidity event and a liquidity shock and a response from central banks governments and uh and Equity holders as well to prevent that liquidity crunch turning into a solvency crunch so the everyone has been working hard and I think some of the um uh some of the support measures put in place for example in the fur of Staff have been very very successful and as a consequence a lot of the productive capacity of the United Kingdom has been kept in place now if you want the E economy to recover quickly then the economic capacity has to be maintained because if you start to lose the ability of the company to of the country sorry to employ and to grow then it will have a profound longer term effect on the economic output and that will naturally result in higher levels of unemployment higher levels of business failures so I think we're in a very interesting point at the moment when you look at stock market we've seen very logical behaviors in terms of protecting the balance sheet of businesses uh so working capital has been retained within companies we've seen dividends being deferred or cancelled we've seen Banks waving um um covant events so that companies are not breaching the banking Covenant and therefore the banks are not coming in and taking control of companies are putting unnecessary uh penalties on companies uh and and as a consequence and as a consequence of that I think we've moved from this event of concern over solvency into a point where investors can start to look forward at the recovery and what the economy certain sectors and businesses will look like like post what will turn out to be a transitory event now we don't know how long this is going to last we don't know the shape of the recovery we can see that the recovery is starting to happen uh people are using China as a blueprint uh we can see uh uh the government in the United Kingdom talking about for example reducing so distancing from 2 m to one meter and we can start to think about the effect that might have on a number of uh on a number of businesses so we're in this very interesting period now it's not all doom and gloom it doesn't mean that all businesses are failing all businesses are finding life very difficult at the moment there are areas of the economy that are doing well and there areas been doing badly and I think the effect longer term of of uh of covid we don't know but at the moment a lot of the speculation a lot of the thought is around how the economy may change going forwards and how behaviors may change going forward so there's a lot of talk about increasing working from home uh the effect that that would have on property um for example if if suddenly you only need uh you need 20% less office space and that doesn't bode well if you're the owner of the property uh in increasing uh data usage therefore everything that goes around that so Broadband capacity um uh uh you know the protection of data for individuals and for companies as well so that so there are so there are lots of areas that that that may well benefit from this a and indeed a lot of the trends we've seen over the last few years May well be catalyzed and accelerate as a consequence of this uh you know there are plenty of people who for the first time have been forced to shop online and have found that it actually works very well so that that acceleration of e-commerce of online shopping and everything that comes around that in terms of the logistics the reverse Logistics I think will continue to accelerate so that it's it's the the 20% contraction of the UK economy is deeply concerning it's been manufactured we wait to see how well the company bounces back given the productive capacity has been kept in place yeah so what do you think are the big opportunities for investors uh in in the midcap space at the moment um it's the Outlook is it remains uncertain you you did ask about brexit before and um I didn't answer that so apologies but um yeah brexit is brexit and the outcome of brexit again is another unknown uh from a personal perspective I think you know you hope that pragmatism leads to a free trade agreement ment that is supportive of business uh from a business perspective they just need to know the rules of the game and they can get out there uh start trading um and and put the the the work at how they need to adjust if indeed adjustments need to be made and can just crack on with things uh going back to the big opportunities in this space I just don't think they've really changed I you know again as a sort of General concept I think well capitalized businesses who can grow turnover ideally organically uh who's growing profits that um uh that are generated by that growing turnover turn into cash and if they can compound that turnover compound compound the profits and the cash flow generation then over time that should lead to very good Equity returns uh you know I often use a stats from a study done by Boston Consulting Group but they showed over 10 years that around 70% of your return comes from the turnover growth of the underlying company and to my mind that's uh illustrative of the increasing economic output over 10 years almost none of your return comes from movement in the multiple so the PE uh that is put a put on a business um because to my mind over the short term and and we're seeing a lot of this at the moment Capital flows will dictate uh the short-term movement in the multiple that stock markets prepared to put on a company so I don't think anything has changed really those companies that can compound their earnings uh are certainly the ones I think you'll get the best return from uh and those are the ones I'll continue to focus on you need to feel comfortable that there's sufficient uh liquidity within businesses at the moment where the insolvency risk is taken off the table and then as ever as a stock picker you know it's a stock market but um you know we often say it's a market of stocks uh we all uh tend to focus on the headline numbers of how indices are moving but under that there's always a huge amount going on so as Things become clearer I think it'll be become clearer as in the effects of covid become clearer I think it will become clearer those companies that are likely to win and lose the Haves and the Have Nots uh you know we can see air travel significantly hit at the moment uh Leisure companies uh property companies whether they're on the High Street which really is just an acceleration of what we've seen over the last 5 to 10 years all the demand for office space falling so you know also you know the market is now pricing in five years with no interest rate Rises well you know that's not a very good background uh for banks so there will be those areas of the stock market that that will be affected uh negatively uh but on the other side there are those companies that will will benefit you know we've mentioned a couple of thematics earlier on but that seemed to work from home I'm I'm slightly skeptical whether we work from home as much as we think we will longer term uh but you know working from home the need for more broadbands the importance of data transfer uh Health Care um you know and and and companies that will profit from that so if more people are working from home I have no doubt there's a market for software that will remotely measure the effectiveness of people's uh output productive output when they are working from home so as ever the world is constantly changing that leads to opportunity inevitably uh but also heartache for other parts of the market and other companies unfortunately yes interesting stuff uh thank you thank you Chris so much for your time today pleasure um if You' like more information about ax of framlington UK midcap please visit fun caliber.com and don't forget to Subs subscribe to the investing onthego podcast please note that these are unprecedented times and markets can react very quickly to news the views expressed are at the time of recording and could change and remember we've been discussing individual stocks to bring investing to life for you it's not a recommendation to buy or sell the fund may or may not still hold these stocks at the time of listening