Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

James Thorne, manager of the Threadneedle UK Mid 250 Fund, presents a compelling case for investing in mid-sized companies. His fund, one of our analysts’ Select 50 choice of favourite investments, aims to deliver “the best risk adjusted returns within the UK equity market”. He believes investing in mid-sized companies is the best way to achieve that.

He describes FTSE 250 stocks - smaller than the FTSE 100 index of the UK’s biggest companies, larger than the FTSE SmallCap which brings up the rear - as the “sweet spot of investment opportunity”. It’s here that he sees “the biggest returns over the short, medium and long term, and much better returns than the wider market”.

So, how does Thorne look to capitalise on this underappreciated area of the market? He recently discussed his thinking with my colleague, Ed Monk.

Something in between

The UK makes an interesting investment case right now. It has the potential to bounce back this year more sharply than most. In part because of its low starting base (the UK has been out of favour for some time now), in part because it’s full of the kind of value, cyclical companies which should benefit most from a rebounding economy.

When people talk about investing in UK stocks, however, they’re usually talking specifically about the FTSE 100. The index is taken as a kind of proxy for the UK market as a whole.

There are advantages to investing in larger companies, but there are also drawbacks. FTSE 100 companies derive around two thirds of their earnings overseas. That’s great for investors looking for global exposure; less so for those looking to capture the UK’s domestic recovery.

There are other points of difference. Large companies typically leave less room to grow than their smaller counterparts. To Thorne, that’s a big plus for mid-caps. He explains:

“Mid-sized companies have a huge opportunity to compound returns. By the very nature of them being a lot smaller than larger businesses, they’re able to expose themselves to areas of opportunity and growth - that includes expanding into international and adjacent markets. They’re also able to accelerate the monetization of their current market.”

Likewise, Thorne thinks mid-caps present a stronger investment case than small. Both enjoy greater growth potential than large companies, but there are familiar risks attached to small companies. Their share prices are more volatile, and you’ll typically find lower levels of investment in a small-cap’s underlying business.

To demonstrate, Thorne highlights the difference in recruitment capabilities. “Businesses are about people”, he says; unlike small caps, medium-sized companies are ones which have proven their business models and their capacity to grow, meaning they “can attract the best people in an industry to work in an area of great opportunity.”

Quality growth

Thorne invests with a bias towards “quality growth”. That means he prefers companies which maintain consistent levels of profitability and which usually offer a competitive “moat” that keeps the competition at arm’s length - a well-renowned brand, for instance. Their robust earnings and defensive characteristics position them well for a recession.

The fund may struggle when economies and markets rebound quickly. In these conditions, Thorne would expect his fund to perform broadly in line with the index.

He remains optimistic for the fund’s long-term outlook. Thorne expects that a combination of inflationary pressures and a normalization of growth rates will soon constrain investors’ enthusiasm for the cyclical stocks that are benefiting from today’s rebounding economy. He expects the sort of growth-focussed companies that he holds to come back into favour shortly.

But he’s reluctant to tar all sectors with the same brush. He likes the look of travel and leisure companies which, after suffering so much during the pandemic, now have significant room to recover. The fund’s second largest holding, SSP Group, a food service company which operates brands like Upper Crust in travel locations across the world, is evidence of Thorne’s thinking.

His is also a very concentrated portfolio. Holding around 30-50 names (currently he’s above that at 59) means the fund is well positioned to capitalise on its holdings’ gains, but investors should note that relying on fewer companies does add a degree of risk.

For investors willing to accept that risk, this fund could be a useful way to tap into the UK market’s underling growth potential. Not too big, not too small, UK mid-caps present an intriguing opportunity.

More on Threadneedle UK Mid 250 Fund

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. The Threadneedle UK Mid 250 Fund invest in a relatively small number of companies so may carry more risk than funds that are more diversified. The fund also invests more heavily than others in smaller and medium-sized companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies. The fund may use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

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