The case for UK Mid Caps

David Moss

David Moss

Managing Director, co-Head of Global Equities, European Equities
Matthew Parker

Matthew Parker

Vice President, Portfolio Manager

Subscribe to our insights

The UK market: doom and gloom?

Current discussions around the UK market often converge on the rising risk pressures that investors are facing. Perhaps the first port of call here is the political and leadership issues within the UK itself and further afield:

  • Ongoing Brexit uncertainty
  • Changes in European political leadership
  • A switch of leadership at the European Central Bank
  • President Trump and his accompanying trade wars

In addition, bond yields for both corporates and governments remain very low, with cheap funding continuing to support elevated corporate leverage, albeit there are no signs of stress in this market as yet. Levels of unsecured consumer debt throughout the developed world in general remain high also.

Despite looking ok at the aggregate level, valuations within the UK market are polarised. There are bubbles emerging in particular areas of the market, where behavioural biases have driven valuations to record highs.

This all paints a rather uncertain, if not gloomy picture of the current UK market. However, regardless of whatever the UK economic backdrop has been over the past 20 years or more, investing in UK mid caps has proved to be rewarding. We expect this to continue owing to the underlying, enduring characteristics of these businesses.

Value creation

First and foremost, mid cap names offer superior value creation over their larger peers – a function of their ability to earn more attractive returns on capital employed (ROCE), deployed at higher growth rates. Over the past decade, mid caps have consistently delivered higher and more stable levels of ROCE versus their large cap brethren, who have destroyed value in three of the last 10 years with sub cost of capital returns.

Opportunity to scale…

Mid-sized companies tend to be less complex, more focused businesses giving them a greater opportunity to scale. Far smaller absolute levels of investment make material differences to the fortunes of these businesses, whereas large caps can spend hundreds of millions – even billions – and barely move the needle.

…and scale to dominate

These are still businesses with sufficient scale to dominate or maintain leading positions in their respective markets – market niches that are generally not particularly well-served and are normally too small for large cap names to play in.

Aligned management

High levels of equity ownership are not uncommon amongst mid cap management teams, providing good alignment with shareholders but also supporting a better, and more considered capital allocation decision-making process.

Alpha potential

There is greater alpha potential within mid caps: analyst research can be materially less in this universe, which has a two-fold effect. Firstly, it means there is a greater opportunity to add value through an informational advantage. Secondly, this lack of coverage can lead to disproportionate reactions to newsflow and results for these names, which offers more frequent opportunities for investors.

Our philosophy

Whilst we believe that the case put forward for this attractive asset class is robust, it is not immune from the vicissitudes of the current market environment. Behavioural biases are very much present, valuations polarised, and in some cases at record highs. We navigate this through a disciplined investment philosophy that revolves around three pillars, none of which are mutually exclusive:

  • Quality
  • Management
  • Valuation

We aim to buy good businesses that we understand with proven, defensible business models that are evident through a record of excess return generation. We want these businesses to be run by proven management teams, again with a record of value-accretive capital allocation decisions. Finally, we want to buy these businesses at attractive discounts to a cashflow-derived measure of intrinsic value, thereby ensuring a sufficient margin of safety for our investments.

Risk Disclaimer

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

Use our handy glossary to look up any technical jargon.

Related articles

Responsible Investment
Woman presenting to an audience
3 min read
June 2022

ESG knowledge shared: June 2022

Keep up to date with responsible investing in our monthly roundup of highlights – interesting events, articles we’re reading, podcasts and more.
Responsible Investment
2 min read
May 2022

Living wage in the retail sector

Our three-year engagement project on living wages comes to an end. We look at progress made and highlight what more needs to be done both within retailers and in their supply chains.
Responsible Investment
Tree honey bees pollinating a purple flower
5 min read
May 2022

Searching for solutions: an update on bee-harming pesticides

Read our update on the controversial use of bee-harming pesticides in agriculture – and whether there are any suitable solutions.
Global Equities
Diver diving in the ocean looking down and fishes
4 min read
May 2022

Investing in our blue planet

The world’s oceans are in crisis, and investors have a critical role to play in resolving this
Responsible Investment
People hiking in the mountains
3 min read
April 2022

Principles for carbon offsetting

We outline our principles on when companies should use carbon offsets and explore our engagement with businesses, especially in high impact sectors.
data analyst presenting charts in a meeting room to others
6 min watch
March 2022

Weekly review: will the equity rally be sustained?

The news from Ukraine has been almost unbearable, and for the people of Ukraine, with no choice in the matter, truly awful.