The UK market has rallied strongly since the 2008 crash and valuations have been rising across the board.
However Steiner warns that valuations on the FTSE 250 are at a huge premium to the other parts of the market, and many funds are piling into this area despite being nominally small or multi cap portfolios.
"The UK market has gone from incredibly cheap to a little bit cheap," he said. "Some areas, like the top of the FTSE 250, have gone to excessive valuations."
"The P/E [price to earnings] premium of the big 250 stocks is 40 per cent higher than both the small cap and large cap stocks."
"We are concerned there’s quite a lot of mislabelling of multi-cap funds that are really 250 funds and smaller cap funds that are really 250 funds."
"While performance is good, that’s great. Drifting away from what you say you are investing in is good until the numbers do not add up any more."
FE Trustnet has recently reported on the growing number of professional investors expressing concern about the crowding in the mid cap area of the market.
Data from FE Analytics shows that all the top-performing IMA UK All Companies funds have a significant weighting to the FTSE 250, as do many IMA UK Smaller Companies funds.
The sector certainly has greater growth potential, having made significant gains in recent calendar years.
Performance of indices over 5yrs
| Name | 2013 returns (%) |
2012 returns (%) | 2011 returns (%) | 2010 returns (%) | 2009 returns (%) | 2008 returns (%) |
|---|---|---|---|---|---|---|
| FTSE 100 |
14.17 | 9.97 | -2.18 | 12.62 | 27.33 | -28.33 |
| FTSE 250 | 23.95 | 26.11 | -10.06 | 27.4 | 50.64 | -38.15 |
| FTSE Small Cap Index | 22.39 | 27.82 | -12.53 | 19.52 | 54.27 | -43.91 |
Source: FE Analytics
However, this comes at the cost of greater volatility. Our data shows that over the past 20 years, taking into account strong and weak periods for the index, the relative outperformance of the FTSE 250 is much less than might be expected.
The average annualised return for the FTSE 250 over that time is 10.92 per cent compared with 7.63 per cent for the FTSE 100 and 7.29 per cent for the FTSE Small Cap.
Steiner says that the key to successful investing is looking for value. For this reason investors who are buying in to UK equities on the back of an improving economic situation could end up in trouble.
"One of the traps people fall into is that what drives your returns is the valuation you buy them at. The correlation to economic growth is virtually non-existent."
"The UK economy doesn’t really have an impact on the stock market."
He points out that the particularly strong gains in recent years came about because the market was recovering from low valuations rather than because of an improving economy.
SVG Investment Managers’ preferred method of assessing valuations is taken from the world of private equity, where former parent company SVG Capital amassed its expertise.
This involves a focus on cash-flow metrics rather than earnings figures, the latter being easier to manipulate.
SVGIM uses these private equity techniques on open-ended multi-cap fund SVG UK Focus and closed-ended small-cap fund SVG Strategic Equity Capital.
The former is a genuine multi-cap product, Steiner explains, with 45 per cent in the FTSE 100 and the rest equally split between the FTSE 250 and the FTSE Small Cap.
The latter is more focused on corporate engagement in the manner of private equity investing, and the trust seeks to raise the valuation of the companies it invests in by influencing management.
"The IT invests in companies which are typically on AIM or the smaller companies index and looking for situations where companies are good but missing something in terms of governance."
Whereas it has an average market cap of about £250m, the fund’s average is closer to £3.4bn.
Both portfolios have been successful recently, with SVG Focus returning top-quartile returns over three years of 69.27 per cent compared with gains from the FTSE All Share of 42.82 per cent.
Performance of funds vs indices over 3yrs
Source: FE Analytics
The smaller companies trust has made 115.09 per cent over the same period compared with gains of 73.56 per cent from the FTSE Small Cap index.
Maintaining its distance from the banking, consumer and mining sectors has helped considerably on the all-cap fund, Steiner explains, and he warns that the poor period for mining could have some way to run, with cycles typically lasting 10 years in each direction.
SVGIM is being bought by Swiss investment business Hansa, which has private equity experience and will take on the stakes currently held by SVG Capital in the funds and aim to enlarge them in the coming years.
This is likely to lead to an increase in the size of the funds, Steiner explains – SVG UK Focus currently has just £96.1m AUM and Strategic Equity Capital has £85.7m.
The deal is subject to regulatory approval.
SVGIM will also aim to increase its marketing resources, although the fund managers and strategies will remain the same; Steiner retains his position.
He says that one disappointment in the recent year has been the low level of M&A activity. SVGIM’s models led it to expect a pick-up in such activity a couple of years ago, but it has so far failed to materialise thanks to nervousness about the economic situation.
This could give the two funds a boost in the years to come if it does occur, although Steiner is reluctant to make any predictions given the ongoing macro concerns.
Although the funds do not aim to buy companies in the hope they are going to be bought out, its strategy naturally leads it to such firms.
"Historically we are four times more likely to own something that’s bought out, but we are weighted to the early stage of the cycle. In 2004 and 2005 we were 10 times more likely to hold something taken over."
Steiner says that there is still plenty of scope for further growth in the market once nervousness diminishes and companies start gearing up again.
"The funds have less than one-times debt to EBITDA, but not by choice," he said. "We think the market is woefully under-geared; it’s quite silly, really."
"Many companies trade on discounts to peers in Asia and elsewhere, which should make them targets for M&A but they haven’t been. It could come back in a big way in the next year."
