A power provider, a technology firm and a telecommunications company are some mid-cap options for investors looking to diversify their UK holdings outside of the well-known large-caps, according to two veteran stock pickers.
The UK mid-cap space is a “very vibrant part of the market,” according to Sue Noffke, head of UK equities at Schroders, with “a lot of diamonds”.
She noted that the lower down the market capitalisation investors go, the less research is done on these businesses, which can lead to mispricing.
It is why Noffke has focused on this part of the market when looking for new allocations to her Schroder Income Growth investment trust.
The manager said that 12 names had been changed out from the portfolio during the past 12 months, and recycled into several mid-cap stocks, one of which was real estate investment trust Workspace.
The company has provides flexible workspace in various locations across London. The ability to work from anywhere other than the office has been a by-product of the pandemic and employees working from home intermittently, has created a demand for work ‘hubs’. Since it launched the company has made a total return of 556%.
Performance of stock since launch
Source: FE Analytics
Another stock Noffke highlighted was telecoms company BT, with its fibre optic network rollout making it extremely appealing, while gaming company 888 was another she added to. The latter benefited from people being on their phones more during lockdown and betting online in place of casinos and traditional betting shops.
The company does face some headwinds from regulation changes in both the UK and wider Europe, but Noffke said this could be outweighed by deregulation on sports betting in the US, creating a bigger market opportunity.
Another attractive name the Schroders manager highlighted was power provider, Drax. The company is undergoing a shift from running a biomass and coal-fuelled power station into providing renewable energy, reacting to the global push for more climate-friendly energy solutions.
Noffke said that the company has the potential to become a major player in carbon capture and storage, as it aims to become carbon neutral by 2030, in-line with the Paris Climate Agreement.
“This is quite exciting from a climate change point of view,” Noffke added.
Investing in companies involved in the renewable energy space and providing solutions enabling this transition away from fossil fuels has been a growing theme in the investment industry, and not just for dedicated ethical funds.
Although many funds investing in these companies have an explicit ethical mandate, many managers without a strict environmental, social and governance (ESG) agenda have been considering the risks of investing in companies not in-line with government policies on climate change and have also been investing into this space.
In some cases the wave of interest has caused valuations of some of the most popular ESG stocks to inflate dramatically.
However, this does not mean that all highly valued ESG stocks should be avoided, including in the UK, as the risk of not taking environmental and social factors into account when considering future growth and returns has been increasing in recent years.
FE fundinfo Alpha Manager Matt Evans, who runs the Ninety One UK Sustainable Equity said that if a stock can still offer growth and financial returns, those are good enough reasons to still hold them, even if they are more expensive.
He added that the way to manage that issue was to have them at smaller weightings in the fund, below 1% for example, a tactic he has taken in his own Ninety One UK Sustainable Equity fund.
From his portfolio Evans highlighted an ESG stock that is running at a higher valuation but is still good option: Spirax-Sarco.
The company specialises in a steam and fluid pump manufacturing and has made more than 5,000% since it launched.
Performance of stock since launch
Source: FE Analytics
The company launched a renewed sustainability agenda last year, which includes steps to reduce its impact on biodiversity, energy usage and carbon output.
“If you're prepared to take a very long-term view, and by that I mean look through several cycles over five or seven years, then these businesses have significant opportunity,” Evans said.