Mid caps have had a storming run in recent years – particularly over the last 12 months or so.
Give or take, the FTSE 250 index has doubled the returns of the FTSE 100 over one, three, five and 10 years.
Performance of indices over 10yrs
| Name | 1yr | 3yr | 5yr | 10yr |
|---|---|---|---|---|
| Old Mutual - UK Mid Cap | 27.99 | 52 | 68.65 | 395.31 |
| FTSE 250 Index | 22.25 | 41.24 | 56.27 | 318.95 |
| FTSE 100 | 13.02 | 23.35 | 25.6 | 129.38 |
Source: FE Analytics
Some mid cap funds have done even better than the index. Watts’ Old Mutual UK Mid Cap fund has outperformed the FTSE 250 over all four time periods, for example.
While such dominant outperformance may lead some to question whether the best time to invest in the index is over, Bradbury, head of equities at the firm, thinks otherwise.
"Back in 2005 I felt mid caps were expensive," he said. "There was a lot of takeover speculation and for me the index was too expensive."
"2006 came, and 2007 came, and the index kept performing well. I was too early, and then 2008 came and washed all that away."
Performance of fund vs indices over 10yrs
Source: FE Analytics
"At current levels, we’re nowhere near where we were in 2005."
Watts, who has headed up the £1bn fund since 2008, is of a similar opinion.
"Overall we think the valuation multiple is still very attractive," he said.
"The FTSE 250 had a brilliant 2012 and has followed that up with 12 per cent so far this year. It’s on a premium [to the FTSE 100], but not unusually so."
"We can expect earnings to grow in the high single digits based on our outlook, which means you’re talking about very attractive returns going forward."
According to data from The Share Centre, the FTSE 250 is currently on a price/earnings (P/E) ratio of 20x, while the FTSE 100 is on a P/E of 14x.
The manager points to the huge degree of diversity within the index as a very important feature when it comes to valuations.
"The mid cap index has some very attractive characteristics that make it stand out," he said.
"First of all these companies tend to grow their earnings quicker than large caps. The extra growth of about 3 to 4 per cent per annum has translated into substantial outperformance."
"The second factor is how dynamic the market is. There is a huge rate of change in the index, meaning that there are often some very exciting opportunities for managers to take advantage of at the bottom and top of the index."
Since he started back on the team in 2002, Watts says that two-thirds of the companies in the FTSE 250 index have been replaced.
On a more general level, both Bradbury and Watts have a positive outlook for equities, believing that potential pitfalls for risk assets are on the decline.
"We have been positive on the UK equity market since the summer of 2009, with the caveat that clients should need to exercise patience through periods of volatility," said Bradbury.
"We remain positive, but feel that we may currently be in the midst of just such a period of short-term volatility."
"The macro environment may not be especially progressive, but it has changed radically in the sense that there has been a marked reduction in the tail risks that have worried investors in recent years."
The manager thinks concerns over a hard landing for China, the possibility of tax rises in the UK as a result of the fiscal cliff, and a breakup in the eurozone have all "greatly reduced".
"This diminution of significant risk has allowed equities to re-rate and this course should continue over the next 12 to 18 months," Bradbury continued.
"Hand in hand with that, we shouldn’t forget that monetary policy in the developed world is still incredibly accommodative."
"It may seem from time to time that our politicians are trying to snatch defeat from the jaws of victory, but our central banks and monetary authorities are doing all that they can to reflate our economies, which is good for equities."
Bradbury is also buoyed by the strength of corporate balance sheets and expects companies "to generate significant levels of cash" in the next two years. This, he says, bodes particularly well for dividend growth.
"They are already highly profitable against a modest growth outlook and will not need to deploy as much of that accumulating cash into capital expenditure or working capital as they might have in a traditional upswing," he said.
"That being the case, we can expect more of the cash to be returned to us as shareholders through a whole series of measures."
"We’re already expecting dividend growth of 7 to 8 per cent this year. We think there will be more special dividends, share buybacks and finally a start to M&A activity, which is generally speaking good for markets."
"On a present forward multiple of just over 11.5x and a dividend yield of 3.5 per cent, the UK market is by no means expensive, while dividend yields should grow over the next few years in high single digits, two or three times the rate of inflation," he finished.
Old Mutual UK Mid Cap requires a minimum investment of £1,000 and has an ongoing charges figure (OCF) of 1.68 per cent.