Beyond Bulls & Bears

Perspectives

UK Mid-Caps: Appealing to a Global Audience

UK-listed mid-capitalisation stocks were not immune from the volatility experienced across the market in the period after the United Kingdom’s European Union (EU) Referendum vote, but have rebounded in the subsequent weeks and months. In this blog, Paul Spencer, portfolio manager, Franklin UK Equity Team, explains some of the characteristics of UK mid-caps that he believes have contributed to their resilience, including overseas exposure and potential for merger-and-acquisition activity, as well as some of the macroeconomic factors underpinning these stocks.

After the surprise result of the United Kingdom’s EU Referendum vote, markets have played out largely as experienced commentators predicted: The volatility of the immediate aftermath quickly calmed down. As my colleagues Colin Morton and Richard Bullas have explained, large-cap stocks with significant overseas exposures have proved particularly attractive to investors, while question marks over the domestically focused smaller end of the capitalisation scale have opened opportunities for smart stock-pickers.

The one area that has received less attention is the mid-cap arena, and we think that is a shame. Indeed, we think the resilience of mid-cap stocks in the aftermath of the EU vote was one of the stories of the summer. The FTSE 250 Index, which we treat as a barometer of UK mid-cap stocks, had fallen 13.6% in the immediate aftermath of the referendum vote on June 23. Within nine weeks of the vote, it had rebounded back to pre-vote levels.1

Macroeconomic factors, notably the weakness of the British pound against the US dollar, have certainly helped make UK-listed mid-cap stocks attractive from a value standpoint. With just under half of FTSE 250 Index earnings coming from outside the United Kingdom, sterling-denominated mid-caps with global exposure have suddenly become much cheaper for overseas buyers. It has also proved attractive for UK investors wary of too much exposure to the domestic economy while uncertainty over the direction of Brexit persists.

In that respect, mid-cap stocks enjoy the same characteristics—and attractions—as their larger cousins, but valuations in the mid-cap arena have remained at levels we consider more reasonable. In many cases, we’re seeing large caps trading at a higher price-to-earnings (P/E) multiple than mid-cap stocks, the latter of which represent much better value, in our view.2

But mid-cap stocks also have some differentiating characteristics we think should also make them attractive in the current environment; in particular, mid-caps are traditionally attractive sources of merger-and-acquisition (M&A) activity. The same value assessments that make UK mid-cap stocks attractive to overseas investors could, we think, lead to heightened levels of M&A in this space in the coming year.

That said, we don’t think M&A will necessarily be confined to overseas players. With the cost of UK borrowing at record lows, there could be an uptick in overall M&A activity.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

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What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments.

1. The FTSE 250 Index represents the largest 250 companies listed on the London Stock Exchange. Indexes are unmanaged, and one cannot directly invest in them. They do not include any fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future performance.

2. The price-earnings (P/E) ratio for an individual stock compares the stock price to the company’s earnings per share. The P/E ratio for an index is the weighted average of the price/earnings ratios of the stocks in the index.