Why mid-caps look good right now

Right now mid-caps are the sweet spot for Australian equity investors, argues Pendal portfolio manager BRENTON SAUNDERS. Here’s why

• Historically, mid-caps outperform small and large caps
• Mid-caps provide a strong platform to manage equity market risk through diversification
• Find out about Pendal MidCap Fund

TURNING points in investment cycles are notoriously difficult to pick.

While the upside of picking the moment can be substantial, so too can be the downside if you get it wrong.

A hedge against getting sector rotation turning points wrong is to invest in style-agnostic mid-cap porfolios, defined as companies on the S&P/ASX200 ranked from 50 to 150, says Brenton Saunders, portfolio manager and analyst of Pendal’s Midcap Fund.

Historically, the mid-cap universe outperforms small caps and large caps in both absolute terms and on a risk adjusted basis, he says.

Mid-cap hedge

“Mid-caps provide managers with the ability to hedge themselves better because they can get equal representation across different sectors,” Saunders says.

“If one sector is doing poorly, you can offset it from other sectors. You can’t always do that in the large cap space if for example the banks and miners are both doing poorly because they represent such a large part of the market.”

Saunders says the recent increases in  bond yields following high inflation readings has created softness in markets. Central bank are raising interest rates as a result.

“The market has moved a bit further along the path into the increase in monetary policy. We’ve seen equities markets roll over off early-year highs.

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“Recently we’ve starting to see some parts of inflation roll over a bit. At the margin we are also starting to seeing some roll over in unemployment,” Saunders says.

“The market is looking for a reason to buy the sell-off. We are in quite a confusing period.

“There’s been a bit of a pause from some of recently outperforming  stocks and some of the stocks that have been hurt most in the sell-off are starting to find their feet again,” he says.

It’s in these periods that mid-cap stocks provide a good option for investors.

Wide sector exposure

“Mid-caps have a large spread of sectors from all walks of life,” Saunders says.

Mid-caps include miners and steel manufacturers, tech stocks, healthcare companies, real estate investment trusts, oil refineries, engineering service companies, media groups, toll roads, education providers, financials, energy players, travel groups and consumer discretionary stocks.

“There’s not the same weighting towards banks and miners as in the large caps. It has a much better balance of sectoral exposure across consumption, non-discretionary, semi defensives and defensives, and materials. It doesn’t have a huge bias in terms of representation.”

As a result, mid-caps provide a better platform to manage risk, Saunders says. They also allow investors to get focused exposure within stocks.

“If you buy BHP, you are buying a mix of copper and iron ore and coal and a whole bunch of things. Among the mid-caps you can buy a company that’s focused just on copper, or just on iron ore.

“Also, among the mid-caps, you have proven  business models and experienced management teams running businesses that are generally offer stable growth and pay dividends.

“And it’s also very often the subject of M&A activity. Big companies look to mid-caps for M&A opportunities.”