Investing in mid-caps has been a good place to be over the long term but has proven a headwind in recent years. Indeed, while the FTSE 250 is ahead of the FTSE 100 large-cap index over 10 years, it is behind over five, three and one year.
The Mercantile Investment Trust has benefited from this phenomenon and then some over the past decade, making 129% by primarily investing in small and medium-sized businesses. It beat the IT UK All Companies sector by 54.2 percentage points over the period, but short-term performance has not been quite so strong.
Returns for the £1.7bn portfolio slumped 25.9% in 2022 in what manager Guy Anderson described as a “really challenging” year.
Here, he tells Trustnet why he questioned his decision making last year and how he shifted the trust’s allocations to meet new hurdles.
Total return of trust vs sector over the past year
Source: FE Analytics
What is your investment process?
Mercantile is trying to deliver long-term capital growth by investing in a diversified portfolio of UK listed mid- and small-caps.
The ideal stock will be a structurally strong business, so we look at whether the financial returns of a business are attractive, whether it has a high return on capital, and whether it can reinvest that capital to drive future growth.
Ideally, those opportunities will also be in businesses where we think the outlook is better than the market thinks.
What sets you apart from your peers?
It is important to have a very disciplined investment process, so every single stock in the portfolio is in there for a reason. Sometimes we get them right and other times we get them wrong, but having that clear investment thesis makes it a lot easier to assess where things have deviated from our expectations, particularly on the downside.
When things go wrong, it's hugely important to then take action. If there’s a substantive change, we should sell our position and recycle the capital into something else. It’ll be a painful decision, but you've got to take them.
Have you had to sell out and recycle much over the past year?
The last year has been really challenging. There was a shift in monetary policy from ever looser monetary policy to clear monetary tightening and, with the portfolio’s quality growth bias, that clearly hurt us.
It was about recognising change when it happened and acting upon it, so we did kick out a number of positions from the portfolio.
There were a few stocks that were very highly rated and we accepted that there was risk that that rating could come under pressure even if we thought the fundamentals of the business were great, so we reduced positions there.
Looking back in hindsight, I definitely challenge myself and ask, ‘did we do enough,’ and I think the answer is probably no.
What would you have done differently with hindsight?
We can always pick holes in decisions that we've taken, but I think, in reality, it was very difficult to set up a portfolio for the sequence of events that happened last year.
There are stock specific examples where I think we should have seen the evidence sooner or maybe we could have taken action to reduce the position and I spend a lot of time thinking about that.
What are some of the biggest changes you’ve made to the portfolio?
The biggest one is definitely a reduction in the consumer discretionary exposure. It went from a 10% overweight down to about a 3% overweight, so we're not talking about the portfolio swinging around dramatically, but that is still quite a big change for us.
Clearly Russia's invasion of Ukraine impacted inflation, which directly hit UK consumers’ disposable income and ability to spend. That then fed through into those stocks.
It was a case of reassessing lots of stocks in the portfolio and asking whether their investment case was still valid, and DFS is an example of one which we sold. It's a great business but it's very cyclical and clearly there are significant risks to the demand profile.
The money previously in consumer discretionary stocks has effectively been recycled into industrial companies.
What was your best performing asset last year?
Our biggest contributor to performance was our investment in Telecom Plus, which added 1.1% to absolute performance.
It owns a company called Utility Warehouse, which is a multi-utility provider that supplies consumers with things like gas, electricity and broadband.
Demand was great because you had lots of UK consumers who want to save money and the supply side was suddenly open because all the competitors fell away after it turned out they had structurally unsound business models.
It’s really important to us that we recognise change when it happens, so we added a lot to that position. It hasn’t even been a 1% position for most of the time that we’ve held it since 2015, but it’s now a top 10 holding in the portfolio.
What was your worst performer?
Our worst contributor was Future, which is a specialist media business. It detracted about 1.9% to absolute performance in the past year.
It had been a fantastic investment for a number of years but last year was really poor for the business. Unsurprisingly, it gets a lot of revenue from digital advertising which came under pressure last year because media budgets were under quite a lot of pressure.
It was a very large position in the portfolio, and, although we still own it, we had to think about whether it was appropriately sized. At the end of 2021, Future made up about 3.8% of the portfolio, and about 1.6% at the end of 2022.
Share price of Telecom Plus and Future over the past year
Source: Google Finance
What are your interests outside of stock picking?
I've got four young boys so I spend a lot of time running around after them. I love spending time with my family, and I also really like being outside and take as many opportunities as I can to go running or out on my bike.