Mid-cap portfolio holdings offer stronger growth opportunity
Political uncertainty caused by the Euro-zone crisis has led to significant volatility in financial markets. In the UK equity market, this has helped to create a gulf in sentiment between large-cap defensive stocks and their mid-cap peers.
The market’s flight to safety resulting from the Euro-zone crisis has boosted large-cap defensives, which are perceived as the most bond-like stocks in the UK market. This bluechip rally is understandable as during a time of heightened volatility investors seek stability above all else. However, the sell-off in mid-cap stocks may represent an opportunity to build holdings in high-quality businesses that offer stronger growth potential. Many mid-caps and small-caps have spent the past three years paying down debt, improving their resilience for tougher times.
We have conviction that over time the market will re-focus on companies that offer stronger earnings prospects, underpinning their dividend outlook. Comparing the capital and income returns of the mid-cap index against the largecap index over the past 25 years shows that midcaps have produced significantly stronger results. This reflects the fact that many large-caps have already reached maturity, while many mid-caps have the best years still ahead of them.
The UK equity market is well-known to be top-heavy in terms of index weightings, but this is even truer when it comes to dividend payers: the top 10 account for over 50% of the total dividend payout. By diversifying the portfolio through a selective increase in the weightings of mid-cap holdings, there is a potential benefit to capital growth, as well as a potential benefit of reducing the dependency on the big dividend payers. This underpins the sustainability of dividend payout.
Over the latest period, the Standard Life Equity Income Trust (SLEIT) continued to grow its dividend. We expect dividends to continue to grow in 2012 despite some headwinds to earnings. Corporate balance sheets are strong and dividend cover is at historically high levels.
Our approach, underpinned by both fundamental and quantitative analysis, is to take advantage of recent indiscriminate selling across the market by building holdings in companies that enjoy strong market positions, positive earnings momentum and solid balance sheets. We remain confident in our view that the midcap holdings in the Trust will deliver strong returns as the market refocuses from politics to company fundamentals.
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