Latest trust commentary

Market review

Global equity markets experienced a volatile and unsettled first quarter. January and February saw strong positive returns, but markets weakened through March due to the escalation of the US-Iran conflict. Disruption to Middle Eastern oil supply routes pushed crude prices above $100 per barrel in March, reigniting concerns over persistent inflation and complicating the outlook for central banks.

UK small and mid‑sized companies continued to lag the largest FTSE 100 constituents. Risk-off sentiment favoured the largest companies in the market with UK small and mid caps more sensitive to interest rates. More domestically focused mid and small caps have also faced ongoing challenges, including modest UK economic growth and higher inflation and taxation.

Historically, UK mid-sized businesses have commanded higher valuations than large cap companies and the shares have significantly outperformed over the longer term because of their stronger growth potential. The current valuation discount and higher dividend yield is therefore an anomaly. This creates a significant opportunity for investors willing to look beyond the most well-known names and identify mispriced opportunities in this under-researched part of the market.

Performance & activity

The Fund delivered a NAV return of -4.9% in the first quarter, ahead of the FTSE 250 ex Investment Trusts TR Index return of -5.7%.

Companies that benefited from the tailwind of higher commodity prices were amongst the largest contributors to performance in the first quarter with oil & gas exploration firm Harbour Energy a leading contributor. Ship-broking business Clarkson performed strongly as its shipping related research and support services were in demand amid the US Iran conflict. Alternative asset manager Man Group was another positive as it benefited from its strong investment performance and its growing reputation as one of the best capital allocators among listed financial companies.

Among stocks we do not hold, avoiding advertising business WPP and housebuilders Vistry and Taylor Wimpey – all of which fell during the period – added to relative performance.

Significant detractors included several consumer discretionary holdings, as renewed inflation concerns and a sharp repricing of interest-rate expectations weighed on sentiment. Online travel agency On the Beach was the largest detractor, alongside Dunelm, the homewares retailer, which faced a tough trading environment, though the underlying resilience of the business was evident in its continued growth and improving gross margins. Specialist media business Future also performed poorly. The business, which owns a range of niche magazine titles and the Gocompare price comparison platform, has faced growing costs and squeezed margins from its reliance on Google to drive traffic to its websites.

Investment outlook

Escalating tensions in the Middle East have unsettled markets and introduced a new source of uncertainty with higher energy prices impacting inflation expectations and the potential future level of interest rates. There are a wide range of potential outcomes, which are virtually impossible to predict. The ongoing uncertainty is driving heightened volatility in markets. UK mid and smaller companies delivered negative returns in the first quarter, lagging large companies of the FTSE 100.

UK small and mid caps continue to offer attractive valuations, both in absolute terms and relative to many other regions, while also providing a differentiated sector mix and exposure to global rather than purely domestic drivers. Within UK mid-sized companies around a half of revenues are generated outside the UK. The undervaluation of UK mid-caps is increasingly being recognised through corporate activity. Trade buyers and private equity continue to pursue acquisitions at significant premiums. The UK has also become the buyback capital of the world, which is a clear signal that management teams believe their own shares are too cheap. Each of these is a potential catalyst for closing the gap between price and value.

Regardless of the policy backdrop, our priority remains building a diversified portfolio of companies that have pricing power, which provides an effective means of growing profits.

We would like to remind investors that the UK mid cap market contains many unique, cash-generative companies with strong growth prospects, some of which are showcased in our Schroder UK Mid 250 podcasts – this is why the Mid 250 index has kept pace with the returns of the S&P 500 and is well ahead of most developed markets over the long term.

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Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.

Fund risk considerations - Schroder UK Mid Cap Fund plc

• Capital erosion: Where fees are charged to capital instead of income, or a fixed distribution amount is paid regardless of the Company’s performance, there is the potential that performance or capital value may be eroded.
• Concentration risk: The Company may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the Company, both up or down.
• Counterparty risk: The fund may have contractual agreements with counterparties. If a counterparty is unable to fulfil their obligations, the sum that they owe to the fund may be lost in part or in whole.
• Gearing risk: The Company may borrow money to make further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase by more than the cost of borrowing, or reduce returns if they fail to do so. In falling markets, the whole of the value in such investments could be lost, which would result in losses to the Company.
• Liquidity risk: The price of shares in the Company is determined by market supply and demand, and this may be different to the net asset value of the Company. In difficult market conditions, investors may not be able to find a buyer for their shares or may not get back the amount that they originally invested. Certain investments of the Company, in particular the unquoted investments, may be less liquid and more difficult to value. In difficult market conditions, the Company may not be able to sell an investment for full value or at all and this could affect performance of the Company.
• Market risk: The value of investments can go up and down and an investor may not get back the amount initially invested.
• Operational risk: Operational processes, including those related to the safekeeping of assets, may fail. This may result in losses to the Company.
• Performance risk: Investment objectives express an intended result but there is no guarantee that such a result will be achieved. Depending on market conditions and the macro economic environment, investment objectives may become more difficult to achieve.
• Share price risk: The price of shares in the Company is determined by market supply and demand, and this may be different to the net asset value of the Company. This means the price may be volatile, meaning the price may go up and down to a greater extent in response to changes in demand.
• Smaller companies risk: Smaller companies generally carry greater liquidity risk than larger companies, meaning they are harder to buy and sell, and they may also fluctuate in value to a greater extent.