Europe mid caps have legs - Aubrey, Janus Henderson among spotters

While the French elections have shown the vulnerability of European equities markets, managers looking to valuations are expressing increasing interest in the mid caps space, according to recent comments from managers such as Aubrey and Janus Henderson.

Portfolio manager Marc Schartz at Janus Henderson recently noted: "European mid caps have been a fantastic asset class over the long term, but this has not been the case over the last two to three years. Mid caps have actually underperformed large caps by more than 30% over that [three-year] period."

"That all culminated at the beginning of this year in a very narrow market, where a handful of large cap stocks accounted for the entirety of the market’s performance. Now since mid-March we have seen signs of stabilisation and actually mid caps have started to claw back a tiny bit of the underperformance they have accumulated."

"A key element in this tentative fightback relates to valuation levels. They had become stressed to the extremes. After poor performance, mid caps have derated, which has resulted in valuation discounts which we have not seen for decades."

Sharon Bentley-Hamlyn, investment manager at Aubrey Capital Management (pictured), adds: "There is a particular argument at this juncture for European mid and small caps."

"The index, dominated by the large cap multinationals, has performed reasonably well year to date, but the mid-small cap area looks neglected. Looking at European mid-cap price/earnings ratios going back to pre-Global Financial Crisis days (September 2007) the current PE is at a 12.5% discount to the average over that time period. By contrast large caps are trading at a 6.6% premium."

"So, the ‘spread’ between large cap index stocks and the off index mid cap sector is nearly 20%. There is strong potential for a catchup. On the basis of mean reversion this could herald a 20% outperformance for European mid-caps versus large. Perhaps it is no coincidence that with indices closing in on their highs, the NAV of Aubrey European is still 20% adrift of its peak."

"Our portfolio is 60% weighted towards the mid-cap area of the market so should benefit. We have a historic precedent for this. After the Global Financial Crisis we outperformed the market by a modest amount in 2009, but 2010 was a bumper year where our strategy outperformed the index by 33%. We had a positive but modest year of underperformance in 2023, and if the same pattern follows, 2024 should be a very good year indeed, both absolute and relative."

Candriam referenced valuation data in early June, stating that: "After a correction of 25% between November 2021 and October 2023, European small caps are now trading at lower valuations than large caps, both in terms of discounted cash flows and earnings multiples, which is a historical anomaly."

"Conversely, large cap European cyclicals appear to be very fully valued, and in some cases overvalued. Thus, European small caps are currently trading on 12-month forward earnings ratios (P/E) of 14.2x (vs. 19.1x on average over the last ten years), while the large caps making up the MSCI Europe index are valued at 14.6x (vs. 15.5x on average over the last ten years)."