The joy of investing in U.S. mid-cap stocks

For the average fund manager, knowing their portfolio companies means looking at not just the news coverage on that company, but also listening to earnings calls, reading analyst reports, analyzing financial statements, and poring through regulatory filings within public record. But when Sonny Aggarwal and his fellow portfolio managers in Mackenzie Investments’ Growth Team say they’re familiar with the companies they invest in, they mean it at a whole other level.

“One great thing about being a portfolio manager in the mid-cap space is you have good access to the C-level management teams of your portfolio companies,” Aggarwal told Wealth Professional. “While I don't think the CEO at Apple is going to necessarily talk to me, I can speak with the CEOs of most of our companies to talk strategy – what they're looking at, what they're trying to do, and what their outlook is three or five years down the road as well.”

Whether by phone or at conferences, he said being on first-name terms with CEOs of portfolio companies has enabled the team to get deep qualitative information to reinforce or counterbalance what their financial data and models are saying. That is just one of several capabilities underpinning the Mackenzie U.S. Mid-Cap Opportunities Fund, which has enjoyed considerable success since being launched exactly one year ago.

The strategy isn’t exactly a new one, as it draws from the proven approach of the nearly two-decade-old Mackenzie U.S. Small- to Mid-Cap Growth Fund. Nonetheless, Aggarwal described launching the U.S. Mid-Cap Opportunities Fund as an “interesting” experience, with the challenges of initial rollout and marketing being exacerbated by external forces whipped up by the pandemic.

“At that time, the market was aggressively recovering off its March 2020 lows,” he said. “Add in the craziness that usually comes with introducing a new product – it wasn’t the easiest launch, but I’ll look back on it as a fun experience in my career.”

Retail investors and advisors have responded positively to the fund. According to Aggarwal, the fund crossed the billion-dollar AUM mark last month, and it has been consistently in the top five of sales across all of Mackenzie’s retail funds since the beginning of 2021.

Its performance has also been remarkable. Since its debut, the U.S. Mid-Cap Opportunities Fund has achieved a 56% return, compared to 40% for the S&P 500 has risen and 53% for the U.S. mid-cap space. Over the past 15 years, Aggarwal noted, U.S. mid-caps have outperformed both the S&P 500 and the small-cap index, reinforcing the notion that mid-cap stocks are a desirable “sweet spot” in the world of equities.

“You see on one end of the spectrum, people invest in large caps because they want established companies with diversified business lines. But a lot of the time, ‘diversified business lines’ is code for mature companies with slow growth,” Aggarwal said. “On the other end of the spectrum, people invest in small-caps because they want that fast-growth, home-run type of scenario. But just like buying lottery tickets, it could be a very risky investment strategy.”

From where Aggarwal’s team sits, mid-caps possess the best of both worlds with growth profiles akin to small-caps and the more stable quality of large-cap stocks. That belief has translated into a high-conviction portfolio of between 30 and 35 names, which has been built up through a well-considered bottom-up approach.

“One sector that we went overweight on initially was financials, which did struggle for the better part of last year while the NASDAQ reached all-time highs from tech valuations going to the moon,” he said. “But we believed the financial sector and other cyclicals would have their time in the sun as the economy rebounded. We held on to financial companies that had a really good credit track record, and it’s paid off nicely over the past three to six months.”

Aside from the reopening trade, the fund benefited from the acceleration in digital commerce through innovations made by a few portfolio companies. Frontdoor, the market leader in providing monthly home repair and maintenance plans to U.S. households, adapted to the pandemic by creating an on-demand digital service, letting users “book” a repair person to fix problems in the home to arrive within a short timeframe. For those worried about health issues, the company also launched a “virtual repair” service: users can use their phone camera to beam images and video of what needs attention to a service professional, who can then remotely walk them through the steps to fix the issue if possible.

But beyond the more immediate considerations arising from the pandemic, Aggarwal said his team looks for companies with strong prospects of sustainable growth, which is typically driven by a large secular theme. To create an all-weather portfolio, they have identified 10 secular themes that well-positioned companies can benefit from not just over the next year, but also the coming three, five, or 10 years.

“A big theme we’re paying attention to is medical equipment. As we all know, baby boomers are getting older, and they will need more supplies and more healthcare equipment down the road,” Aggarwal said. “One company we've invested in is Dentsply Sirona, which is the largest dental supply and technology company out there.”

Automation is another secular trend that they believe will do well over the next five to 10 years. To capitalize on the growing use of artificial intelligence and robotics, they've invested in Wabtec, whose catalogue of proprietary technologies includes a driverless train that helps train companies automate the unloading and loading process as they arrive at the train yards.

“Innovation is almost a matter of survival for these companies, and that's why we find small- to mid-cap stocks so interesting,” Aggarwal said, reflecting on his 20-year career focused on the space. “Everyone knows Apple and Google, and we know they're great companies. But it's so fun to find these neat little companies which no one's ever heard of, and could become the next big thing. You're trying to find diamonds in the rough.”