Asset Allocator: August 2015- Focusing on the FTSE 250

Following on from his investment theme, David Stevenson's latest asset allocator post argues that when seeking exposure to UK equities investor should focus on the FTSE 250 and its outperformance of the FTSE 100 Index.

The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only.

 Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment.

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ASSET ALLOCATOR: August 2015 

10/07/15- Focusing on the FTSE 250 

 

This week I wanted to return to the subject of the FTSE 250 – the focus of our August review which you can read here. To recap, I argued that if you are a) bullish on global equities generally and b) believe that the UK economy will perform in line with global growth expectations and c) not a value orientated investor with a focus on cheapo stocks, then investing in the FTSE’s mid cap index made sense. It’s not especially cheap but is I think a strong momentum play with a good mix of businesses that will benefit from the continued UK recovery.

For most opportunistic investors, a decision to move in and out of this ‘high beta’ index (relative to the blue chip FTSE 250) should be relatively straightforward tactical one i.e buy when momentum is flashing green, sell when worries about risk are bubbling. 

But there is an alternative more systematic way of looking at the FTSE 250, which is to stay long this index using momentum based measures and then only move out when momentum flags. The idea here is that the FTSE 250 has in the past been a more appropriate index to track over the long term as a proxy for the UK economy. 

Go to the fantastic stockmarket stats based website www.stockmarketalmanac.co.uk and you can see how the FTSE 250 mid cap index has performed against its bigger, blue chip peer, the FTSE in previous years. Here you’ll see a review of performance data for the FTSE 250 index relative to the FTSE 100 index. The table below comes from this website (its online at http://stockmarketalmanac.co.uk/tag/ftse-250/) and shows those months over the period since 1986 where the FTSE 100 index has outperformed the FTSE 250  –  the numbers shown are relative returns between the FTSE 100 and the FTSE 250, with those months where the latter outperformed shown in blue .i.e in January 1986 the FTSE 100 underperformed the FTSE 250 by -1% over the month.

 

But what’s even more fascinating is that this out performance has another dimension – seasonality. The website StockAlmanac also charted that relative performance over different months. Its results – demonstrated in the chart below? “As can be quite clearly seen the FTSE 250 has been strong relative to the FTSE 100 for the three months January to March. …For example, on average in January the FTSE 100 has under-performed the FTSE 250 Index by 1.5 percentage points.

 

Add this all up and a relatively straightforward systematic portfolio strategy suggests itself. 

If you believe the numbers above, when markets are a) in bullish mood and b) the UK economy is also performing at least on a par with its rivals, investors should switch to the FTSE 250 index for all months of the year except for September and October when the data suggests that the bigger, blue chip index convincingly out-performs the FTSE 250. 

Or as the website StockAlmanac puts it “the portfolio would be invested in the FTSE 250 from January to August, at the end of August it switches out of the FTSE 250 and into the FTSE 100 for two months, then back into the FTSE 250 until the end of August the following year.” The next chart shows the result of operating such a strategy from 2000. The FTSE 100 portfolio would have grown -5%, the FTSE 250 risen +153%, and the FTSE 100/FTSE 250 monthly switching portfolio would have increased +237%. These figures do not include transaction costs, but these would not be significant as the strategy only requires trading twice a year”. 

 

Another take on the same strategy comes from a new book by professional portfolio manager Edmund Shing who’s looked at the same data but proposes a slightly different strategy in his new book The Idle Invetsor. He’s also a big fan of the FTSE 250 index as a play on bullish appetites for risk but he proposes an alternative switch/trade, - I featured these ideas in a Money Week column back in July but they’re absolutely worth repeating here. 

Shing’s book identifies a whole bunch of important learning points about investing but the key takeaway for this observer is his championing of three very simple strategies for surviving market turbulence. The first is called The Bone Idle Strategy, and involves a very simple 60/40 portfolio strategy. This means investing 60% of your portfolio in shares (Shing zeroes in on the FTSE 250 index) and 40% in UK government bonds. In this strategy the investor stays away from risky assets in the typically turbulent months of September and October i.e investors keep their 60% allocation to a FTSE 250 tracker until the end of august, at which point they sell out, stay in cash and then reinvest at the end of October. The UK government share at 40% remains reinvested. 

The next strategy is the Summer Hibernation Strategy which involves juggling three pots of markets but avoiding the summer months for equities. From  November through to May the investor equally splits their money between UK mid-caps (a FTSE 250 ETF), US mid/small caps, and last but by no means least a Eurozone equities tracker built on an index that excludes the most volatile stocks (called a low volatility index). From May through to November, the investors splits their cash between UK government bond, US government bonds and Euro government bonds. 

My favourite idea though explicitly accepts the idea of market momentum by using something called the moving average. This measure does what it says on the biscuit tin i.e it’s the moving average over say a month in the lifetime of a share price or index. Most professional investors use a range of moving averages with durations that vary from 20 days, one month, and three months through to 200 days..and beyond. It can all get very technical - cross–overs between the 20 and 200 day moving average are hugely popular – but with virtually any share, index, or fund you can go to a site like Yahoo Finance, chart the price and then see if that price is/isn’t above its moving average. If it is above all the moving averages I’ve mentioned (20 day through to 200 day), that share has incredibly strong price momentum. 

In Shing’s Multi Asset Trending Strategy (a bit of a mouthful I concede) the plan is actually deadly simple. Stay diversified by investing a in a bunch of key regions but switch between risky stuff (shares and especially the FTSE 250 index) and less risky stuff) bonds) based on what the moving average is telling you. If shares look like they have momentum behind them, stick with them. If shares look like they are losing momentum (they are below their moving average), sell out and switch back into bonds. Crucially this all done on a monthly basis with four key target regions –the US, Eurozone, emerging markets and of course the FTSE 250 index for the UK. 

So, how does Shing’s idea work? The key is to look for that moving average as the all-important signal.  So in the UK you’re looking at a chart that shows the FTSE 100 and whether its above its three month average …or not ! The same is true in Europe with an index called the EuroStoxx 50 index (again, you are looking to see if it is above its three month moving average). In the US the focus is the S&P 500 ( the three month average again) while for emerging markets you are also looking at the S&P 500 index again but this time focusing on the TWO month average. 

At the end of each month you look at each region, see if the signal is positive (the equity index is tracking above its signal) and if it is, stay invested in the equity ETF. If it’s not, sell immediately and reinvest in the bond alternative. Last but by no means least at the end of April every year, take stock of all your holdings, and rebalance each of the four different regions back to a 25% proportion within your portfolio. According to Shing this strategy produced a compound annual growth rate between 1990 and 2012 of 27.6% with the worst loss between 2007 and 2009 of -9%. For 2013, this strategy returned 14.4% after costs while in 2014 the return was a more modest 4.2% - for 2015 through to the end of May the portfolio has returned 5.1%.  

I’d also caution that this clever little idea does involve lots and lots of turnover in the funds you hold and some costs in terms of trading in and out of ETFs. According to Shing his backtest over the last 20+ years indicates an average number of transactions per year of 3-4 per region .i.e roughly around 15 trades a year on average over the longer term. One other caution – I very much doubt future returns from this strategy will be running at 27% per annum mainly because the great bull market in bonds (a big driver for positive returns in bear equity markets) is almost certainly over! 

Shing has also assumed transaction costs plus bid-ask spread of approximately 25 basis points for each trade. He estimates that the total cost to the portfolio per year is about 0.75% - 1% on average although he argues that this strategy would have delivered a double benefit. First it would have kept you invested in the sectors displaying the most momentum and secondly it would also have kept you out of the worst market crashes by switching into bonds. Intuitively I have to say that this last strategy of Shing’s makes absolute sense and for those investors willing to spend say half an hour a month looking at a site like Yahoo Finance and then placing a bunch of trades, I think this could be an absolute life saver. Crucially you’d also save yourself all those fees charged by advisers and wealth managers.

 

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The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes  responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.

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