ASSET ALLOCATOR

Weekly Review: the FTSE 250 Index

The views expressed in Asset Allocator are those of David Stevenson, an independent financial journalist, and not those of Societe Generale or its representatives. The views expressed are David Stevenson’s current views as of the date of publication only. Any views expressed are subject to change without notice. David Stevenson is under no obligation to update the information contained herein.


WEEKLY REVIEW: THE FTSE 250 INDEX

This week we’re going to subtly change the format of these regular articles, focusing instead on the huge range of different asset classes and markets that can now be tracked using ETFs... along the way  identifying key characteristics and opportunities for each individual investment space. In this spirit, we’re going to kick off with an index called the FTSE 250 Index, one of the most interesting indices for UK based investors and their advisers.

This ‘mid cap’ index typically receives much less attention than its better known ‘large cap’ sibling, the FTSE 100 Index – this latter index tracks the 100 largest companies on the London Stock Exchange (LSE) by market capitalisation whereas the FTSE 250 Index tracks the next 250 largest by market cap.

In very simple terms the FTSE 250 Index is a traditional market capitalisation index that tracks ‘mid cap’ stocks such as Admiral Insurance or builders like Taylor Wimpey i.e they’re neither large capitalisation stocks nor tiddly little small caps. But the FTSE 250 Index is much more interesting than just a listing of “also rans”, too big for the racy FTSE Small Cap Index and too small to make it in the FTSE 100 Index.

Investors buying into the FTSE 250 Index are buying into four very straightforward investment outcomes:

1. The FTSE 250 Index is a much more diversified index than its blue chip, larger cap sibling the FTSE 100. The table below shows the wide mix of ‘sectors’ within the FTSE 250 Index – the first thing you’ll notice is that there’s a much smaller footprint of highly cyclical ‘resources’ stocks i.e miners and big oil companies. The FTSE 250 Index does of course boast a good many resource companies of its own but this mid cap index is much more varied largely because it tends to be jam packed full of equally interesting specialist financials (financials in the FTSE 250 Index tend to be much less banking focused, with a wide dispersion of asset managers and insurance companies) as well as a good job lot of industrial companies and consumer focused specialists. That range of sectors means that the index is typically very diversified with no dominance by a small number of big banks and oil major.

TOP TEN SECTOR ALLOCATIONS

 

Data : FTSE 28th June 2013

2.     The FTSE 250 Index is typically what’s called a higher beta index, attractive to more optimistic ‘growth’ orientated investors. This all sounds very technical but in reality all this language means is that if you are bullish about equities, the companies in the FTSE 250 Index are likely to produce better price returns than other indices. Essentially the FTSE 250 Index is a classic ‘risk-on’ index for investors who want to buy into companies that may be tomorrow’s massive blue chips i.e they'll grow their profits. That focus on ‘faster growing’ companies brings with it some obvious downsides, namely that investor’s tend to over pay in terms of the share price i.e the multiples in terms of price to earnings ratios are nearly always much higher for companies in the FTSE 250 Index as against FTSE 100 Index constituents, with much lower dividend yields. This may sound risky to more defensive investors (at the very least you don’t benefit from solid, compounding dividend growth) but if you are willing to be more tactical and align your investment portfolio to key indicators, the FTSE 250 Index could be a fantastic growth investment. How might this work? If equity markets are in buoyant mood, and indices are grinding higher, the FTSE 250 Index is likely to move even higher than the FTSE 100 Index.

3. The FTSE 250 Index and its various trackers and ETFs are also a more accurate way of tracking sentiment within the UK domestic economy. The FTSE 100 Index is a hugely diversified basket of global blue chip companies where the sensitivity of corporate earnings growth is likely to be highly attuned to US or emerging markets growth. The FTSE 250 Index by contrast is likely to be much more influenced by UK domestic growth – at this moment in time, that’s a positive as the UK consumer slowly starts to recover their confidence and spend more. Looking at some of the top companies in the index (outside of investment funds), it's easy to see how the likes of builders Taylor Wimpey and Barratt, aerospace industrial Cobham and infrastructure engineer Invensys will do well from a resurgent UK economy. There is though one caveat to this domestic argument – many of the companies in the FTSE 250 Index are still big enough to be internationally diversified, which means that if you are looking for a very focused UK index , its probably best to look at the FTSE Smaller Cap index

4.  The last and perhaps most powerful argument in favour of the FTSE 250 Index is the simplest – looking at the statistics it has proved to be a better index over the last five years not only in terms of returns but also risk. This surprising conclusion is based on various risk metrics that compare the FTSE 100 and the FTSE 250 Indices.

Looking at weekly periods over the last five years, the FTSE 250 Index has actually been only marginally more volatile (and by marginal, we really do mean that there has been very little difference) than its supposedly safer , larger cap peer the FTSE 100!

If we look at the table below we can see that volatility levels have been virtually the same but the FTSE 250 Index has massively out-performed the FTSE 250 Index in terms of total returns. If we look at more technical measures such as the Sharpe ratio that positive picture becomes even more obvious. In very simple terms the Sharpe ratio measures risk adjusted returns comparing returns and risk as measured by volatility. Any positive number for a Sharpe ratio is good news, with the higher the number the better the ‘risk adjusted return’ profile. On this basis the FTSE 250 Index comprehensively trounces its larger cap FTSE 100 peer. 

INDEX PERFORMANCE COMPARISON

 

THE BOTTOM LINE

The FTSE 250 Index is a more diversified, UK focused index that has in the past produced better risk adjusted returns than the FTSE 100 Index. It is clearly not an index for investor’s worried about a future sharp slow down in the business cycle – the FTSE 250 Index has a higher beta, which means that it is more sensitive to changes in market sentiment. It is likely to be very negatively impacted by a sudden business slowdown. But that of course betrays the very logic of investing in equities – shares are more risky than bonds because future returns are always predicated on hopes of future (earnings) growth.

This insight also contains within it the chief criticism of investing in the FTSE 250 Index – focused value investing with its focus on dividend growth is likely to be a more rewarding story over the very long term compared to the hope of jam tomorrow from rising earnings. The FTSE 250 Index will always be a more speculative index whereas a dividend focused index is likely to be a more powerful very long term success. But that out-performance may take a decade or two to fully reveal itself, and many investors don’t have the patience to stick with a dividend focused ‘value’ strategy. If you are willing to move in and out of risky/non risky assets in a more dynamic or even tactical fashion, then the FTSE 250 Index could be a great surrogate for ‘risk on trades’ alongside more mainstream indices such as the US focused S&P 500 Index.

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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 and not those of Societe Generale or its representatives. The views expressed are David Stevenson’s current views as of the date of publication only. Any views expressed are subject to change without notice and David Stevenson is under no obligation to update the information contained herein.

INDEX DISCLAIMER

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