It is simply amazing that the FTSE 100 has increased by 65% over the past 10 years when earnings have fallen 76%. This conceals important fundamental developments, but powerfully demonstrates the long-term valuation premium being demanded. Mid-caps have achieved far superior earnings growth of 17% over ten years, although this comes with greater exposure to the industrial development of a Brexit-riddled domestic economy.
Anyone making a decision between the two markets are inevitably exposing themselves to the state of the currency. As only 25% of large-cap revenue is derived onshore, a rebound in sterling would hurt the FTSE 100 far more than the FTSE 250 which obtains 50% of its revenue domestically. Of course, the same applies in reverse.
What are You Buying?
There are sector sensitivity and concentration issues that must be understood by investors. As one such example, the top 10 holdings in the FTSE 100 account for 43% of the exposure versus just 11% for the FTSE 250. Therefore, mid-caps provide greater diversification benefits at a stock selection level. In addition, there are perceived research inefficiencies among mid-caps that provide a natural hunting ground for top-quality fund managers. We see a structural bias by managers towards mid-cap companies, which has created superior historical earnings profiles but a short-term drag against the FTSE 100.
What Next for Mid-cap Stocks?
For some investors, this may prompt them to sell out of mid-caps and favour large-caps but is there still a case to be invested for the long-term in UK mid-cap companies?
By virtue, the FTSE conundrum is leading some investors to gamble on the future prosperity of the U.K. versus international peers. However, this illustrates the folly of making political and economic predictions and completes ignores long-term valuation analysis. Most often, investors get whipsawed by attempting to chase performance and this behavioural trait can easily become an expensive path of wealth destruction, both in fees and poor performance. Inevitably, the lowest-cost option is to stay the course. Creating unnecessary transaction costs is a guaranteed way to reduce a pension pot.
For investors that have the resources and inclination to take active positions, they are required to balance fundamental conviction and risk analysis to succeed. The U.K. market is predisposed to fundamental gravity just like every other asset market. Therefore, it is unsustainable to believe either the FTSE 100 or the 250 will grow at rates that exceed their long-term valuation drivers.
