Key takeaways:
- UK mid caps have recently underperformed but key characteristics exist that make the FTSE 250 an attractive proposition
- When mid caps outperform they have historically done so significantly.
- UK assets are undervalued but certain areas of the UK market are more expensive than others.
- The macro environment remains supportive which has led to positive earnings surprises.
- After a peak in interest rates the FTSE 250 has historically outperformed the UK market.
- Throughout bull runs, mid cap companies have outperformed large cap businesses.
After a period of underperformance for UK mid cap stocks, we believe that investors should be reminded of some of the key characteristics that make the FTSE 250 a particularly attractive space at the present time.
When mid caps outperform, they really outperform
Over the long run, mid cap businesses have outperformed their large cap counterparts as indicated by the cumulative returns of the FTSE 100 vs FTSE 250 (ex IT) for the last 20 calendar years. The data shows that the FTSE 250 outperformed the FTSE 100 in 13 of those 20 years, 65% of periods.
Performance was equal in 5% of periods, and the FTSE 100 outperformed the FTSE 250 in 30% of periods. The significance of the outperformance however must not be overlooked, 35% of the time the FTSE 250 outperformed the FTSE 100 by over 15% on an absolute basis, compared to the inverse which occurred only 5% of the time.
To put the recent underperformance into perspective, this is one of the largest periods of FTSE250 underperformance, surpassing the 2007/08 Global Financial Crisis sell down.
Figure 1: FTSE performance
Many investors are aware of the valuation story within the UK at present but very few have considered the distribution of value across the capitalisation spectrum.
The UK is cheap, but not everywhere…
Many investors are aware of the valuation story within the UK at present but very few have considered the distribution of value across the capitalisation spectrum.
A forward P/E ratio compares a company’s share price to its expected earnings over the next year and is frequently used as a relative valuation measure. On a forward P/E basis, companies rated <11x P/E are materially above their average of the last decade. Conversely, businesses rated between 11-21x earnings have been trending lower and are now materially below their average of the last decade (figure 2). The 12 month forward P/E of the FTSE 250 index is 11x next year’s earnings, this is at the bottom end of the long term range and is over a 20% discount to the long term average of 14x.
This suggests that quality value and sensibly priced growth stocks are an attractive area of return for UK mid caps, and that other areas of the market which include deeper value names are looking expensive relative to history,
Also, the dividend yield of the index is nearly at parity with the FTSE 100, at c.4%, which is broadly recognised for its propensity to deliver attractive income (figure 3).
Both of these measure indicate that a significant degree of value remains in the FTSE 250. This has been recognised by broader financial markets, which have seen £14bn worth of bids for UK companies since the beginning of the year.
Figure 3: FTSE 250 versus FTSE 100 trailing dividend yield relative
Figure 2: Leading P/E by valuation band (UK)
Positive surprises for macroeconomists and domestic firms alike
Figure 4: UK earnings revisions have improved from 2022 lows albeit they are only closer to neutral and lagging large caps marginally
Macro data has generally been stronger than expected over the last 12 months and economists suggest that peak interest rates are at least in sight.
Consumer spending has also proved resilient as the £200bn saved during the pandemic provided a healthy buffer through a period of rising prices.
A strong labour market, continued wage growth, political stability, and a relative moderation of energy prices have all contributed to the evasion of a technical recession within the UK.
This has fed through to domestic earnings revisions which have greatly improved since the ‘peak-pessimism’ sentiment of Q4 2022 (figure 4).
Outperformance after peak rates
If economists are correct about interest rates peaking shortly then this may bode well for the FTSE 250. The index has historically delivered relative outperformance compared to the broader UK market in the periods immediately following a peak in interest rates (figure 5).
Figure 5: Historic FTSE 250 cumulative returns in the periods immediately following a peak in interest rates
Mid caps have historically outperformed in bull runs
It is difficult to call the bottom of the market, however present UK mid cap valuations are near trough-level multiples.
No investor can consistently predict the future with any accuracy, but during the last two bull runs (2003-2007 and 2009-2019) the mid cap index has significantly outpaced the UK market and our active offering has outperformed further (figures 6 and 7).
Figure 7: 28/02/2003 – 30/11/2007
Figure 6: 01/04/2009 – 31/12/2019 
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1 FE Analytics, 31st December.
2Panmure, 31 March 2023.
3Berenberg, 30 April 2023.
4Barclays, 30 April 2023 2023.
5Bloomberg as at 30/04/2023.
5FE fundinfo 2023, 01.04.2009-31.12.2019.
7FE fundinfo 2023, 28.02.2003-30.11.2007.
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This information is issued and approved by Martin Currie Investment Management Limited (‘MCIM’). It does not constitute investment advice. Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested.
The information contained in this document has been compiled with considerable care to ensure its accuracy. However, no representation or warranty, express or implied, is made to its accuracy or completeness. Martin Currie has procured any research or analysis contained in this document for its own use. It is provided to you only incidentally and any opinions expressed are subject to change without notice.The distribution of specific products is restricted in certain jurisdictions, investors should be aware of these restrictions before requesting further specific information.
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Risk warnings - Investors should also be aware of the following risk factors which may be applicable to the strategy shown in this document.
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