In the two weeks following the vote to leave the EU the FTSE 250 continued to lag the UK blue-chip index.
The mid cap index slumped by 13 per cent in the two days after the EU vote, before rebounding. But it has since slid back sliding as Brexit and a weaker sterling continue to impact on prices.
Two weeks on from the referendum, the mid cap index had lost some 10 per cent of its value compared with the FTSE 100, which instead climbed 3.8 per cent.
Bank of England governor Mark Carney recently said the slumped FTSE 250 points to wider economic gloom, saying the mid cap index is a better barometer of the economic outlook than the FTSE 100 due to its domestic focus.
AJ Bell investment director Russ Mould says markets are factoring in an economic slowdown, or even a recession in the UK over the next 12 to 18 months. He says if this scenario comes to pass this would hit the FTSE 250’s earnings and cashflows much harder, relative to the FTSE 100.
A number of stocks within the 250 index released profit warnings after the EU vote.
BlackRock iShares chief strategist for EMEA Ursula Marchioni says while UK equities only saw outflows of $72m (£55m) in UK equities after the Brexit vote, there was a “clear rotation” out of the FTSE 250 into the FTSE 100.
Marchioni says: “With just 21 per cent of revenues being derived from UK operations for FTSE 100 companies versus 59 per cent of revenues from the domestic market for FTSE 250 companies, investors are clearly trending towards large caps given the greater exposure to internationally focused revenues amongst domestic uncertainty.”
Hargreaves Lansdown senior analyst Laith Khalaf says despite the bad performance of the FTSE 250 in the first weeks after the vote, holding “a healthy slug” of mid-caps is a strategy which has served as a big tailwind to active managers over the long term.
Khalaf notes the FTSE 250 has returned 57 per cent over five years and 128 per cent over 10 years compared with 31.7 per cent and 61.4 per cent for the FTSE 100 in the same period.
Mould adds: “The FTSE 250 has left the FTSE 100 for dead, outperforming massively since the turn of the century. In capital terms, the FTSE 250 has rocketed from around 6,400 to just under 16,000 at the moment, while the FTSE 100 has gone sideways to down over the same period.
“As such, a period of FTSE 100 outperformance was inevitable at some stage, especially if markets got a fresh attack of the jitters about global growth.”
Rathbones chief investment officer Julian Chillingworth says while FTSE 100 values may come to look “stretched” in the medium term, he says “the discerning buyer” could find some bargains in the 250 that have been hit by overly bearish sentiment. He says though “it is too early to jump in just yet”.
The stronger profit growth of mid-cap companies over the past year also led to the FTSE 250 seeing higher dividend cover than the FTSE 100, according to research by The Share Centre.
It says net profits in the FTSE 100 fell 34 per cent compared with the 7 per cent increase in the FTSE 250 over the period.
However, The Share Centre warns the market reaction to the referendum result suggests FTSE 250 profitability will deteriorate as the economy slows.
UBS Asset Management head of fixed income economics Joshua McCallum says: “If you are sitting outside the UK, then you don’t care about the value of the FTSE in sterling; you care about the value in your currency. So Bank of England rate cuts help you less because rate cuts push down the currency.
“Even if existing holders are mostly hedged, the marginal buyer will look at the FTSE and decide if it is worth buying. For example, on a US dollar-basis both the FTSE 100 and FTSE 250 have fallen substantially but not recovered. In other words, foreign investors are not attracted to buy UK equity despite the fact that it is now cheaper to them.”
Neptune head of UK equities Mark Martin, manager of the £566m UK mid cap fund, expects a surge in mergers and acquisitions from overseas buyers as a result of falling valuations and weakening sterling.
He says: “The level of dispersion I see now in the index creates a lot of opportunities for the mid cap sector and the fact the index is now much more international than it used to be also offers opportunities.”
Martin says around 50 per cent of FTSE 250 revenues are now outside the UK and he is overexposed to that part of the index that will benefit from the weakness in sterling.
But he says: “It is going to be tough for some parts of the index like housebuilders and construction companies will continue to struggle even with the sell off.”
But in the cyclical parts of the FTSE 250, Martin says there are some “bright spots”, like technology stocks.
Mark Wright, manager of the Seneca Diversified Growth fund, which is strongly mid-cap biased, says he has not sold out of any FTSE 250 stocks post-Brexit and will keep the current mix of domestic and non-domestic oriented stocks in the £103.4m fund.
He says: “We have a mid cap bias because these stocks outperform in the long run. There are many companies with scope for growth and also outperforming their small cap counterpart.
“For the share price falling in most cases these moves have been very quick and possibly overdone so it’d be foolish to say the UK economy is slowing down by just looking at what happens to the index.”
But Axa Wealth head of investing Adrian Lowcock says going forward it is important to remain selective on the index as other firms will continue to be hard hit.
He says: “There is a potential to recover for the FTSE 250 but it will stay low for longer depending on the fluctuation of the sterling. In the longer term businesses will be able to recover independently by the currency but until this cycle turns back pressures will continue.”