For most investors, their investment world revolves around the FTSE 100. That’s understandable since it’s made up of the 100 largest companies listed in the UK and is the place where most investors have their funds tied up for the long term. And with it offering a highly favourable risk/reward ratio, it’s an excellent place to invest for the long term.
That is, until you consider investing in the FTSE 250. It’s often viewed as being a riskier place to invest than the FTSE 100 and while this may be true in the sense that it’s made up of smaller companies, in recent months it has fallen by a lot less than its larger peer.
For example, since the FTSE 100 hit its all-time high of 7,103 points on 27 April 2015, it has fallen by 18.8%. Clearly, that’s a hugely disappointing performance and while we’re not technically in a bear market (although for one day the FTSE 100 did slip into bear market territory having been 20% down from its high), it’s very much on the near-term horizon.
With the FTSE 250 apparently offering greater risk than the FTSE 100, many investors may think that it will have fallen by much more than the FTSE 100 during the same time period. However, the FTSE 250 is down by 11.3% since 27 April 2015 and this indicates less, rather than more, risk.
Faster recovery
Even during the credit crunch when the FTSE 100 fell by 47% from its 2007 high to its 2009 low, the FTSE 250 declined by only marginally more than its larger peer. During the same time period the FTSE 250 dropped by 50% and while that’s a worse performance than the FTSE 100, the mid-cap index recovered much, much quicker. In fact, since those March 2009 lows, the FTSE 250 has risen by 160% versus an increase of 50% in the level of the FTSE 100.
Clearly, the FTSE 100’s recent performance has been hurt by the horrific performance of the resources sector to a much greater extent than the FTSE 250. That’s because resources companies make up a much greater proportion of the FTSE 100 than the FTSE 250 and looking ahead, will continue to have a bigger impact on the larger index. As such, a comeback for commodity prices could lead to an outperformance of the FTSE 250 by the FTSE 100.
However in the long run, the FTSE 250 seems likely to beat its larger peer. Although its constituents are smaller and arguably less stable, as well as being less dominant businesses in their respective fields, history tells us that they also offer higher rates of growth than larger companies.
In fact, since the turn of the century the FTSE 100 is down 17% while the FTSE 250 is up 149%. For investors with long-term time horizons therefore, the latter seems to be the better buy. In other words, the FTSE 250 offers the potential for higher rewards that appear to outweigh the prospect of higher risks which, as has been the case in recent months, sometimes fail to materialise.