If you had invested your entire portfolio in the FTSE 250 five years ago, your capital gain would have been 151%. That’s over four times greater than the 37% capital gain managed by the FTSE 100 and shows that the mid-cap index is the place to be when it comes to capital growth.
Elephants Don’t Gallop
The infamous words of legendary investor Jim Slater are highly relevant when comparing the appeal of the FTSE 250. Certainly, he was referring to the comparison between large companies and small companies (rather than between large and mid-caps), but the statement that ‘elephants don’t gallop’ is highly applicable here, too.
The FTSE 100 contains some of the oldest, most consistent, best diversified and lowest risk companies in the world. But while they may offer excellent value, reduced volatility, great income prospects and the best management teams around, the chances of them posting stunning earnings growth or superb capital gains are rather slim.
In contrast, it is far easier for a smaller, younger company that has not yet become as efficient as it could be, and which is not yet exposed to all of the best regions of the globe, to grow its bottom line. Furthermore, the smaller and younger the company, the easier it is for profit and capital gains to be very high.
However, while smaller companies offer greater potential reward, they also come with additional risk. For example, they tend to be more reliant upon one product or one major client, and do not have the same financial firepower or cash flow of their larger peers. As such, the risks they come with are significantly higher than for FTSE 100 stocks.
This, then, is where mid-caps offer real value, since they offer a relatively appealing balance between risk and reward. That means that your portfolio is unlikely to see catastrophic losses, whilst at the same time enjoying the very real prospect of a much better growth rate than if you invested solely in the FTSE 100.
Of course, it could be argued that the divergence in performance between the FTSE 100 and FTSE 250 during the last five years will now correct. After all, the period has been one of the strongest bull markets in living memory, with the artificial boost from quantitative easing pushing profits and valuations ever higher.
And, with the outlook for the UK economy being very uncertain as a result of the prospect of the UK leaving the EU, it could be argued that larger, more robust and defensive companies such as those found on the FTSE 100 will outperform their mid-cap peers.
However, at every moment in history there have been uncertainties. And to avoid investing because there are “known unknowns” over the short, medium and long term would have meant sitting on a cash balance since the stock market first began. Of course, volatility and risk are higher for mid-cap stocks, but for growth investors who can live with greater uncertainty but who want to limit their downside risk, there really is only one place to be — the FTSE 250.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.