Why I’m More Bullish On The FTSE 250 Than The FTSE 100

Since the turn of the century, the FTSE 100 has fallen by 15%. Clearly, that’s hugely disappointing and investors quizzed on New Year’s Eve 1999 regarding the prospects for the index would have been unlikely to make that prediction. That’s because the FTSE 100 had soared by 465% in the previous 15 years even though it had experienced a crash in 1987 and lacklustre economic growth in the early-to-mid-90s.

Looking ahead, the FTSE 100 is likely to post significantly better returns over the next 15 years than it has during the last one-and-a-half decades. That’s because it’s now relatively cheap and with global economic growth likely to be relatively strong owing to a prosperous US and transitioning China, buying the FTSE 100 right now seems to be a sound move.

However, it could be eclipsed by its ‘little brother’, the FTSE 250. In the last 15 years little brother has soared by 154% and a key part of this is its lack of exposure to the mining and energy sectors that have hurt the performance of the FTSE 100 in recent years. For example, while the FTSE 100’s make-up is still 16.3% energy/mining companies, that figure is much lower for the FTSE 250 at just 5.7%.

And with the price of oil and other commodities likely to come under further pressure as the US dollar appreciates, Saudi Arabia maintains its high supply level and China moves to a consumer-led economy, high exposure to the energy/mining sectors could prove to be a disappointment in the short run.

Growth potential

In the longer term, the FTSE 250 also has more growth potential than the FTSE 100 simply because of the types of companies that make up its index. For example, mid-caps tend to be younger businesses that are less well-established than their FTSE 100 counterparts. But these also offer greater scope to expand into new geographies and new product lines. Certainly, such companies may come with more risk since their revenue streams are arguably less stable than is the case for larger stocks, but the additional risk appears to offer greater potential rewards in the long run.

In addition, the FTSE 250 appears to benefit from the process of promotion and relegation to/from the FTSE 100. When a FTSE 100 company’s share price falls and its valuation declines, it may eventually drop into the FTSE 250 and be replaced by a stock that has done the exact opposite. As a value investor, buying cheaper stocks has huge appeal and as such, it could be argued that the FTSE 250 benefits in the long run from gaining cheap stocks fro its big brother and losing more expensive stocks to the FTSE 100.

Of course, the FTSE 100 has a yield that’s historically around twice that of the FTSE 250 and so for income-seekers the former may be of greater interest. However in the long run, capital gains from the FTSE 250 are likely to more-than-compensate for deficiencies on the income front.

Meanwhile, with liquidity in FTSE 250 stocks being relatively robust, they appear to offer the perfect halfway house between the resilience and resilient finances of the FTSE 100 and the high growth/high risk profile of small-caps. As such, buying the FTSE 250 seems to be a better move than buying the FTSE 100 in the coming months and years.

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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.