Traditionally, the FTSE 100 has been seen as the prime target for income investors, while the FTSE 250 is considered the better index for finding growth prospects.
That makes a lot of sense, as a company needs to achieve a market capitalisation of around £4bn to break into the top index, while its smaller cousin is home to companies as small as £200m or so.
Recent statistics have borne that out.
In the five years to July last year, the FTSE 100 managed a gain of 21%. Not too shabby, but over the same period the FTSE 250 almost doubled that with 41%.
And though top-tier dividend yields were higher, the FTSE 250’s overall annual returns remained a few percentage points better than the FTSE 100’s. The answer is clear, if unsurprising — if you’re looking for growth, you should invest in smaller companies.
But those who saw the trend and changed horses last summer might now be thinking they’ve missed the boat, as the 250 has been giving up some of its relative gains.
I can see that trend continuing, and I expect the FTSE 100 to provide better overall returns over the next few years. Here’s why…
Over the past decade and more, two of our biggest FTSE 100 sectors have been hammered.
Oil giants Royal Dutch Shell and BP are our largest and fourth largest companies respectively, with Shell around twice the market cap of BP. While BP has been through its own disaster in the Gulf of Mexico, the oil slump and continuing weak prices have helped hold share prices down for both.
HSBC Holdings is in third spot, and banks are still depressed from the crisis even now. Also in the top 10 we have a big pharma pair, and a handful of miners — the former have been in a new drugs slump for a while, and the commodities sector has been up and down following the vagaries of worldwide supply and demand.
As my colleague Rupert Hargreaves noted, during that time the UK economy was doing relatively well (with the free markets of the EU playing a big part in our success, in my opinion), and that’s good for smaller UK firms.
But how things have changed in just a couple of years. Being yanked away from the EU could seriously put the UK’s economic growth on hold, with forecasts already having been pared back.
On top of that, there are growing signs that FTSE 100 companies are increasingly oversold and are becoming better and better value. The clue is in the dividends.
By the end of 2016, the FTSE 100 was offering dividend yields of around 4.2%, which was ahead of its long-term average, suggesting top shares were already looking undervalued even then.
Wind that forward to today, as earnings and dividends have kept on growing and share prices have stagnated, and we’re looking at forecast yields of around 4.9%.
That’s astonishingly high, and such a disjoint surely can’t last for ever. With both indexes performing nicely so far in 2019, I really can see a period of FTSE 100 outperformance ahead of us. Headline performances might well stay close together, but I think the top index’s superior dividends should make for better overall returns.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.