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Why I think the FTSE 250 will beat the FTSE 100 in the next decade

Traditional wisdom has it that investors seeking income would do better to invest in the resilient dividend stocks of the FTSE 100, while those chasing growth should set their sights on the smaller but upcoming companies in the FTSE 250.

The thinking is that the mid-cap index is home to more companies in the earlier stages of their lives, with more room to grow. And that once a company reaches the heights of the FTSE 100, it’s more likely to have exhausted its growth phase and have matured into a company that can pay out the bulk of its earnings as dividends.

While there might be some general truth in that, there are attractive FTSE 100 growth stocks and FTSE 250 dividend stocks to be had. And I’m not convinced the distinction between growth and income is one worth making – it’s surely total returns that count, whichever way they’re achieved.

Tradition

The FTSE 250 has traditionally outperformed the FTSE 100, but with higher individual stock risks – while there might be more attractive growth potential, there’s a greater chance of smaller growth stocks crashing and burning. As a result, a lot of investors will buy FTSE 250 stocks when they think things are going well and they’re feeling bullish. But in more uncertain times, there can be a so-called flight to safety when cash migrates to big FTSE 100 stocks with lower risk.

That’s exactly what seems to have been happening in the recent Brexit plagued years, as the mid-cap index’s outperformance came to a halt around the middle of 2015. From then until late September 2019, the two kept pretty much neck and neck with each other.

If we pick a couple of years within that range, we see the 100 beating the 250. In 2016, the year of the EU referendum, the large-cap index provided a total return of 19%, while its smaller sibling managed just 6.7%.

And in 2018, while the FTSE 100 lost 8.7%, the FTSE 250 performed worse with a 13.3% loss. Even at June 2019, the 100 had managed a total return of 1.5% while the 250’s total return was negative at -3.8%.

Turning?

We still have 12 months of uncertainty ahead in 2020 as the UK government sets its sights on hammering out a long-term trade deal with Europe, and the PM’s insistence that it’s do or die by 31 December looks like it will weigh heavily on market sentiment throughout the year.

But I think the relative performance is an indicator of general market sentiment, and the usual trend seems to be returning. In the past three months, the FTSE 100 has risen by 12.2% (excluding dividends) while the FTSE 100 has managed a less impressive 5.2% (also excluding dividends). And since the election, the FTSE 250 has been inching further ahead.

Does that presage a return of cash from traditionally safer big blue-chip dividend stocks and back towards higher-risk smaller growth shares in 2020 and beyond? These days I tend to prefer bigger income stocks to the smaller growth shares I used to chase in my youth, but I’m starting to eye up some FTSE 250 shares whose risk I think is reducing and that are starting to look increasingly attractive.

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Views expressed 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.