Chris St John, manager of the AXA Framlington UK Mid Cap fund, talked to the Fund calibre team, walking them through the FTSE 250, providing insights into its composition, changes, and dynamics.
In the interview they cover the diversity within the index, sectoral makeup and international exposure and well as the potential for M&A activities in 2024. Chris explains why the FTSE 250 is more sensitive to UK economic factors like interest rates and employment levels versus the FTSE 100, and addresses the performance disparities between the two indices
Why you should listen to the interview: Having run this fund since launch in 2011, Chris is extremely knowledgeable on the benefits of investing in the mid-cap space, especially where compounding earnings growth is concerned. He also believes that balance sheet strength married with attractive valuations will lead to continued M&A activity this year, which he views as both good and bad for his fund. Find out why by listening to the full interview.
Please note, answers are edited and condensed for clarity. To gain a fuller understanding and clearer context, tune in to the ‘Investing on the go’ podcast. This interview was recorded on 30 January 2024.
What to look out for in this interview:
FTSE 100 vs FTSE 250
“People view the FTSE 250 as a very domestic UK index. Currently, 54% of the turnover that’s generated in the FTSE 250 is generated inside the UK. Which means 46% is actually generated from markets outside of the UK. So, it’s a very varied index and does have significant exposure to international businesses.
“It is very different to the FTSE 100 certainly in terms of its makeup. The FTSE 100 has much bigger holdings and what I would call older, more capital intensive, perhaps more environmentally harmful businesses such as mining which sits with basic materials, big oil and gas companies, and telecoms, this one less so now. And healthcare and consumer staples are also very big constituents. The UK FTSE 250 index has much more consumer discretionary, more industrials, more financials, more real estate
“The other quite big difference I think is the concentration of the index. The FTSE 250 is a much broader spread of businesses in terms of what they do, but also valuation as well. The top 10 stocks in the FTSE 250 represent 16% by value, whereas in the FTSE 100, about half of the index by value is in the top 10 stocks, with the largest stock in the FTSE 100 being around 9%, which I think at the moment is AstraZeneca. Whereas in the FTSE 250, the largest company in the index is around 2%. So, there are a lot of differences.
“In terms of performance – given the higher UK economic exposure in the FTSE 250, and by that, really, we’re talking about house builders, retailers, pubs, restaurants, property – those companies by definition are more sensitive to interest rates to the UK economic output generally, also levels of employment, or unemployment in the UK, and the level of disposable income as well. So, when interest rates are moving in the way they have, in an upward direction, that has put quite a bit of pressure on a number of the UK domestic businesses.
“I think you can view our fund as a core mid-cap fund, but it can invest up to 15% in the FTSE 100. The reason that was put into place is so that if companies get promoted up to the FTSE 100, we’re not a forced seller of those stocks, so, I can run companies into the FTSE 100. Note that there has to be a minimum of 70% of the fund in FTSE 250 index stocks. That number is around 80% at the moment. So, that does leave a balance that can be invested elsewhere and that is the part of the fund that might end up in the small cap space.”
Long-term performance of the FTSE 250
“When we talk about performance of this area, the last couple of years have been very, very difficult. Up to the end of December 2023, the FTSE 250 index, excluding investment trusts, was actually down 10.3%, whereas the FTSE 100 was up 13%. That’s a dramatic difference – a 23% difference – in the performance of those two indices over two years which just shows that this has been a very, very unusual period.
“If you look back historically for 10, 20 or 30 years pre-Covid, even 40 years, the annualised return of this part of the market was around 10-11%. But actually, over the last 10 years, because of the effects of Covid, because of the effects of the inflationary pressures we’ve seen, because of the extreme movements in interest rates, the annualised return over the last 10 years at this part of the market has only been 4.4%. So it’s been a very, very unusual event in the FTSE 250 space.
“And if you take it back even longer, you can see this ongoing compounding effect of returns and total returns in the FTSE 250 space. Indeed, if you go back to December 1999, there’s a dramatic outperformance of the FTSE 250 total return versus not only the FTSE 100, but also MSCI World. So, historically, this has been a place of great interest.”
A place of interest going forwards?
“From a company-specific perspective, absolutely!
“We still have broadly the same number of companies to look at within the index and we can, to some degree, go outside of the index in this fund as well. And there are many drivers that are around today that perhaps haven’t been there historically which are affording companies a great opportunity. We’re also seeing those companies with high levels of service taking a lot of market share at the moment. Companies that can differentiate through service are seeing increased sales numbers in terms of the services that they sell.
“From a company bottom-up perspective, there is plenty to be excited about and plenty of interest. I think, because of what we’ve seen from a performance perspective – and yes, that is compounded by the outflows that you’ve seen from the UK markets – the FTSE 250 space has been left looking very cheap in the context of its own history certainly. It currently trades on a forward PE of 11.7, and so would need to move up around 20% to be in line with its long run average.”
The unusual case of technology in the UK
“We are overweight in technology which is an area where we found some very interesting businesses that have incredibly long growth horizons, that are attractively valued. The tech sector is interesting because it’s a slightly odd sector in the UK in that there are those companies that I would say are out and out technology companies, which are providing technology for other businesses to make them more efficient and effective. And there are quite a few companies in there that are using technology to differentiate themselves.
“A business like Autotrader, which started its life offline as a magazine, is now a completely online business. I’m sure people would’ve gone on and had a look at the Autotrader website – that actually sits within technology. You could sit and debate whether that is a technology company or not, but it’s certainly a business that has used technology to build a very, very strong market position with strong competitive moats around it. But you probably wouldn’t call that an out and out technology company. So there’s a real mix in this sector.”
Conclusion: As Chris St John talks us through the heritage of investing in mid-caps, we like how he builds a case for it as the home to particular types of UK companies as well as an engine for growth, not only for the FTSE 100 but also for the UK economy.
Main image: annie-spratt-IT6aov1ScW0-unsplash
