Should you invest in the FTSE 100 or FTSE 250?

With so much uncertainty, it can be difficult for investors to understand whether their investments might be better sheltered from any downside by being skewed towards either domestic stocks that earn their revenues largely from overseas, or those which rely more heavily on the UK market to derive their revenues.

FTSE 100 companies derive approximately two-thirds, or around 70 per cent, of revenues from overseas, while for the FTSE 250 50 per cent of revenues originate from outside the UK.

In terms of the types of companies typically found in either index, the FTSE 100 is full of mining stocks, oil majors, pharmaceuticals, tobacco companies and banks, while the FTSE 250 will give you a broader opportunity, according to Adrian Lowcock, head of personal investing at Willis Owen.

He adds: “The FTSE 250 is also a mixture of companies growing that are perhaps destined for the FTSE 100, but also those that have fallen out – for example, Marks & Spencer – as well as businesses that don’t seem to change value.”

The largest mega-cap 30 companies in the FTSE 100 are truly global businesses, says Colin McLean, managing director of SVM Asset Management.

“But at the lower end of the FTSE 100, and in the medium-sized firms of the FTSE 250, business is more domestic UK, in sectors such as retail and housebuilding. All but the largest investment managers tend to focus their research and portfolio focus away from the mega-caps.”

What does this mean when it comes to Brexit?

A spokesman from JPMorgan Asset Management explains: “This means the FTSE 250 is more sensitive to Brexit news flow and this has been visible in the market [recently].”

Among active managers performance will be largely determined by stock selection, he adds, which means that investors need to understand what stocks are held in the portfolios they are invested in.

The size of those companies will also impact on performance.

“Funds with a large allocation to the smallest companies are likely to have struggled as sentiment has deteriorated this year,” points out Alex Moore, head of collectives research at Rathbones.

“However, an outcome that would see investors take a more constructive perspective on UK GDP could see such funds benefit from improved sentiment.

“As the UK political saga rumbles on, investors need to be mindful about the short to medium-term impact any Brexit deal with have on their investments in UK equities and collectives.”

Mr Moore notes that this is a challenge, given that funds are often a blend of companies whose performance could be materially impacted by Brexit, positive and negative.

Hardest hit

In terms of specific funds, Mr Lowcock explains: “There are the more domestically-focused funds, such as Invesco Income and Merian UK Alpha, which are positioned for Brexit impact being minimal but are therefore dependent on a resolution one way or another.

“The likes of the Lindsell Train UK fund could underperform peers if Brexit is resolved, as valuations of some of the investments are not cheap and the fund would get as much of a kick from a resolution as some peers.”

Juliet Schooling Latter, research director at Chelsea Financial Services, explains that if there is a deal when the UK leaves the EU, the pound is likely to rally and this would hit the larger dollar earners hardest. 

She continues: “If we had a no deal, then those funds holding mid and small caps and domestically-focused companies, like the banks, would have been hit hardest.

“In the first scenario, funds like Evenlode Income and Lindsell Train UK Equity [would be hit].

“In the second scenario, funds like Liontrust UK Mid Cap (newly-named Neptune fund), Jupiter UK Growth, Investec UK Special Situations. But it may only be short term, before individual fundamentals of a company come back into play.”

There are plenty of investors who do not hold any actively managed funds, and have kept costs to a minimum by investing in the stock markets via passively managed products.

Tineke Frikkee, head of UK equity research at Waverton Investment Management, says: “If one were to invest through passive funds/trackers, a favourable Brexit resolution and strengthening pound should lead to the FTSE 250 and small companies outperforming the FTSE 100, and vice versa.”     

She adds that for active funds, the outcome is less clear.

“Large-cap focused funds may be more domestically tilted than expected and mid/small-cap focused funds may be more overseas tilted than expected,” Ms Frikkee notes.

Currency moves

The fortunes of FTSE 100 and FTSE 250 companies are inextricably linked to the strength of the UK’s currency.

As Fidelity International portfolio manager Ayesha Akbar observes, sterling and the FTSE 250 recently outperformed the FTSE 100 following more positive news flow surrounding a potential deal.

“This is broadly in line with what we would expect, given the FTSE 100 benefits from sterling weakness, and the FTSE 250 tends to benefit from stronger sterling,” Ms Akbar adds.

David Stevenson, manager of the TB Amati UK Smaller Companies fund, acknowledges that the impact Brexit could have on an individual company will depend on a variety of factors, and will not simply come down to whether it is an exporter or international earner that will benefit from sterling weakness.

“Services-based companies will also be affected differently to manufacturers.

“Some of these myriad complexities can affect both large and small companies, and both UK-focused and overseas dependent earnings,” he explains. “Nonetheless, the stock market has voted with its feet since the 2016 referendum result, with UK domestic players significantly underperforming their overseas exposed counterparts.”