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In the first of our three part series, Shares explains why the fabulous FTSE 250 is flying high and flush with takeover targets
Thursday 19 Aug 2021 Author: James Crux

There are lots of good reasons why investors should have allocations to the FTSE 250, London’s high-flying index oriented to mid caps which provides a purer play on the domestic UK economy than the exporter-heavy FTSE 100.

The FTSE 250 captures those growth stocks that have come up from the small cap ranks and therefore had a chance to establish themselves. And crucially, it can catch these ‘second liners’ at a point in their growth path before they ascend to the ranks of the blue chip benchmark where rapid expansion can be harder to achieve.

And performance has proved stellar, with the FTSE 250 dramatically outshining the FTSE 100 over the past two decades and rebounding faster than the large cap index since the Covid lows of March 2020. At the time of writing, the mid cap index is testing fresh highs, powered by a combination of reopening optimism, earnings upgrades and the slew of takeover activity that has seen FTSE 250 constituents picked off by private equity, foreign and other buyers.

Over three articles, Shares will explain what’s driving the FTSE 250 and outline the different ways investors can screen for opportunities. Here in part one, we explain why mid cap stocks are so attractive to investors.

We also shine a spotlight on the stocks that carry the most weight in the index today, those that have driven the 250’s rip-roaring performance over time, and show how investors can purchase low-cost exposure to the index to boot.

ABOUT THE FTSE 250

Launched in October 1992, the FTSE 250 is a capitalisation-weighted index consisting of the 101st to the 350th largest companies listed on the London Stock Exchange (LSE).

Whereas the global FTSE 100 index dominates the news headlines, the more domestically-focused FTSE 250 has proved the superior performer since its inception.

Offering a dividend yield of 1.88% at last count, the 250’s biggest sector weights according to Refinitiv Eikon are financials (36.2%), consumer discretionary (17.8%) and industrials (16.85%). This contrasts with the 100, where health care, basic resources and industrial goods and services are the largest weights, followed by energy, banks and personal care and drug stores.

Over the past two decades, companies that have helped to power the FTSE 250 higher, rising through the mid cap ranks ahead of promotion to the FTSE 100, include the likes of trainers-to-tracksuits retailer JD Sports Fashion (JD.) and the online groceries platform Ocado (OCDO), while more recently, the likes of hedge fund Pershing Square Holdings (PSH) and discounter B&M European Value Retail (BME) have been promoted from the 250’s ranks to the FTSE 100, having made shareholders a mint in the process.

FTSE 250 takeovers

The index is seeing a renewed level of bid interest at present from private equity and overseas buyers, with Brexit done and dusted and debt financing cheap. ‘Second liners’ taken over or bid for year-to-date operate across a dizzying array of different industries and attest to the sheer quality of the mid cap index.

They range from temporary power provider Aggreko and online bingo operator Gamesys (GYS) to hospital group Spire Healthcare (SPI) and infrastructure play John Laing (JLG), not to mention defence contractor Ultra Electronics (ULE) and asset management services provider Sanne (SNN).

Bidding wars are underway for Bradford-based grocer Wm Morrison Supermarkets (MRW) and jet parts manufacturer Meggitt (MGGT) too, with Morrisons’ market value swelling to £6.83 billion with a Fortress-led consortium and buyout group Clayton, Dubilier & Rice vying for control of the UK’s fourth biggest supermarket.

Meanwhile, Meggitt’s market tag has soared to £6.47 billion off the back of a premium-priced offer from Parker-Hannifin, since trumped by TransDigm. Another name that has seen competing bid interest is drug inhalation technology company Vectura (VEC), which has just unanimously accepted a controversial takeover offer from tobacco giant Philip Morris. Another exemplar is student accommodation-focused REIT GCP Student Living (DIGS), which has recommended a premium-priced offer at 213p from Scape Living and iQSA.

WHY MID CAPS ARE A MUST

The FTSE 250 offers opportunities to invest beyond the FTSE 100, where exciting mid-sized companies are often below the radar of many investors. Mid cap companies are attractive for a variety of reasons; more established than smaller firms, they are typically profitable and more robustly financed than corporate small fry, and less risky as a result.

Yet they also appeal to investors as they tend to be faster growing than mature large cap counterparts and usually have years of market share gains and sales and profit growth ahead of them. As Shares outlined here in June Jean Roche, lead manager of the Schroder UK Mid Cap Fund (SCP) and co-manager Andy Brough, refer to the FTSE 250 as the ‘Heineken Index’ given its potential to ‘refresh’ portfolios in a way other parts of the market cannot.

M&A activity makes room for the next tranche of exciting mid cap companies, which can either be new (or returning companies) which join the stock market through initial public offerings, or small caps vying for promotion to the FTSE 250.

Georgina Brittain, who manages investment trust JPMorgan Mid Cap (JMF) along with Katen Patel, told Shares: ‘The FTSE 250 offers exposure to great British businesses with plenty of scope for growth. Recent impressive performance has been driven by a number of factors but, in particular, success with vaccinations and the resurgence in optimism about economic recovery as restrictions have lifted.

‘While uncertainty still remains, which may cause some short-term volatility, we see attractive growth opportunities, with FTSE 250 constituents well placed to thrive in a recovery over the long-term.’

Looking out to 2022, Brittain said the FTSE 250 is ‘now on a price-to-earnings ratio of 15.8 times, which is slightly above its long run average. However, earnings are forecast to grow 27% this year and 13% next – and we believe our companies can potentially grow faster than this. While we are closely monitoring the impact of global supply chain issues and inflationary pressures, the strength of the economic backdrop is very positive, and the ongoing rush of M&A provides clear evidence of the value seen in the UK stock market.’

WHICH STOCKS MATTER MOST

Analysis of the FTSE Mid 250 Index using     Refinitiv Eikon data reveals the index is more diversified than the FTSE 100 in terms of the distribution of weightings to various stocks. So whereas the blue chip benchmark has nine stocks with weightings above 3%, such as AstraZeneca (AZN) at 6.44%, Unilever (ULVRat 5.49% and HSBC (HSBA) at 4.29%, no one stock accounts for more than 1.5% of the FTSE 250, with nine companies concentrated in the 1%-to-1.5% weightings bracket.

As at 12 August 2021, the two stocks with the biggest weights were Meggitt and Morrisons at 1.5% and 1.46% respectively. Hot on their heels were Howden Joinery (HWDN), the up-market kitchen supplier that commands a market value of £5.61 billion. Howdens rode the boom in demand for new houses, aided by Help To Buy and the stamp duty holiday introduced last year, and also profited from the increase in people making home improvements, which has driven demand for the stock.

Other 250 names with considerable index clout include Dechra Pharmaceuticals (DPH), the veterinary pharmaceuticals play that has traded strongly through the pandemic, electronic component distributor Electrocomponents (ECM), a beneficiary of the global reopening, not to mention the UK’s oldest collective, F&C Investment Trust (FCIT), a notable index constituent with a 1.1% index weight.

STAR PERFORMERS

In order to identify the names fuelling the FTSE 250’s stellar gains, Shares has run the data to reveal the best performers over the past three, five and 10 years. It should be noted the lists provided exclude those companies that have been promoted to the FTSE 100 or picked off by predators over these time periods.

Software reseller Softcat (SCT), Liontrust Asset Management (LIO) and media firm Future (FUTR) are the three best performers on a 10 year basis, having generated spectacular total returns of 2960%, 2790% and 2160% respectively.

Over five and three years, Future, fantasy miniatures maker Games Workshop (GAW), digital transition company Kainos (KNOS) and newspaper publisher Reach (RCH) have all delivered outstanding total returns to shareholders.

A QUESTION OF QUALITY

The index is also the domain of some companies with impressive long-term records of generating a high return on capital employed (ROCE), a useful metric in assessing a company’s historic profitability and how efficient it has been in using its capital.

Among their number are the likes of stockmarket newcomer Bytes Technology (BYIT), the software reseller boating a long-term average ROCE of 66.7%, followed by market darling Games Workshop with a long-term average of 61.6% and asset manager Ninety One (N91) with a 61.3% ROCE.

Other high-ranking names on this measure are the sought-after Softcat, promotional products firm 4imprint (FOUR), Moneysupermarket.com (MONY) and WH Smith (SMWH). The latter has a long-term average ROCE of 44%, which is exceptionally high for a retailer, although this is flattered by the fact WH Smith leases a lot of its stores in a bid to keep costs low against a backcloth of structural pressures.

 LOW COST WAYS TO PLAY

Investors hungry for exposure to the current crop of mid cap marvels might consider exchange-traded funds (ETFs) which track the FTSE 250 index. These ETFs offer a cost-effective way to invest in mid caps without the hassle of having to manage individual investments.

Among the ETFs available is Vanguard FTSE 250 ETF (VMIG), which has more than £3.6 billion of assets under management, meaning it has a very tight bid-ask spread and is also the lowest cost FTSE 250 ETF with an ongoing charge of just 0.1% a year.

Other options include Xtrackers FTSE 250 ETF (XMCX), with net assets of £81.5 million and competitive total expense ratio of just 0.15%, HSBC FTSE 250 UCITS ETF (HMCX), with an ongoing charge of 0.35%, and last but not least, the iShares FTSE 250 ETF (MIDD), with a total expense ratio of 0.4%.

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