Investment Insider: Diversity helps mid-caps outperform blue chips

Mid-caps shares may be seen as the poor relation of the stock market, but they have trounced their blue-chip rivals every year since the start of the millennium.

While the FTSE 100, currently at 5,743 points, remains 18 per cent below its high of 6,798 since the start of 2000, the FTSE 250, at 11,494 points, is within touching distance of its all-time high of 12,220 points.

What's more, since 1 January 2000, the FTSE 250 index has delivered a total return of 164 per cent, which equates to an annual return of around 8 per cent a year. By comparison, the FTSE 100 index has returned just 33 per cent, which equates to an annual return of only 2 per cent.

Unlike the FTSE 100, which is heavily weighted to just a handful of shares, the FTSE 250 has a more diversified composition.For example, the top 10 companies in the FTSE 100 account for over half the value of the index.

By comparison, the top 10 weighted companies in the FTSE 250 account for just 10 per cent of the index. And perhaps more importantly, they are drawn from 10 different industries that include house building, gaming and engineering.

So can the mid-cap index continue to beat the blue chips?

Looking purely at valuation, the favourite from here appears to be the FTSE 100. The blue-chip index is currently valued at around 11 times earnings and offers a dividend yield of 3.8 per cent, which is covered more than twice by profits. In contrast, the FTSE 250 trades on a price-to-earnings ratio of around 18 and yields about 3 per cent. So, on valuation grounds, it seems the FTSE 100 may now have the upper hand.

And bear in mind the FTSE 100 is hamstrung by a collection of lumbering heavyweights, which can be both a blessing a curse. HSBC alone accounts for around 7 per cent of the FTSE 100 index, so every 1 per cent rise in its shares would account for about a four-point increase in the index's value.

David Kuo is director of fool.co.uk