Jeremy Warner's Outlook: Even the attractions of the mid-caps might not see off the growing cult of fixed income

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The merits of big cap versus mid cap is one of those perennial investment debates that never seems quite to exhaust itself. Since January 1999, the mid cap index - the FTSE250 - has outperformed the the rest of the stock market by some 55 per cent, and although it has been off the boil in recent months, the index remains close to its all time high. Meanwhile, the FTSE100 is still at levels well below its turn of the century peak.

The merits of big cap versus mid cap is one of those perennial investment debates that never seems quite to exhaust itself. Since January 1999, the mid cap index - the FTSE250 - has outperformed the the rest of the stock market by some 55 per cent, and although it has been off the boil in recent months, the index remains close to its all time high. Meanwhile, the FTSE100 is still at levels well below its turn of the century peak.

The recent softness of the FT250 has prompted some City commentators to warn of the start of a new investment rotation, with the mid-cap falling out of fashion and bigger companies coming back into their own. In a circular published yesterday, Oriel Securities takes the contrary view. There's still plenty of value to be had among the mid-caps, opines Oriel's Nick Redfern, and there is no need to panic quite yet. The key factors in mid-cap outperformance have not disappeared, he insists.

Is he right about this? Up to a point I think he probably is, though it ought first to be born in mind that the relative performance of the big and mid cap indices is as much about the sectors that make up these indices as a big versus smaller company phenomenon. The only reason for believing that a smaller company is inherently a better bet than a bigger one is that theoretically it has more room to grow. Set against this, however, are the natural advantages of bigger companies, including market dominance and lower cost of capital.

The underperformance of the FTSE100 is down to a relatively small number of sectors and companies - in particular telecoms, which were bid up to absurd levels during the technology bubble of the late 1990s, life assurers, exposed as they were to the downturn in the stock market, pharmaceuticals and some big legacy retailers, such as Marks & Spencer and J Sainsbury.

By contrast, the mid caps have a high exposure to sectors that have done particularly well out of the last five years of low interest rates, raging house price inflation and high levels of consumption. House builders and smaller retailers have been star performers. The mid caps have also experienced a much high level of takeover activity from private equity and elsewhere, if only because their relatively small size makes them easier to digest.

One of the big tests of the FTSE250 is therefore going to be its resilience to the consumer and housing market slowdowns. For instance, can housebuilders throw off the cyclicality that has characterised this sector in the past? Mr Redfern doesn't suggest that everyone in the mid-cap will continue to do well, but he notes takeover activity should remain high because of the weight of private equity money awaiting investment. Asset backed, financially robust companies will feature high on predators' hit lists, he believes, while a still benign interest rate environment should alleviate the usual lows of the cycle to some extent.

One good reason for being bearish about all equities, never mind whether they are big, mid or small cap, is the world's growing obsession with fixed income. This is adversely affecting equities on a number of fronts, but no more so than in the demands being put on companies for fixed income backing for their pension obligations. This requires more aggressive funding than has been common in the past, undermining profits, and at the same time forces pension funds to switch out of equities into bonds. The size of the pension deficits tends to be bigger in the FTSE100, but relative to size, many mid-caps are equally badly placed.

It is perhaps never a good idea to wish a period of sustained inflation on any economy, but that is perhaps what is required to end the madness of the present fixation with debt as the preferred form of capital, and give a much needed boost to corporate profitability to boot.

Bmi goes low cost? Not quite.

Is it a no-frills airline, is it a low-rent British Airways or is it a bit of both? The latest re-incarnation of bmi, the country's second biggest full-service airline, creates a beast which is neither fish nor fowl. Either way, it is going to be some challenge to make it fly, even for such a wily operator as Sir Michael Bishop.

The decision to remove the curtain from the aisle and revert to a single class cabin takes bmi back to the early 1990s, before the brand consultants got their hands on the business and British Midland Airways used its precious runway slots at Heathrow to carve out a profitable little niche in the air travel business.

Times have moved on since then. The arrival of Ryanair and easyJet has stolen Sir Michael's airline lunch, making it well nigh impossible for full-service carriers to make money in Europe. BA can only afford its short-haul network because of the traffic feed it supplies for inter-continental routes. But Sir Michael has not got that justification, his transatlantic ambitions having been repeatedly thwarted.

Bmi reckons its new business model will turn it into the first true low-cost carrier at Heathrow, offering one-way fares starting at £25. Unless they have been sniffing too much aviation fuel, this is surely more of a gimmick than a serious business proposition. Heathrow, with its high charges and congested runways, is just about the worst airport in the world at which to base an airline which depends on low costs and quick turnaround.

The best that bmi can probably hope for is that the promise of low fares will lure shoppers into its website, where they can be sold higher-priced tickets, in much the way that Ryanair and easyJet operate.

In the meantime, bmi must wait for that elusive open skies deal which finally unlocks the transatlantic market. Lufthansa, bmi's largest outside shareholder, has grown tired of waiting and would like to sell. But Sir Michael, smart operator that he is, holds the put option which forces them to buy him out. As the years roll on, the temptation to exercise it must get stronger. Is this a last throw of the dice, or the start of a bright new future for Sir Michael and his airline? We'll see.

Jarvis: lessons in how not to do it

What a tragedy is Jarvis, a one time glamour stock that promised to grow fat on the Government inspired boom in public private partnership work. At its height, the company was worth £828m. Yesterday, the market capitalisation sank to as low as £10m after it emerged that current shareholders will be all but wiped out in a planned debt for equity swap - they'll be lucky to end up with more than 5 per cent of the company.

In any big corporate fall from grace, there are generally three defining events. In Jarvis's case, these started with involvement in the Potters Bar rail crash. Jarvis was the company responsible for maintaining the line, and though the company's former chairman, Paris Moayedi, has always suggested sabotage, the evidence continues to be more indicative of negligence.

Jarvis was later forced to withdraw from rail maintenance work altogether after a train inexplicably found that the tracks had been removed on a stretch out of King's Cross. No one was hurt, but it was Jarvis's misfortune that Alistair Darling, the Transport Secretary, happened to be opening the first phase of the high speed rail link that very day, and he didn't take kindly to being upstaged in the headlines by another near rail disaster.

Yet the biggest and worst failings, financially at least, were in the company's headlong rush into school and hospital renewal programmes, where Jarvis found it couldn't complete the contracts for the low ball prices it had quoted. Few of Jarvis's original debt holders have hung around long enough for the final meltdown. Today the company's £280m of debt is substantially held by vulture capital funds. They'll be calling the shots in the latest refinancing, and the assumption has to be they'll do very well out of equity holders' misfortune. Hey ho.

j.warner@independent.co.uk

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