A Look Inside the FTSE 250
The UK's domestically focused index is stuffed full of global investment trusts
I’ve written previously on why I’m bullish on the UK – stable government, improving macro backdrop, reforms to encourage investment. Granted, Keir Starmer’s first 100 days have been far from Rooseveltian, but the government has a large majority and time on its side. And the economy seems to be walking the tightrope of moderating inflation, lower interest rates, and steady employment (as the US economy is too). I’ll check in on this view in the coming months but in the meantime, if you buy the argument of an improving UK domestic outlook, how do you invest for it? The obvious play is to buy domestically focused equities, which leads to portfolios tracking the FTSE 250 index. But there’s a big reason to think twice about this.
The FTSE 100 is the UK’s flagship equity index, comprising the 100 largest companies listed on the London Stock Exchange. Launched on 3rd January 1984, it arrived just before the Big Bang reforms of 1986 that deregulated the stock exchange in the UK, sparking an increase in trading volumes and market capitalisation. The FTSE 250, comprising the next 250 largest listed companies after those in the FTSE 100, followed in October 1992, and has been the leading UK mid-cap equity benchmark since then.
The FTSE 250, which currently contains companies ranging from ~£360 million to ~£5 billion in market value, is commonly viewed as more domestically focused than the FTSE 100, which is heavily weighted towards large multinationals with a high share of overseas earnings. This has some truth to it. In 2022, over 80% of the sales of FTSE 100 companies came from outside the UK compared to ~55% of the sales of FTSE 250 companies.1
The two indexes also tend to react differently to movements in the pound. With its greater share of overseas sales (and earnings), then all else equal, a falling pound leads to a rising FTSE 100, as foreign earnings are worth more when translated back to pounds. This dynamic became clear in the years after Brexit when “bad” news (anything that increased the likelihood of a hard exit) tended to trigger a fall in the pound alongside a rise in the FTSE 100. The impact of changes in the pound on the FTSE 250 are generally more muted.
Sectoral composition of the FTSE 250
So far so good then in getting more UK domestic exposure through the FTSE 250. But let’s take a closer look at the sectoral composition of the index. Here’s a chart using holdings data from the iShares ETFs tracking the two indexes2:
Less healthcare, energy and basic materials in the FTSE 250 makes sense. No AstraZeneca, BP, Shell or any of the major international mining groups. A lower weighting in consumer staples is understandable too. No Unilever or Diageo. But over 40% of the FTSE 250 in financials. Something seems off.
And it is. It turns out that the FTSE 250 index is not made up of 250 companies, but 160 of what I’ll term “proper” companies and 90 investment trusts3. Investment trusts make up 31% of the market value of the entire index and mostly fall under the financial bucket, with a few property funds classed as real estate.
What are investment trusts
Investment trusts are a UK-specific form of closed-end fund. Closed-end funds are like mutual funds in that an individual can use them to access a diversified portfolio of investments (shares in companies, debt, property, for example), but unlike mutual funds, they issue a fixed number of shares.
Practically speaking, this means a closed-end fund raises money much like a company. It lists on an exchange through an IPO process and raises an initial amount of capital with the potential for follow-on offerings. The trust then employs a manager to invest this capital into other assets, including publicly listed stocks.
Here’s the ten largest investment trusts in the iShares FTSE 250 ETF as of 14 October 2024:
I have no issue with investment trusts and closed-end funds. They’re more complicated than mutual funds and ETFs to understand, and the fees can sometimes be hidden (and make no mistake, all these trusts charge fees) but they can also provide access to more illiquid asset classes, such as infrastructure and private equity. Whether it’s worth paying a premium to do that is a separate question. But I do have a big issue with investment trusts being included in an index that claims to be the “leading measure of the UK economy’s health”.
Let’s take Alliance Witan plc. It’s a recently formed mega merger between Alliance Trust and Witan Investment Trust with ~£5bn of AUM allocated across 11 separate fund managers, benchmarked to the MSCI World Index. Alliance Witan plc is 1.5% of the iShares FTSE 250 ETF portfolio, meaning that if you buy this ETF, part of what you’re buying is a global equity fund-of-funds with its largest holdings in Amazon, Alphabet, Visa and Microsoft. You are buying a fund within a fund within a fund!
Polar Technology Trust is a portfolio of mostly US technology stocks. Nvidia, Microsoft, Apple, Meta, and the like. At least it’s only a fund within a fund. Go further down the list and you’re into a weird world of country equity funds (Japan, India, Vietnam) and private illiquid assets (global infrastructure, hedge funds). Based on the AIC categories, around 80% of these funds by market value are in global rather than UK focused strategies.
Why are investment trusts included in the FTSE 250
I don’t know why investment trusts are/were included in the FTSE 250 index. I imagine it’s a function of some historical quirks (role of investment trusts in the UK), lobbying from the industry (this is great way to raise AUM!) and a general apathy towards UK capital markets that means no one has much incentive to change it.
I do know that it’s not standard elsewhere. The Russell 2000, for example, part of the same FTSE Russell group of indexes, excludes all closed-end funds. And all major equity indices exclude ETFs. Part of the reason I’m writing this is that having cut my cloth in mostly US stock market space, I was genuinely surprised when I discovered this a few years ago.
It’s also evident that the problem has got worse over time. In 2014 Morningstar wrote about the investment trust issue in the FTSE 250 noting that they accounted for 15% of holdings. Today, it’s up to 36% of holdings.
Better options for UK domestic exposure
FTSE Russell also produces a range of UK equity indexes that are “ex-investment trust” and some UK investment funds either track or are managed to this benchmark instead of the standard FTSE 250. Legal & General’s UK Mid Cap Index, for example, aims to track the performance of the FTSE 250 ex. Investment Trusts Index.
The problem is that you need to know what you’re looking for and then wade through to find the right fund with the right benchmark. If your go-to is to buy the iShares or Vanguard ETF, you’re going to get a portfolio loaded with investment trusts. That’s not what I want from a UK equity index.
Does it matter?
If you’ve got this far and are feeling aggrieved by this UK index quirk, I’m about to disappoint you. In theory you’d expect a reasonable divergence between the performance of the FTSE 250 and the FTSE 250 ex-investment trust indexes given the difference in composition. However over the last five years, performance has been exactly the same - probably another reason for why this quirk continues.
I guess there is a lot of beta (aka general market movements) wrapped up in both portfolios and there may be some quirk around the five year period incorporating volatile Covid market trends in which stocks moved together more. I’d welcome views from anyone with better insight. Over the last year though performance has diverged, and it’s reasonable to expect that this would continue if you buy the UK domestic outperformance story.
For me though this is less about performance and more about simplicity for investors and global standardisation. The FTSE 250 is an odd anomaly in having such a high concentration of investment trusts. It seems time for a wider rethink.
I used ETFs as a proxy as index data is not freely available.
My estimates using portfolio holdings of the iShares FTSE 250 index as of 14 October 2024, cross-referenced against a list of investment trusts from the Association of Investment Companies as of 30 September 2024.
In 2014 Morningstar wrote about the investment trust issue in the FTSE 250 noting that they accounted for 15% of holdings. Today, it’s up to 36% of holdings.
Is this by ticker count or value? Can imagine US based trusts alone have 5x since 2014.
Rooseveltian - love it. Is this an early dividend from moving to the US?
Great article. I’m a huge fan of investment trusts, especially now the charging transparency is close to a sensible resolution. However, I less wonder of their inclusion than have a straight up concern what such a volume in the 250 means for the health of the market and economy. It’s a stark reminder of over reliance on the City.