Will market turmoil spark a flight to large cap equities?

Market jitters could drive UK equity investors back to large-cap stocks after a five-year period of relative neglect, says Fidelity International, the UK’s largest mutual fund manager.

Even before the recent market sell-off, there was evidence that investors had begun to switch their money to blue-chip companies. In the six months to 30 June 2007, the FTSE 100 Index had risen by 8 per cent, almost double the percentage point rise in the 250 mid-cap Index.

Fidelity argues that large-cap stocks offer some of the most attractive opportunities in the UK market at present, not only on grounds of relative valuation but also on the quality of the underlying business franchise. Blue-chips are also better placed to withstand further turmoil in credit markets.

Nicky Richards, CIO UK and European Equities at Fidelity International, says: “Since the market rebound of 2003, the action has been mainly in smaller and mid-cap stocks, culminating in a mergers and acquisition frenzy over the past 18 months. Arguably, the latest bout of acquisition has been fuelled by the easy availability of debt.

“With liquidity now seeping away in some corners of the credit markets, we are already beginning to see some deals either put on hold or the terms of their financing renegotiated. In this changed climate, large cap stocks could come back into their own as investors focus again on the business fundamentals.”

Return of the Mega Cap?

The UK’s Mega caps - the top ten biggest companies by market capitalisation – have significantly underperformed all other sectors of the market over the past five years, including their peers in the FTSE 100 Index, according to analysis by Fidelity International.

The ten biggest companies 5 years ago – BP, GlaxoSmithKline, HSBC, Vodafone Group, Royal Bank of Scotland, Royal Dutch Shell, AstraZeneca, Barclays, Lloyds TSB Group, and Diageo – accounted for more than half (57%) of the value of the UK stock market. Their composition has changed little since 2002, with Lloyds TSB and Diageo falling out to be replaced by Anglo American and a second Royal Dutch Shell listing.

Total returns (in Sterling) from this group of ten over the five years to the end of June amount to just 40%. That compares with 69% for the 100 largest Blue Chips and 141% from mid-cap stocks. The bulk of the return for investors – 25 percentage points – has been in the form of reinvested dividends. Capital appreciation of the top ten has been just 15%.

The under-performance of UK Mega Caps is less pronounced over longer time periods. Over 10 and 15 years their total returns are more or less the same as the FTSE 100 and FTSE 350 indices. Mid-cap stocks, however, remain the area of the market that returned the most for having returned almost 300% more than both large and small cap stocks in the last 15 years.