Some managers in the sector, such as Standard Life’s Harry Nimmo, hold on to their holdings when they outgrow the smaller companies index, meaning their funds have a higher weighting to the FTSE 250.
However, our data shows that many smaller companies managers have also been buying new positions in mid cap companies.
Five out of the six most-bought stocks in the IMA UK Smaller Companies sector over the past year are FTSE 250 stocks, as are 11 out of the top-20.
With FTSE 250 companies popular among IMA UK All Companies funds too, the data raises the question of whether the mid cap part of the market is over-bought.
Most-bought stocks in the IMA UK Smaller Companies sector
| Stock | FTSE index |
|---|---|
| Dechra Pharma | 250 |
| Ashtead | 250 |
| Advanced Computer Software | AIM |
| Paragon | 250 |
| Howden Joinery | 250 |
| Keller Group | 250 |
| Iomart | AIM |
| RWS Holdings | AIM |
| Optimal Payments | AIM |
| St Modwen | 250 |
Source: FE Analytics
Some commentators suggest that the popularity of this part of the market could backfire, with Simon Callow, manager of the CF Miton Diversified Growth fund, telling FE Trustnet last week that he was reducing his exposure to it as a result of these fears.
Callow says that such is the popularity of this part of the market he thinks liquidity would be a problem should markets sell off.
One sign of a potential crowding in the FTSE 250 is its valuation relative to other parts of the market, which Paul Spencer (pictured) and Richard Bullas, managers of the Franklin UK Smaller Companies fund, say is already stretched.
"The Numis Smaller Companies index is currently trading at a discount to the FTSE 250 Mid Cap Index," they said.
"Both indices are on a slight premium to the FSTE 100, however if you strip out the volatile resources and financials sectors the FTSE 100 is also on a slight premium to smaller companies."
The FTSE 250 has outperformed both the FTSE 100 and the Numis smaller companies index over the past year, explaining its popularity among managers.
Data from FE Analytics shows that the FTSE 250 has made 23.01 per cent over 12 months compared with 14.59 per cent from the FTSE 100 and 14.28 per cent from the Numis index.
Performance of indices over 1yr
Source: FE Analytics
Callow says this run cannot continue for ever and it is time to take profits from the sector, warning that any unwinding of the positions managers have taken up could prove painful for investors, with a rush of sellers driving down the price.
Spencer and Bullas also think the outperformance is likely to come to an end and say the prospects are better in the true small cap area of the market.
"Earnings growth is also forecast to be higher for UK small caps, with current projections forecasting around 7 per cent growth compared with just 5 per cent for the larger blue chips."
"Earnings expectations seem to have reached a realistic level after a period of downgrades during the second half of 2012 and this valuation discount seems excessive and has the prospect to narrow over the next 12 months."
According to FE Analytics data, Dechra Pharmaceuticals, a company that manufactures drugs for pets, is the most-bought company among funds in the IMA UK Smaller Companies sector.
Artemis UK Smaller Companies, Liontrust UK Smaller Companies and Marlborough Special Situations are among the smaller companies funds to hold it in their top-10.
Artemis UK Growth has 5.6 per cent in the stock while Old Mutual UK Smaller Companies holds 3.9 per cent.
Building equipment rental company Ashtead Group, with a £3bn market cap, is the second most-bought stock, and is held in the top-10 of 13 smaller companies funds as well as 24 IMA UK All Companies funds.
The stock is also the fourth most-bought in the latter sector over the past year, a year in which it has made 129.79 per cent. The company does 80 per cent of its business in the US, meaning that it is dependent on a recovery in that country.
Howden Joinery, with a market cap of £1.4bn, is another stock attracting attention from managers in different sectors: it is the sixth most-bought in the IMA UK All Companies sector and the fifth most-bought in smaller companies funds.
Buy-to-let mortgage lender Paragon Group, which has a market cap of £1bn, and ground engineering specialist Keller Group, at just over £500m, are both also FTSE 250 stocks and are the fourth and sixth most-bought stocks among UK smaller companies managers.
All five stocks have had exceptional years, according to our data.
Performance of stocks over 1yr
Source: FE Analytics
Richard Troue, investment analyst at Hargreaves Lansdown, says that investors should be aware that mid and small cap companies can be more volatile than their larger counterparts.
For that reason he agrees with Callow that if a market pull-back does occur then mid caps are likely to be hit harder than large caps.
Franklin UK Smaller Companies is only £20m in size and has a greater concentration towards the AIM than the FTSE 250. Xaar and RWS Holdings are the fund’s two biggest positions, which are listed on the FTSE Small Cap index and AIM respectively.
However, Bovis Homes and Paragon are top-10 holdings and both are FTSE 250 companies.
The fund is available with a minimum initial investment of £1,000 and has ongoing charges of 1.7 per cent.