Last year saw a significant outperformance of mid caps versus large caps. The chart below shows that the FTSE 250 index outperformed the FTSE 100 index by 14.4% in 2013. Expectations (misplaced, in our view) of a sustained improvement in UK economic conditions drove much of this mid cap outperformance, the FTSE 250 index being much more domestically and cyclically oriented than its large cap counterpart.

But this outperformance also led to an increasing valuation gap between these two parts of the market. In PE terms, the FTSE 100 Index started the year on a forecast multiple of 12.9x earnings, compared to the somewhat more stretched 16.1x for the FTSE 250 Index (source: Bloomberg).

2014, thus far, has shown a very different pattern. Early year mid cap outperformance has petered out, with the FTSE 250 Index currently 6% below its late February highs. This differential was particularly pronounced during the recent spell of slightly more risk averse market sentiment .

The valuation gap has moderated slightly as a result but valuations generally remain more attractive amongst large caps. Even here, however, it is as important as ever to be selective and vigilant.

Its also important to point out that we are not at all prescriptive about what size of company we will invest in we will go wherever we find the most attractive investment opportunities. from the largest companies to the very smallest, as Neils Insight article last week explained. In this respect, size doesnt matter at all. What does matter is that we are convinced that a company, regardless of its size, is attractively valued and capable of delivering attractive long-term returns. Nevertheless, it is fair to say that many of the most attractive opportunities that we find in the market today are amongst the large caps.

The UK stock market as a whole is broadly flat year-to-date but clearly there’s been a lot happening beneath the bonnet. This isnt just a UK phenomenon either US and European markets have shown a similar trend. We wouldn’t be surprised to see continued outperformance of large caps – in particular, attractively-valued, high quality large caps – going forward as fundamentals and valuations reassert themselves.

The views expressed in this article are those of the author at the date of publication and not necessarily those of Woodford Investment Management LLP. The contents of this article are not intended as investment advice and will not be updated after publication unless otherwise stated.