While the FTSE 250 and the FTSE Small Cap indices are both up around 25% this year, the FTSE 100 has only risen 13%, with mega caps such as Shell and Imperial Tobacco in the red for 2013.

Those valuation discrepancies may be about to close, fund managers suggest, as the economic cycle matures and large-cap managers find themselves with money to invest from Vodafone’s sale of its US business and subsequent return of cash to shareholders.

Matt Hudson, manager of the Cazenove UK Equity Income fund, has been selling mid-cap consumer cyclicals such as Taylor Wimpey and buying mega caps like BP and Rio Tinto.

“The mid-cap area, but the medium-term opportunities are developing more frequently among larger caps,” Hudson said.

“This is consistent with the evolution of the business cycle from consumer cyclicals towards later stage industrial and commodity cyclicals.”

Jamie Hooper, manager of the AXA Framlington UK Growth fund, believes the fortunes of “the big ugly stocks often known as the ‘mega traps’” are about to change.

“There is an opportunity to selectively add to some of these larger holdings,” the manager said.

“We have been adding to the likes of Rio Tinto, BP and GlaxoSmithKline. The proceeds from Vodafone’s divestment of its US operations will also be looking for a home.”

Meanwhile, Premier Income manager Chris White, has pointed to larger stocks’ increasing resilience in the face of disappointing earnings, a trend which suggests valuations do not have much further to fall.

White has upped his mega-cap exposure from 60% to 70% since Q4.
However, his colleague David Hambidge, director of multi-asset at Premier, noted managers face difficulties if the largest stocks do begin a concerted period of outperformance.

“It will be a problem for active managers short term if we see a period where mega caps drive the market, because managers cannot invest too much in one stock,” said Hambidge, who has nonetheless been increasing exposure to large-cap funds. This has happened before in the late 90s, when many index funds outperformed.”

UK managers’ moves are being mirrored by those in the US such as Ed Cowart, manager of Nordea’s North American All Cap fund, and Sam Peters, manager of the Legg Mason Value trust.

“I am finding much more attractive risk-adjusted returns in large and mega caps,” said Peters.

Meanwhile Schroders US Mid Cap fund manager Jenny Jones, speaking at a conference in New York, said valuations in her segment of the market are “beginning to get very high”

UK 10 largest stocks by market cap