The happy medium. Right down the middle. The sweet spot. We’ve got hundreds of different sayings pointing to the virtues of being somewhere in the middle, and yet when it comes to Wall Street, we all seem to have a glaring blind spot.
Many investors love the safety offered by big, blue-chip large-capitalization stocks that offer security, stability and generous dividends. Sure, they might only provide meager capital gains, but we all praise their scrappy performances like they’re the second coming of Red Sox second baseman Dustin Pedroia.
When we want growth, we sprint to the other side of the aisle, eyeballing those sexy small-cap stocks that can double, triple, quadruple overnight. The “baggers.”
Lost in the water cooler talk, however, are mid-caps — stocks between $2 billion and $10 billion that seem to just bridge the gap.
And that’s a shame. Investors are missing out on a doozy of an opportunity.
Why mid-caps dominate. “Mid-caps combine some of the best attributes of their small- and large-cap peers,” says Dan Burrows, feature writer for InvestorPlace.com in Rockville, Maryland. “Mid-caps sit in the happy middle and have offered superior returns over the last past few decades.”
A 2014 study by Wells Capital Management shows a stunning amount of outperformance of the Standard & Poor’s MidCap 400 against both the large-cap S&P 500 as well as the S&P SmallCap 600 index of smaller companies.
| % of Periods During Which the S&P MidCap 400 Outperformed | S&P MidCap 400’s Average Annualized Return Advantage During Period of Outperformance (%) | S&P MidCap 400’s Average Annualized Return Disadvantage During Period of Underperformance (%) | |
|---|---|---|---|
| Rolling 3-Year Periods (189) | |||
| Relative to S&P 500 | 83 | 5.99 | -5.27 |
| Relative to S&P SmallCap 600 | 57 | 4.24 | -1.81 |
| Rolling 5-Year Periods (106) | |||
| Relative to S&P 500 | 94 | 5.48 | -2.11 |
| Relative to S&P SmallCap 600 | 64 | 2.91 | -1.51 |
| Rolling 10-Year Periods (73) | |||
| Relative to S&P 500 | 100 | 5.34 | N/A |
| Relative to S&P SmallCap 600 | 70 | 1.22 | -0.29 |
| Source: Wells Capital Management |
Where mid-caps really shine is during drawdowns, however. In four of the seven drawdowns of 10 percent or greater since 1981, the S&P MidCap 400 outperformed the S&P 500 index, including a run from September 2000 to March 2006 in which the mid-cap index persevered by 20 percentage points.
The sweet spot. Mid-caps don’t just hold a favorable spot in between small and large caps — the company characteristics are pulled from each side. “Small caps may have outsized growth prospects but they also come with more volatility, greater dependence on debt and a general paucity of dividends,” Burrows says. “Large caps have stronger balance sheets and are more likely to pay dividends, but their days of outsized growth are behind them.”
Mid-caps straddle that middle ground, offering more stability, access to debt markets and even dividends than small caps, but boasting far greater growth potential than their large-cap brethren.
After all, to borrow from an old saying: It’s a lot easier to grow your revenues from $10 million to $100 million than it is to grow them from $10 billion to $100 billion.
Charles Sizemore, founder of Sizemore Capital Management, a fee-based registered investment advisory firm based in Dallas, says mid-caps offer investors a value proposition that large caps can’t replicate:
“The mid-cap space can be a real treasure trove of value because it tends to not be covered as exhaustively as the large-cap space,” he says. “When looking at a large-cap stock, you’re competing with every large institutional investor on the planet. And really, what nugget of value are you going to find on the balance sheet that a thousand other analysts haven’t already seen? But mid-caps are often too small for large institutional investors to buy, so they are often under-researched and — if you’re lucky — undervalued.”
Admittedly, mid-caps have run into a relatively short funk over the past couple of years. Since the end of 2013, the iShares Core S&P 500 exchange-traded fund (ticker: IVV) has outperformed the iShares Core Mid-Cap ETF (IJH) 15.8 percent to 8.3 percent, including flat returns over the past 52 weeks to a 3 percent loss for IJH.
But that outperformance has largely come on the shoulders of an amazing run for large-cap tech stocks. Consider the gains in these S&P 500 top 10 holdings over the past two years:
— Apple (AAPL): 41.6 percent
— Microsoft Corp. (MSFT): 57.5 percent
— Amazon.com (AMZN): 68.5 percent
— Facebook (FB): 95.5 percent
It’s not terribly usual for companies in the hundreds of billions in market cap to shoot up 40 to 95 percent in just a couple of years.
Of course, this isn’t the first shorter period in which the S&P 500 has outperformed mid-caps — but longer rolling returns historically have shown that mid-caps end up being the better buys in the end.
How to buy mid-cap stocks: When it comes to mid-caps, there are numerous ways to buy, but for those looking for simple, straightforward ways to enter the space, it’s hard to ignore the allure of cheap index funds.
“Two of my favorite funds include the iShares Core S&P Mid-Cap ETF (IJH) and Vanguard Mid-Cap ETF (VO),” says David Fabian, managing partner and chief operations officer of FMD Capital Management in Irvine, California. “Both ETFs offer a unique subset of stocks with minimal fees, high liquidity and complete transparency.”
The IJH holds 401 stocks, with its top holdings going to financials (26.7 percent), information technology (16.5 percent), industrials (15.1 percent) and consumer discretionary (12.7 percent). It features a slightly higher yield (1.5 percent) than the Vanguard Mid-Cap ETF (1.4 percent) but also slightly higher expenses (0.12 percent to the VO’s 0.09 percent).
VO holds 369 stocks, with similarly weighted top holdings, so there’s no meaningful difference in overall diversification. Where you start to see a difference is in the sector weights — while financials (19.5 percent) and industrials (16.6 percent) share No. 1 and 2 weights, VO has a much heavier concentration in consumer stocks (roughly 28 percent to IJH’s 17 percent). Tech is less emphasized, at 12.3 percent.
Which fund is better for you is likely going to hinge on the sector breakdowns — otherwise, both funds perform similarly over time, with the IJH boasting a 31-basis-point advantage on 10-year average annual returns, but the VO leading in most shorter-term periods.
Regardless of which fund you pick — be it IJH, VO or another fund — you shouldn’t overlook mid-caps.
“While mid-cap stocks don’t always get as much recognition as their large- or small-cap peers, they do have the potential to be successful long-term growth candidates.” Fabian says. “This segment of the market is an important component of a diversified ETF portfolio.”
More from U.S. News
8 Stocks to Buy for a Great 2016
7 Dividend ETFs for the Income-Minded Investor
12 of the Biggest Data Hacks of 2015
Mid-Caps Are a Slice of Wall Street You Shouldn’t Ignore originally appeared on usnews.com
