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It’s often said that mid-cap stocks are overlooked compared to their large- and small-cap counterparts and that’s true despite the fact that over long holding periods, smaller stocks often outperform larger equivalents. That’s often seen as small-cap beating large-cap, but the reality is different.
Market history confirms that over lengthy holdings periods mid-caps beat their larger and smaller competitors and often do so with volatility than small-caps. Yet that history is often ignored – a scenario that’s worsened in recent years as equity markets were powered higher by mega-cap growth stocks.
Over the past three years, the S&P MidCap 400 Index, due in part to a lack of tech exposure relative to the S&P 500, trailed the large-cap benchmark, but the mid-cap gauge beat the S&P SmallCap 600 Index by a margin of almost 3-to-1 and did so with annualized that was 450 basis points below that of the small-cap gauge.
Fortunately, advisors with client bases that aren’t intimately familiar with mid-caps don’t have to stretch to articulate the benefits of this segment of the market. One way – an accurate one at that – for advisors to articulate mid-caps to clients is this is a market segment with superior growth prospects relative to large-caps and better balance sheets, broadly speaking, compared to smaller companies.
Why Mid-Cap Matter
Confirming that mid-caps merit deeper examination, State Street Global Advisors (SSGA) analyzed 15 hypothetical portfolios – some including mid-cap stocks, others excluding that fare. Put simply, the portfolios featuring mid-caps outperformed their exclusionary peers.
“Mid-cap core, growth, and value exposures, as measured by versions of the S&P MidCap 400® Index, have outperformed those large- and small-cap styles since the index’s inception in 1994,” according to SSGA research. “In fact, mid caps’ average excess total return is 608% across the three styles — which can translate to an average annualized excess return of 1.12%.”
SSGA also points out that when examining the Sharpe and Sortino ratios – used to assess risk-adjusted returns – of mid-cap core, growth and value, mid-caps generally outpace large- and small-caps across those spectrums with the exception being large-cap growth.
Add to that, mid-cap performance, though not always the best of the three cap segments, is durable over the long haul.
“Mid caps’ strong periodic performance is also persistent. When we analyzed rolling six-month returns, of the 355 periods available, mid caps beat large caps 53% of the time, across styles,” notes SSGA. “Within the core, the overall average excess return was 0.7%, with a 5.0% excess return in the actual six-month periods mid caps outperformed. Mid caps also outperformed small caps 54% of the time, but with a more narrow positive excess return (0.4%).”
Mid-Caps Pass with Flying Colors
How advisors portion mid-cap stocks or funds in client portfolios obviously depends on the client, their age and tolerance for risk. The good news is that under a variety of theoretical portfolio scenarios, it’s worth including mid-caps.
SSGA went through an array of scenarios, but in the essence of time, I’ll focus on just three: a 50/50 large/mid-cap portfolio, an equal-weight split of large- and small-caps against an equal-weight mix of including mid-caps and a “90/10 split between large caps and small caps versus a 90/8/2 large cap, mid cap, small cap portfolio, reflecting the current market capitalization weights of the three.”
The exercise was performed across core, growth and value and I’ll reveal the core results, but the study with deeper details can be found via download at the SPDR site. Bottom line: the aforementioned portfolio splits when featuring mid-cap core exposure beat the portfolios that featured no allocations to mid-caps. That’s something to think about.