Where's the love for mid-cap stocks?

With many fixated on either large-cap stability or small-cap growth potential, investors may be overlooking the middle ground

Where's the love for mid-cap stocks?

The ETF industry has been driven in past years by investors’ preference for cheap passive strategies, with many gravitating toward large-cap equity exposure. There have also been some alpha-seekers who went in the opposite direction by buying small-cap funds that offer more growth potential.

But in the midst of that dichotomy, mid-cap securities may be falling through the cracks — leading investors to potentially miss out. As noted by CFRA Director of ETF and Mutual Fund Research Todd Rosenbluth, “midcap securities remain under the radar with most investors.”

In a recent piece for ETF.com, Rosenbluth drew from a report authored by Matt Bartolini, head of SPDR Americas Research, titled What You Miss by Overlooking Mid Caps. Aside from stability and balance-sheet strength similar to large-caps, Bartolini found that mid-cap equities possess growth potential similar to small-caps.

An optimal middle ground
An analysis of benchmark performance since the 2008-2009 financial crisis, Rosenbluth reported, shows that companies in the S&P Mid Cap 400 Index have had median return on assets similar to companies in the S&P 500 Index, but the former group had lower total debt-to-asset ratios.

“Meanwhile, since 2000, mid-cap companies have generated average earnings-per-share growth comparable to small caps in the Russell 2000 index—though with lower volatility,” he said.

Citing Bartolini, Rosenbluth added that midcaps had higher risk-adjusted Sharpe ratios than large-caps in 58% of 242 five-year rolling periods analysed over a 15-year stretch ended June 2019; a similar comparison over the same periods, this time against small-caps, showed mid-caps with higher ratios in 94% of instances.

No strong suit in active management
A survey of mutual funds and ETFs indicates inconsistent attention being paid to mid-cap strategies. Rosenbluth said that, according to CFRA Research, US$520 billion was invested in mid-cap mutual funds in June 2019, compared to US$193 billion in mid-cap ETFs.

“Historically, investors favoured mutual funds with a portfolio team actively aiming to identify winners rather than broadly based and index-based strategies,” he explained.

Managers have also brought out a wider selection of small- and large-cap active mutual funds, with the categories having 525 and 784 unique funds, respectively, at the end of 2018. In contrast, there were only 289 unique active midcap mutual funds at that time.

“But active management with midcaps has faced performance challenges,” Rosenbluth said. Referring to SPIVA Persistence Scorecard data as of March 2019, he noted that none of the top-quartile mid-cap managers from 2015 have kept their top-quartile status up to today, based on prior one-year returns. Similarly, comparing those mid-cap fund managers that were top-half performers in March 2015 with those in March 2019 reveals that only 2% exhibited staying power over the period.

“In other words, it may be time for investors to apply an index ETF strategy to the mid-cap equity space,” Rosenbluth said.

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