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Mid-Caps Are Far From Middling

By Mike Zaccardi, CFA, CMTStock MarketsJun 25, 2021 11:32AM ET
Mid-Caps Are Far From Middling
By Mike Zaccardi, CFA, CMT   |  Jun 25, 2021 11:32AM ET
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This article was originally published at The HumbleDollar

You might recall Malcolm in the Middle, a turn-of-the-century TV sitcom in which the middle child often feels ignored. That’s kind of what goes on with mid-sized stocks.

Large-capitalization growth shares and small-cap value stocks seem to get all the attention these days. The former feature the FAAMG companies (Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOGL)) and other 2020 winners, while the latter are the darling of investors who embrace academic research showing strong long-term outperformance by small-cap value shares.

But how about some kudos for mid-sized stocks? Bank of America recently compared U.S. large, mid-cap and small-cap total returns since 1978. A $1 initial investment would have grown to $139 in large-cap stocks, $181 in small-cap shares and $199 in the mid-cap index. That’s a 13.1% annual return for mid-caps.

Why have mid-cap stocks performed so well? One possibility: The category includes smaller companies that are reasonably valued but growing fast—and the best performers among them get handed off to the large-cap index when they get big and are likely to turn sluggish.

Knowing a portfolio’s sector composition is important. Mid-caps are more tilted to the industrials, real estate, financials and materials sectors than the large-cap index, but less exposed to communication services and information technology. Result: Mid-cap stocks are more value-oriented than large-caps.

This also seems to be a part of the market that’s overlooked. Bank of America says that since 2003, mid-cap funds received just 4.6% of all exchange-traded stock fund flows, versus 7.9% for small-caps and 87.5% for large-caps. Perhaps mid-caps deserve more attention. Earnings growth for mid-caps has averaged 9.2% a year since 1995, versus just 6.4% for large-cap companies.

Some investors claim they get mid-cap exposure through total market index funds like Vanguard Total Stock Market Index Fund ETF Shares (NYSE:VTI). But the data show that the Vanguard fund has just an 18% weight in mid-caps, according to the Morningstar style box. Instead, more than 70% of the fund is in large-cap shares. When you buy a total U.S. market fund, you’re essentially buying big companies. I’d argue that spicing it up with some extra mid-cap exposure, and maybe also some small-cap value, can make sense.

You could get your fix of mid-cap stocks with a fund like Vanguard Mid-Cap Index Fund ETF Shares (NYSE:VO). Its biggest holdings include companies like Amphenol Corporation (NYSE:APH), Digital Realty Trust (NYSE:DLR), IDEXX Laboratories (NASDAQ:IDXX) and Microchip Technology (NASDAQ:MCHP). Are you familiar with all of these? Neither am I.

But there’s no need to fret over the largest holdings in a mid-cap index fund. If a stock grows really big, it’ll get called up to the large-cap index. As a result, mid-cap index funds tend to spread their assets more evenly than the top-heavy large-cap index funds. For instance, the top 10 holdings in Vanguard Mid-Cap ETF represent 6% of total assets, versus 26% for Vanguard Large-Cap Index Fund ETF Shares (NYSE:VV).

There are other solid mid-cap fund options, including iShares Core S&P Mid-Cap ETF (NYSE:IJH), iShares Russell Mid-Cap ETF (NYSE:IWR), Schwab U.S. Mid-Cap ETF™ (NYSE:SCHM) and SPDR SPDR® S&P MIDCAP 400 ETF Trust (NYSE:MDY).

Another route is to own the “extended market” through a fund like Vanguard Extended Market Index Fund ETF Shares (NYSE:VXF), which owns everything outside the S&P 500. Interestingly, Vanguard Extended Market owned Tesla (NASDAQ:TSLA) last year, whereas some mid-cap index funds did not—resulting in higher 2020 returns for Vanguard and other extended market funds.

Mid-Caps Are Far From Middling

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Mid-Caps Are Far From Middling

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