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 midsized 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, Apple, Amazon, Microsoft and Google) 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 midsized 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 ETF (symbol: 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 ETF (VO). Its biggest holdings include companies like Amphenol Corp., Digital Realty Trust, IDEXX Laboratories and Microchip Technology. 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 ETF (VV).
Another route is to own the “extended market” through a fund like Vanguard Extended Market ETF (VXF), which owns everything outside the S&P 500. Interestingly, Vanguard Extended Market owned Tesla last year, whereas some mid-cap index funds did not—resulting in higher 2020 returns for Vanguard and other extended market funds.
Mike Zaccardi is an adjunct finance instructor at the University of North Florida, as well as an investment writer for financial advisors and investment firms. He’s a CFA® charterholder and Chartered Market Technician®, and has passed the coursework for the Certified Financial Planner program. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com and check out his earlier articles.