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Far From Middling

Mike Zaccardi

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.

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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).

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

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.

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Todd Decker
Todd Decker
10 months ago

I 100% agree. While the bulk of my stock investments are in the Total Stock Market and S&P500 funds, I’ve always kept about 10% of the stock portion of my portfolio in Mid-Cap and Small-Cap funds to balance against the enormity of the top 5 or 10 companies that dominate the broader index funds. To me this strategy feels more stable in the long term and when emerging from recessions, stock market dips, pandemics and other market maladies this strategy tends “spice up” overall performance.

John M
John M
10 months ago

Ssshhhh. The first rule of Midcaps is that you don’t talk about Midcaps!

It’s important to note that the reason VTI is 18% midcaps is because midcaps are about 20%% of the total US market cap (78% / 20% / 2% LC/MC/SC according to the Fidelity chart I’m looking at.) A purist would say you shouldn’t own more unless you think you know something the market doesn’t.

Otoh, I’ve long had a hefty skew to MidCap, near 40% of my equities. I don’t have any special knowledge, so why so much? I believe that midcaps will do no worse than large caps over the long run, it has a history of outperformance, and I think it is overlooked by academics and professionals – partially because it’s hard to define. (What exactly is a ‘mid-cap’? Everyone looks at it a little differently.)

Also, unlike Small Cap Value, it does not have every investor and their extended family and friends tagging along in a tiny market space hoping for outsize returns. The smart play loses luster in my eyes when everyone believes they are in on it. Most people don’t realize that SCV is about 1% of the US market, which is a tiny space to have so many people relying on for that extra kick to their portfolio.

holylandphotos
holylandphotos
10 months ago

MZ — Your articles never disappoint. Thank you!

Mike Zaccardi
Mike Zaccardi
10 months ago
Reply to  holylandphotos

Thank you so much!

Brent Wilson
Brent Wilson
10 months ago

Thank you, Mike. I’ve been meaning to do this for some time, but I’ve just exchanged a small portion of my S&P 500 and US Total Stock Market funds to an Extended Markets index fund that tracks both small and mid-cap companies. I too am surprised of the mid-cap performance relative to large and small-cap since 1978.

Andrew Forsythe
Andrew Forsythe
10 months ago

Mike, thanks for a very interesting article. I was surprised to learn that mid-caps have outperformed their larger and smaller counterparts since 1978. And while I knew Vanguard Total Stock Market was weighted towards large caps, I didn’t realize it was to that extent. Guess I’d better hang on to my Vanguard Mid-Cap and Extended Market.

Guest
Guest
10 months ago

I was very happy to see Joel Tillinghast, the PM for Fidelity’s Low-Priced Stock Fund, a mid-cap value fund, named M* Outstanding PM (a recognition across all boxes) this week. His long-term performance in the mid-cap box is legendary.

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