Gorillas in the Portfolio: Embracing Mega-Cap ETFs

On a historical basis, mega-caps often lag their small-cap peers during the first few years of a recovery. That has been the case over the past three years as the Vanguard Mega-Cap ETF (NYSEArca: MGC) is up 60.4% compared to a 68.5% gain for the iShares Russell 200 ETF (NYSEArca: IWY).

The good news for mega-caps is that their under-peformance of small- and mid-caps has many behemoth stocks trading at valuations that are below those of broader indices like the S&P 500. Plus, many mega-caps are sturdy dividend payers, which can steady these stocks during times of elevated market stress. U.S. mega-caps are discounted and are levered to international growth opportunities, broadening their appeal in slow-growth enviorenments. [Mega-Cap ETFs for a Low-Growth Environment]

Morgan Stanley likes the idea of emphasizing global mega-caps.

“We think emphasizing global gorillas continues to make sense, as we expect: quality stocks will pay off over time; the rate of change of growth and policy overseas is improving; attractive secular trends, such as a rapidly expanding middle class in the emerging markets, remain intact; and valuations are relatively attractive compared with smaller-cap stocks,” said Hernando Cortina and Dan Skelly of Morgan Stanley Wealth Management in a note.

Cortina and Skelly note that since the market bottom in 2009, there have been instances of out-performance by companies with questionable balance sheets over well-heeled mega-caps.

“In the equity rally of the past several years, high-quality stocks have not always been in favor. Indeed, we note that, coming off the 2009 bottom and through 2010, there was an extreme divergence in performance between low-quality companies—those with weaker balance sheets—and their higher-quality and, often, larger-cap counterparts,” the duo said in the note.