WisdomTree: Paring Mid-Cap Winners

We’ve written multiple blog posts about U.S. equity market performance in 2013, so we won’t belabor the point that it happened to be quite strong. Instead, we’d like to take the opportunity to discuss one of the less-mentioned areas of the equity market capitalization spectrum—mid-caps.

Mid-Caps Deserve Consideration

Investors know that small caps may respond more quickly to positive changes in economic growth expectations or that long-established large-cap blue chips are a good choice to potentially mitigate portfolio volatility. But what about mid-caps—do they deserve special consideration in portfolio allocations?

The fact of the matter is that mid-cap equity1 performance2 has been impressive, outpacing that of U.S. large caps3. Similar to small caps, some of these firms might be potential acquisition targets and others might be poised to grow into the large-cap segment in the coming years.

WisdomTree MidCap Earnings Index (WTMEI) as a Case Study

Mapping the Performance Picture

While the whole Index was up about 40% between annual rebalances4, we know that this is an average and not every stock was up by this amount. If we think broadly in terms of sector performance:

Three Sectors Greater Than 50%: Consumer Staples (62.1%), Health Care (52.7%) & Telecommunication Services (65.0%)

Three Sectors Less Than 30%: Energy (26.2%), Materials (25.0%) & Utilities (19.6%)
We believe that performance dispersion such as this leads to potential opportunities for a relative value rebalance to go to work—just as we wrote for the WisdomTree SmallCap Earnings Index (WTSEI).

How Chips Were Taken Off the Table

Shifting to a constituent level, it’s important to remember that WTMEI is unique within the U.S. mid-cap equity space in that it weights constituent firms by earnings.

Greater Earnings = Road to Greater Weight: The typical firm receiving increased weight in WTMEI will have grown or at least maintained its earnings but have had lackluster price performance. Conversely, the typical firm receiving lower weight will have had stronger price performance but earnings growth that did not keep pace.

Losses Lead to Deletion: Every constituent of WTMEI must prove its cumulative profitability over the four quarters prior to the November 30 screening. Lack of profits leads to lack of representation.

Trimming Weight from Top Performers