While many allocate specifically to large caps and/or small caps, mid-caps tend to be something of a forgotten size segment. Our research team conducted an under-the-hood analysis of smart beta indexes to detail their underlying factor exposure and explain factor return drivers in performance comparisons. The relative tilt of a portfolio or index to small-cap stocks and value stocks can have a large impact on performance,1 and one of the interesting takeaways from our factor analysis was just how different the size indexes and exposure factors were for the various mid-cap indexes.

In this blog post, I will first show the size factor analysis across mid-cap indexes and then provide a framework that can serve as a strategic baseline for considering how much of a portfolio could be allocated to mid-caps.

The Mid-Cap Size Factor Spectrum: WisdomTree at “Book-Ends”

For definitions of indexes in the chart, please visit our glossary.

Fundamentally-Weighted “Book-Ends”: It’s interesting that the WisdomTree MidCap Dividend Index (WTMDI) is the largest mid-cap Index shown, whereas the WisdomTree MidCap Earnings Index (WTMEI) is the smallest. Size factors of 0.20 to 0.52 represent a wide variation in size exposure, in our opinion, and therefore very different potential risk and return characteristics. Even within the market capitalization-weighted peers, the S&P MidCap 400 Index’s small-cap tilt was more than 50% greater with its size loading factor of 0.43, compared to 0.28 for the Russell Midcap Index.

“Book-Ends” Offer a Size Exposure that Is Materially Different from the Large and Small Caps: While the S&P 500 (large cap) and the Russell 2000 (small cap) have size factors at opposite ends of the spectrum (at -0.15 and 0.85, respectively), the mid-cap indexes occupy a notably different niche, with factors that range from 0.2 to 0.52. This suggests that mid-caps potentially offer a different return experience than their large- and small-cap peers.

Blends Worth Considering: Based on these figures, a blend of approximately 75% WTMDI and 25% WTMEI would match the size factor of the Russell Midcap Index, whereas a blend of approximately 72% WTMEI and 28% WTMDI would match the size factor of the S&P MidCap 400 Index. These are very different portfolios, which helps us emphasize that benchmark selection is very important when considering mid-cap equities in the U.S.

Having discussed the unique ways of accessing mid-caps and how different the size factor exposure can be across index families, let’s turn to the larger question of how much of a total portfolio should be allocated to mid-caps. One framework to answer this question begins with the Russell 3000 Index as of December 31, 2013, and cuts the exposure as follows. Approximate weights:

• Large caps: Over $10 billion in market capitalization (78.4% weight)

• Mid-caps: Between $2 billion and $10 billion in market capitalization (16.4% weight)

• Small caps: Below $2 billion in market capitalization (5.2% weight)