Middle-capitalization stocks and exchange traded funds have attracted greater interest over the years with their better risk-adjusted returns. However, investors may not want to overweight the asset category as valuations are looking pricey.
There are a number of broad mid-cap stock ETF plays that investors have looked over. For instance, the iShares Core S&P Mid-Cap ETF (NYSEArca: IJH) and SPDR S&P MidCap 400 ETF (NYSEArca: MDY) both track the S&P MidCap 400 Index, with about 69% mid-cap exposure and 31% in small-caps. [The Lengthy Out-Performance of Mid-Cap ETFs]
The Vanguard Mid-Cap ETF (NYSEArca: VO) provides an alternative as it follows the CRSP US Mid Cap Index, but the it also includes a 20.2% weight in large-caps, along with 79.0% mid-caps.
Investors can also consider the Schwab US Mid-Cap ETF (NYSEArca: SCHM), which follows the Dow Jones U.S. Mid-Cap Total Stock Market Index. The index holds 86.8% mid-caps and 10.4% small-caps.
Alternatively, there are a number of smart-beta index ETFs that tilt toward mid-cap stocks due to their indexing methodologies. For example, the Guggenheim S&P 500 Equal Weight ETF (NYSEArca: RSP) equally weights S&P 500 stock components and includes 46.7% mid-caps, 40.2% large-caps and 12.8% mega-caps.
“With higher returns than large caps but less risk than small caps, mid-caps have generated better risk-adjusted returns,” writes Morningstar analyst Michael Rawson. “But with elevated valuations, now may not be the best time to overweight mid-caps.”
Rawson points out that mid-cap stocks have experienced a near unchanging relationship between risk and excess return since 1926.
However, mid-caps are now trading at more expensive price-to-forward-earnings. Specifically, the Russell Midcap Index was trading at a 19.7 P/E at the end of March, higher than all but 18 of 444 months since 1978. The Midcap Index is also trading at a 12% premium to the 17.6 P/E of the large-cap Russell 1000 Index. Rawson noted that the mid-cap and large-cap indices have historically traded at about the same P/E ratio.
Mid-caps also have a higher debt-to-capital ratio and are less profitable than large-cap stocks, which make middle-capitalization companies more volatile and more sensitive to business cycles.
For more information on middle-capitalization stocks, visit our mid-cap category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.