Investors may target middle capitalization stocks through exchange traded funds to capture attractive risk-adjusted returns.
“Sometimes referred to as the market’s sweet spot, mid-cap stocks are positioned in a way that gives them the potential to achieve impressive risk-adjusted returns,” writes Karen Wallace, senior editor with Morningstar.
Mid-cap companies are slightly more diversified than their small-cap peers, which allows many mid-sized companies to generate more consistent revenue and cash flow and provide more stable stock prices. Additionally, they are not so big that their size would slow down growth. [Interested in the U.S.? Look to ETFs that Target Smaller Companies.]
Looking at Morningstar data, the mid-cap asset category has generated an average annualized 8.7% return over the past 15 years with a 17.5 standard deviation, a measure of historical volatility. Meanwhile, over the past 15 years, large-caps generated an average 3.8% return with a 14.9 standard deviation and small-caps returned 8.9% with a 19.8 standard deviation.
“You can see that mid-caps have outperformed their large-cap peers, but with lower volatility than small caps,” Wallace added. “In fact, the returns of mid-cap stocks have also beaten those of small-cap stocks during the trailing three-, five-, and 10-year periods, with lower volatility.”
To get a sense of how much investors should be allocated toward mid-caps, middle capitalization stocks make up about 18% of total stock market index funds and account for 20% of the U.S. equity universe, according to Morningstar data.
Investors interested in mid-cap focused ETFs can take a look at a number of options, including the iShares Core S&P Mid-Cap ETF (NYSEArca: IJH), the largest offering in the space. IJH tries to reflect the performance of the S&P MidCap 400 Index and comes with a 0.15% expense ratio. The ETF is down 1.6% year-to-date.
Alternatively, the SPDR Mid-Cap 400 (NYSEArca: MDY) covers the same mid-cap index. However, due to the older unit investment trust structure, the ETF is less flexible than Regulated Investment Company fund structures found in most other ETFs, like IJH. Consequently, MDY can not lend shares or efficiently reinvest dividends. MDY also issues a costlier a 0.25% expense ratio. The fund is down 1.7% year-to-date.
The Vanguard Mid-Cap ETF (NYSEArca: VO) tries to reflect the performance of the CRSP US Mid Cap Index. CRSP’s weighting methodology differs from the S&P. Consequently, the average market for a stock in the underlying index is $9 billion, which is less than the $62 billion in the S&P 500 and a little more than the $4 billion for the S&P 400. VO is down 1.0% year-to-date and comes with a 0.10% expense ratio.
The Schwab U.S. Mid-Cap ETF (NYSEArca: SCHM) tracks the Dow Jones U.S. Mid-Cap Total Stock Market Index, which includes the 500 stocks by market cap after the largest 500. The average market-capitalization in the index is about $5.3 billion. SCHM is up 0.8% year-to-date and has a cheap 0.07% expense ratio.
Additionally, investors interested in a smart-beta offering can look at the First Trust Mid Cap Core AlphaDEX Fund (NYSEArca: FNX). The fund selects stocks from the S&P 400 Index, but chooses stocks based on growth factors, sales to price and one year sales growth, along with value factors like book value to price, cash flow to price and return on assets. Consequently, the ETF leans toward more small-cap names, which make up aout 40.2% of the portfolio. FNX is down 4.6% year-to-date and comes with a 0.66% expense ratio.
For more information on middle capitalization stocks, visit our mid-cap category.
Max Chen contributed to this article.