An Active ETF Approach to Best-Navigate the Mid Cap Landscape

Exchange traded fund investors can focus on a mid-capitalization fund strategy targeting today’s high-conviction stock picks.

In the recent webcast, Don’t Dilute Your Dollars with an Index-Only Strategy, Amy Zhang, Executive Vice President, Portfolio Manager, Alger, highlighted the historical outperformance of the mid cap category, which has generated an annualized total return of 12.3% from 1990 through 2020, compared to the 11.0% for small caps and 10.7% for large caps over the same period.

Despite higher returns, mid cap risk has historically come in between large- and small-caps. From 1990 through 2020, mid caps showed a standard deviation of 16.3, compared to the 14.6 for large caps and 19.2 for small caps.

Over the long-run, mid caps have provided superior risk-adjusted returns given their historically high returns. From 1990 through 2020, mid caps showed a 0.60 Sharpe Ratio, compared to 0.56 for large caps and 0.44 for small caps.

In the current market environment, Zhang argued that investors should consider the cheap valuations that mid caps offer.

“We believe underperformance has compressed mid cap valuations as compared to history,” Zhang said.

Looking ahead, Zhang also argued that earnings estimates for mid-capitalization stocks are projected to grow much faster than for large caps.

The market participants are also not looking at mid caps as closely as other market segments. Mid cap stocks have less sell-side research coverage, with an average 10.7 number of analysts per mid cap stock, compared to 20.6 analysts per large cap stock.

“We believe it is easier to have differentiated views on sales, earnings, cash flows and ultimately value given far fewer research analysts per mid cap stock,” Zhang said.

To help investors better-target the mid cap category, Alger offers the actively managed Alger Mid Cap 40 ETF (FRTY), which is managed by Zhang. FRTY will seek out 40 high-conviction mid cap growth stocks. The strategy primarily invests in a focused portfolio of approximately 40 holdings of mid cap companies identified through Alger’s fundamental research as demonstrating promising growth potential.

Zhang explained that the firm is a benchmark-agnostic investor. It seeks to invest in companies exhibiting sustainable and growing revenue streams.

“We believe companies undergoing Positive Dynamic Change offer the best investment opportunities for our clients,” Zhang said. “Our competitive edge is identifying these companies and capitalizing on the change before it is recognized by the market. We embrace change found in ‘traditional’ growth companies and in companies experiencing a ‘growth renaissance’.”

These “traditional” growth companies have growing revenues, growing unit volume, increasing market share, and an expanding business. Additionally, a catalyst drives these companies to experience a “growth renaissance,” resulting in an improving earnings trajectory leading to P/E expansion.

Alger’s investment process follows a defined plan. Companies generally exhibit operating revenues of more than $500 million at initial point of investment; have solid operating history with long-term, sustainable revenue growth; show defensible competitive position with differentiated products and services; offer strong balance sheet and profitability to fuel and sustain earnings growth; and are headed by visionary management capable of driving long-term growth.

FRTY offers a best ideas, benchmark-agnostic portfolio based on vibrant, proprietary, fundamental research. The ETF provides exposure to high-quality growth companies in dynamic industries with innovative and potentially life-changing technologies and services.

Financial advisors who are interested in learning more about the mid-cap strategy can watch the webcast here on demand.