Are You Under-Allocated to Mid-Caps? | ETF Trends

Investors often overlook mid-cap stocks, but exchange traded funds can help fill that void on a cost-effective basis. Well-known mid-cap ETFs include the iShares Core S&P Mid-Cap ETF (NYSEArca: IJH), Vanguard Mid-Cap ETF (NYSEArca: VO) and the SPDR Mid-Cap 400 (NYSEArca: MDY).

IJH and MDY track the widely followed S&P MidCap 400 Index. Over a long-term horizon, though, mid-caps have outshined the competition. Since 1996, the S&P MidCap 400 generated an average annual return of 10.4%, compared to 7.3% for the S&P 500 and 9.7% for the SmallCap 600.

While historical data confirm the out-performance potential of mid-caps, other data points indicate investors are under-allocated to the asset class.

“Based on overall market capitalization, we might expect funds to allocate twice as much to mid-caps compared to small-caps,” according to S&P Dow Jones Indices. “Instead, the aggregate core allocation to small-and mid-caps is approximately the same: investors appear to have a preference for small-caps over mid-caps in their core holdings. The data shows this preference is especially true for active funds.”

Mulling Mid-Caps

Mid-cap stocks and funds are often overlooked relative to large- and small-cap equivalents. Historical data confirm that should not be the case because mid caps typically outperform larger stocks while delivering less volatility than smaller stocks.

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, along with providing more stable stock prices. Additionally, they are not so big that their size would slow down growth.

“Despite being under-allocated and under-represented as investment solutions, our research indicates that mid-caps may have attractive risk/reward profiles compared to their larger-and smaller-cap counterparts,” notes S&P Dow Jones.

As investors look over their equity market exposure, they may find that large-cap stock positions are too big for rapid growth and small-caps may expose them to more volatile short-term moves, but middle capitalization stocks and related ETFs may be just right. Middle capitalization stocks, or sometimes referred to as the market’s sweet spot, could help investors achieve improved risk-adjusted returns. Mid-caps also offer benefits over smaller stocks.

“All else being equal, we can argue that mid-cap stocks are more liquid and have higher investment capacity than small-cap stocks,” said S&P Dow Jones. “Trading S&P MidCap 400 stocks should be easier than trading small-cap stocks.”

For more information on middle capitalization stocks, visit our mid-cap category.