Mid cap stocks have outperformed versus small and large cap benchmark indices

Although mid cap stocks are sometimes overlooked in the asset allocation discussion of how much to invest in stocks, bonds and alternative investments, they can be a meaningful contributor to portfolio returns and diversification.  The chart above shows that the outperformance by the Standard & Poor’s Midcap index compared to both the Standard and Poor’s 500 and Russell 3000, both indices of the largest companies, since 1995.  Annual average return for S&P’s Mid cap index was over 4% greater than the large companies.  Why?

First, a definition of mid cap stocks

Mid caps are less easy to define than small or large capitalization stocks – by their very nature of being in the middle.  Small cap companies tend to be defined as those valued at less than $1-3 billion (depending on the index family).  And, large cap companies tend to be well known – think of Exxon, Apple, IBM etc. –  and measured in the hundreds of billions.

In contrast, mid cap stocks may be defined as high as $15 billion depending on the mutual fund manager. Benchmark families may also define mid cap stocks differently. S&P defines mid caps as the 400 companies with market value between $1-4.4 billion.  Russell goes as high as $8 billion.

Why do mid caps outperform?

Regardless of the exact parameters of middle-sized companies on the capitalization scale, the long-term outperformance is clear.  One strategist I know prefers mid caps, describing them as small caps on their way to becoming large caps, with a stopover in the mid cap range during their high-growth phase (Note: companies, large or small can also be fast growers but mid caps seem to capture the high-growth stage more demonstrably.)  Mid caps tend to be more established – read older – than small cap companies with more experienced management teams.  Mid caps may also be attractive as acquisitions to large companies looking for growth.   And in a period where US companies are outperforming many parts of the world economy, mid caps tend have a greater proportion of domestic earnings than large multinational companies.

Your stock allocation

Mid cap stocks represent less than 10% of the equity market in terms of value.  They are a good way to increase the equity diversification in a portfolio along with large and small cap stocks.  Adding mid caps increases the breadth of equity exposure in a well-diversified portfolio.  Just like the middle child, do not overlook your mid caps.



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