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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