Insights

Mid Caps Can Make a Positive Difference in Performance

Many diversified portfolios are missing an allocation to mid caps, which translates to missing an average annualized excess return of 1.11%.¹
We constructed 15 rules-based portfolios to compare the impact of including and excluding mid caps.
The result? All portfolios that included mid caps outperformed portfolios without mid caps — with an average cumulative outperformance of 54.5%.²

Matthew J Bartolini, CFA, CAIA

Head of SPDR Americas Research

Mid-cap stocks have a total market capitalization of $2.5 trillion. Yet many diversified portfolios don’t include a mid-cap allocation.³ What do you miss by skipping mid caps? The potential for enhanced returns.

Mid-cap core, growth, and value exposures, as measured by versions of the S&P MidCap 400® Index, have outperformed those large- and small-cap styles since the index’s inception in 1994. In fact, mid caps’ average excess total return is 519% across the three styles — translating to an average annualized excess return of 1.11%, as shown below.⁴

Plus, this broader coverage across the capitalization spectrum has historically improved returns without a discernible increase in volatility. On a risk-adjusted basis across all styles, mid caps’ Sharpe and Sortino ratios were better than small caps’ ratios⁵ (considering 17% standard deviation for mid caps versus 18% for small caps).⁶ In the core, mid caps had similar Sharpe and Sortino ratios to large caps, with higher ratios for value.⁷ For growth, however, large caps fared better.⁸

Mid Caps Outperform Across Styles Since 1994

Description	Annualized Return (%)	Mid Cap Excess (%) - Annualized	Cumulative Return (%)	Mid Cap Excess (%) - Cumulative
S&P 500 Index	10.68	1.23	1,599.81	612.91
S&P Mid Cap 400 Index	11.91		2,212.72
S&P Small Cap 600 Index	11.06	0.85	1,769.79	442.94

S&P 500 Growth Index	11.80	0.04	2,148.75	20.37
S&P Mid Cap 400 Growth Index	11.83		2,169.12
S&P Small Cap 600 Growth Index	10.63	1.21	1,576.21	592.90

S&P 500 Value Index	9.16	2.62	1,053.86	1,081.99
S&P Mid Cap 400 Value Index	11.77		2,135.85
S&P Small Cap 600 Value Index	11.07	0.70	1,775.44	360.41
*Average Excess*		*1.11*		*518.59*

Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. You cannot invest directly in an index. Source: FactSet, as of December 31, 2021. Return data from January 1994 to December 2021. Past performance is not a reliable indicator of future performance. All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.

Mid caps’ strong periodic performance is also persistent. When we analyzed rolling six-month returns, of the 330 periods available, mid caps beat large caps 53% of the time, across styles. Within the core, the overall average excess return was 1.06%, with a 5.29% excess return in the actual six-month periods mid caps outperformed. Mid caps also outperformed small caps more than 50% of the time with a narrow positive excess return.

And over a rolling 12-month period, the overall average excess returns for mid-cap core to large- and small-cap core benchmarks were 2.13% and 0.16%,⁹ respectively, both improvements over the six-month results.

Market Cap and Style Rolling Six-Month Returns Since 1994 Favor Mid Caps

	Mid-cap to Large-cap	Mid-cap to Small-cap	Mid-cap Growth to Large-cap Growth	Mid-cap Growth to Small-cap Growth	Mid-cap Value to Large-cap Value	Mid-cap Value to Small-cap Value
% Outperforming	53.0%	50.3%	54.3%	51.9%	54.7%	61.2%
Average Overall Excess Return	1.1%	0.1%	1.1%	0.2%	0.9%	1.9%
Average During Outperformance	5.29%	3.15%	6.20%	4.29%	7.61%	5.24%

Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. You cannot invest directly in an index. Source: FactSet, as of December 31, 2021. Return data from January 1994 to December 2021 based on price returns. Past performance is not a reliable indicator of future performance. Mid caps = S&P 400 Mid Cap Index, Small Caps = S&P 600 Small Cap Index, Large Caps = S&P 500 Index.

These results improve further when run against the Russell 2000 Index, another small-cap benchmark, underscoring the importance of benchmark selection for this market cap segment. Measured against the Russell 2000, mid caps’ outperformance on a six- and 12-month basis improves to 61% and 65%, respectively, as shown below. The average overall excess returns also increase from the narrow rates above, to 0.9% and 2.0% for the respective rolling periods.

Mid-Cap versus Small-Cap (Russell 2000 Index) Rolling Returns Since 1994

	Mid-cap to Small-cap (Russell 2000) – Six-Month Screen	Mid-cap to Small-cap (Russell 2000) – Twelve-Month Screen
% Outperforming	61%	65%
Average Overall Excess Return	0.9%	2.0%
Average During Outperformance	3.41%	5.17%

Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. You cannot invest directly in an index. Source: FactSet, as of December 31, 2021. Return data from January 1994 to December 2021 based on price returns. Past performance is not a reliable indicator of future performance. Midcaps = S&P 400 Mid Cap Index, Small Caps = Russell 2000 Index.

Complete Your Portfolios with Mid Caps

Mid caps have beaten both large caps and small caps over the past 28 years.¹⁰ But knowing the impact of “how much” and “when” mid-cap exposures were added could help you to understand the magnitude and depth of the outperformance.

To help frame the impact of including a mid-cap allocation, we constructed 15 rules-based portfolios that included mid caps with varying allocations and compared them to portfolios that excluded mid caps. Both versions followed the same rules to avoid concerns of cherry-picking.

All portfolios used price returns (neutralizing any return differences from mid and small caps historically offering a higher yield, while also acknowledging real-world dividend reinvestment policies will differ across every portfolio). We also rebalanced portfolios on a monthly basis on the last day of the month and excluded any fees or trading costs. The core portfolios’ start date was January 1994, while the value and growth styles were originated in July 1997, due to the availability of index data. While not fully replicating all possible combinations, our list of portfolios includes:

50/50 portfolio of large caps and mid caps versus a 50/50 portfolio of large and small caps
An equal-weighted 50/50 portfolio of large caps and small caps versus a 33/33/33 portfolio of large caps, mid caps and small caps
90/10 split between large and small caps versus a 90/8/2 large cap, mid cap, small cap portfolio, reflecting the current market capitalization weights of the three
Large- and small-cap dual momentum strategy¹¹ versus large-, mid- and small-cap dual momentum strategy
Large- and small-cap inverse volatility-weighted portfolio versus large-, mid- and small-cap inverse volatility portfolio

Versions of these five portfolios were created for core, value, and growth market cap exposures, leading to the 15 total portfolios. However, these portfolios may not fully reflect real world applications, as they are meant to illustrate the mid-cap allocation decision. For instance, some of the portfolios may appear too concentrated and others too tactical, as we considered only three asset exposures. It is also unlikely an investor would hold just one market cap segment and not any other, or equal weight them as it introduces far too much active risk (i.e., tracking error) to broad equity markets.¹²

For the dual momentum strategy, the rules are:

Step 1: Calculate the relative momentum of each market cap segmentation, based on trailing 12-month returns
Step 2: Pick the market cap with the strongest relative return and compare it to the trailing 12-month return on T-Bills
Step 3: If greater than T-Bills, own the market cap exposure. If not, own T-Bills
Step 4: Repeat each month

In an inverse volatility-weighted portfolio, highly volatile assets are allotted smaller weights, and low volatile assets are allotted larger weights. For this inverse volatility portfolio, a market cap exposure is weighted in inverse proportion to its risk, based on the trailing 12-month standard deviation of returns. The average weights over the analyzed period were 39%, 32%, and 29% for large-, mid- and small-cap exposures, respectively.¹³

Minding the Middle Pays

All 15 portfolios that included mid caps outperformed portfolios without mid caps. The average cumulative outperformance is 54.5%. Some of the differences were in the triple digits, while others were relatively small, as shown below. Given the different starting dates for the style portfolios, as mentioned above, one portfolio should not be compared to another (e.g., Growth to Core). The goal of this exercise is to compare a portfolio with mid caps to a portfolio without mid caps, not if an inverse weighted volatility portfolio is superior to an equal weighted version.

Theoretical Portfolio Cumulative Performance

	Without Mid Caps	With Mid Caps	Difference
Core
50/50 Portfolio	1112.4%	1163.0%	50.6%
Equal Weighted Portfolio	1112.4%	1223.9%	111.5%
Market Cap Weighted	937.3%	941.4%	4.1%
Dual Momentum	609.8%	722.4%	112.5%
Inverse Volatility	1110.4%	1221.7%	111.3%
Growth
50/50 Portfolio	756.7%	772.6%	15.9%
Equal Weighted Portfolio	756.7%	824.3%	67.6%
Market Cap Weighted	624.1%	624.5%	0.4%
Dual Momentum	503.2%	657.6%	154.4%
Inverse Volatility	650.0%	666.5%	16.4%
Value
50/50 Portfolio	383.5%	399.8%	16.3%
Equal Weighted Portfolio	383.5%	462.7%	79.2%
Market Cap Weighted	252.2%	253.4%	1.2%
Dual Momentum	283.7%	293.9%	10.3%
Inverse Volatility	305.4%	371.7%	66.3%

Source: Bloomberg Finance, L.P., data as of December 31, 2021, based on SPDR Americas Research calculations. Past performance is not a reliable indicator of future performance. Core portfolios start in January 1994, with the exception of the Dual Momentum and Inverse Volatility portfolios as 12-months of return history was needed. Dual Momentum and Inverse Volatility portfolios begin in January 1995. For Growth and Value, the portfolios start in August 1997, with the exception of the Dual Momentum and Inverse Volatility portfolios as 12-months of return history was needed. Those portfolios begin in August of 1998. Returns are based on the S&P 500 Index, S&P Mid Cap 400 Index, and S&P Small Cap 600 Index for core, growth, and value benchmarks using price returns.

The performance deviations across the portfolios directly relate to the amount of mid caps owned. For instance, the differential in the market cap weighted portfolios is low, given that mid caps are only an 8% allocation. For the dual momentum strategy, the one portfolio where mid caps could be 100% of the allocation, the return differences were some of the widest. And as shown below, the mid-cap dual momentum portfolio outperformed the portfolio without mid caps within both the core and styles.

Interestingly, however, dual momentum underperformed the market-cap-weighted portfolio across the board, signaling that this type of tactical rotation was ineffective in and of itself. This is not surprising, as this type of technical rotation typically needs more asset classes with wider performance dispersion.¹⁴

For the 15 portfolios, volatility levels were not noticeably impacted, as the average increase in the standard deviation of returns is only 0.05% across all the strategies, as shown below. In fact, in four instances the volatility profile was lower. The minimal change in volatility shows that the increased returns are not from an increase in risk – an aspect further reinforced by examining Sharpe Ratios¹⁵ being greater in 13 out of the 15 portfolios that had mid caps.

While the return improvements by some of the mid-cap portfolios over the version without mid caps were slight, and unlikely to pass a significance test at the 5% confidence interval, the results are encouraging overall. Yet, the average cumulative outperformance of 54%, as noted above, is significant.

Combined with the rolling and periodic return analysis, the theoretical portfolio returns show that a distinct mid-cap allocation within portfolios can be additive and would not likely detract from returns. Therefore, omitting mid caps from portfolios could be a costly oversight going forward.

Add Lower Cost, Indexed Mid-Cap ETFs

Cost is an important consideration when adding mid-cap exposures to your portfolio. The average fee for active mid-cap mutual funds (1.20%) is much higher than for indexed mid-cap ETFs (0.09%).¹⁶

Also, by nature of their unique create and redeem functions, ETFs are inherently more tax-efficient vehicles than mutual funds and typically do not distribute capital gains as often as mutual funds do. Roughly two-thirds of mutual fund managers have historically paid capital gains in a calendar year, with more than 90% in some years.¹⁷

That makes choosing lower cost, tax-efficient, index-based mid-cap ETFs the optimal approach when adding mid-cap exposures to your portfolio.

Own a Piece of the Middle

Footnotes

¹ FactSet, as of December 31, 2021. Return data from January 1994 to December 2021. Past performance is not a reliable indicator of future performance.
² Bloomberg Finance L.P., data as of December 31, 2021, based on SPDR Americas Research calculations. Past performance is not a reliable indicator of future performance.
³ Morningstar, as of December 31, 2021, in Large Blend, Mid-Cap Blend, and Small-Cap Blend categories. Large-Cap Blend has $6.4 trillion, Mid-Cap Blend has $469 billion, and Small-Cap Blend has $586 billion.
⁴ FactSet, as of December 31, 2021. Return data from January 1994 to December 2021. Past performance is not a reliable indicator of future performance.
⁵ FactSet, as of December 31, 2021, for the S&P MidCap 400 Index and S&P SmallCap 600 Index for core, growth, and value benchmarks. Mid-cap core, growth and value Sharpe Ratio are 0.55, 0.51, and 0.54 respectively versus small-cap core, growth and value ratios of 0.47, 0.43 and 0.46. Sortino are 0.82, 0.77, and 0.79 versus 0.68, 0.63, and 0.67, respectively.
⁶ FactSet, as of December 31, 2021, for the S&P MidCap 400 Index and S&P SmallCap 600 Index based on annualized monthly returns from January 1994 to December 2021.
⁷ FactSet, as of December 31, 2021, for the S&P 500 Index and S&P MidCap 400 Index for core and value benchmarks. MidCap core and value Sharpe Ratios are 0.55 and 0.54 versus 0.57 and 0.46 for large-cap core and value, respectively. Sortino are 0.82 and 0.79 versus 0.83 and 0.63, respectively.
⁸ FactSet, as of December 31, 2021, for the S&P 500 Index and S&P MidCap 400 Index growth benchmarks. Sharpe Ratios for Mid-cap growth is 0.51 versus 0.62 for Large-cap growth. Sortino is 0.77 versus 0.92 for Mid-cap growth and Large-cap growth, respectively.
⁹Bloomberg Finance L.P., as of December 31, 2021. Return data from January 1994 to December 2021 based on price returns. Past performance is not a reliable indicator of future performance. Mid caps = S&P 400 MidCap Index, Small Caps = S&P 600 SmallCap Index, Large Caps = S&P 500 Index.
¹⁰ FactSet, as of December 31, 2021. Return data from January 1994 to December 2021. Past performance is not a reliable indicator of future performance.
¹¹ “Dual Momentum Investing,” Gary Antonacci.
¹² Based on the Bloomberg US Equity Fundamental Risk Model an equal-weighed S&P 500 Index, S&P MidCap 400 Index, and S&P SmallCap 600 Index would have 15% active risk versus the S&P 1500 Total Market Index.
¹³ Based on Bloomberg Finance L.P. data and SPDR Americas Research calculations, as of December 31, 2021.
¹⁴ “A Tactical Asset Allocation Horserace Between Two Thoroughbreds”, Wesley Gray PhD.
¹⁵ Bloomberg Finance L.P., data as of December 31, 2021, based on SPDR Americas Research calculations. Standard deviation calculated based on monthly portfolio returns since the start period multiplied by the square root of 12. The average annualized return for the risk-free rate was 2.30% during the analyzed period based on the return of the Bloomberg US 3-Month T-Bill Index. Past performance is not a reliable indicator of future performance.
¹⁶ Morningstar, as of December 31, 2021. Based on oldest share class of actively managed mutual funds and ETFs. Past performance is not a reliable indicator of future performance.
¹⁷ Morningstar, as of December 31, 2021. Based on oldest share class of actively managed mutual funds and ETFs. Past performance is not a reliable indicator of future performance.

Glossary

Growth
In style investing, a strategy that focuses on companies that have the potential to grow their earnings at a high rate.

Momentum Investing
An investment strategy that seeks to profit from a continuation of existing market trends. The core idea is that once a trend is established it is more likely to continue than to reverse. The strategy can be applied to assets that are either in a rising trend or a falling trend.

Russell 2000® Index
A benchmark that measures the performance of the small-capitalization segment of the U.S. equity universe. The Russell 2000® is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes about 2,000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000® Index is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.

Sharpe Ratio
A measure for calculating risk-adjusted returns that has become the industry standard for such calculations. It was developed by Nobel laureate William F. Sharpe. The Sharpe ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. The higher the Sharpe ratio the better.

Sortino Ratio
A measure for calculating risk-adjusted returns that only considers the standard deviation of the downside movements.

S&P 500® Index
A market-capitalization-weighted stock market index that measures the stock performance of the 500 largest publicly traded companies in the United States.

S&P 600 Index
The S&P Small Cap 600® provides investors with a benchmark for small-sized companies. The index, which is distinct from the large-cap S&P 500®, is designed to measure the performance of 600 small-sized companies, reflecting the distinctive risk and return characteristics of this market segment.

S&P MidCap 400™ Index
The S&P MidCap 400™ provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500®, is designed to measure the performance of 400 mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment.

Value
One of the basic elements of “style”-focused investing that focuses on companies that may be priced below intrinsic value. The most commonly used methodology to assess value is by examining price-to-book (P/B) ratios, which compare a company’s total market value with its assessed book value.

Volatility
The tendency of a market index or security to jump around in price. Volatility is typically expressed as the annualized standard deviation of returns. In modern portfolio theory, securities with higher volatility are generally seen as riskier due to higher potential losses.

Yield
The income produced by an investment, typically calculated as the interest received annually divided by the price of the investment. Yield comes from interest-bearing securities, such as bonds and dividend-paying stocks.

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