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Conventional wisdom claims large-cap stocks usually hold up the best when the market drops and small caps climb the quickest when the market rallies—a mindset that leaves mid-cap stocks out in the cold. Although they’re underappreciated by many market participants, mid-cap stocks can have a lot to offer, including a notable track record of outperformance and superior risk-adjusted returns.
Mid-sized firms often occupy a sweet spot, pairing much of the operational dexterity of small caps with much of the business maturity associated with large caps. This unique blend has helped mid caps generate strong absolute and risk-adjusted returns relative to both large- and small-cap stocks over multiple market cycles and across sub-investment styles (i.e., growth, value).
When we analyzed absolute returns on a five-year rolling basis since 1994 according to a monthly frequency, mid caps outperformed large caps 72% of the time and small caps 93% of the time, as shown below. Moreover, Sharpe ratios were higher in 62% and 100% of the 257 five-year rolling periods analyzed versus large caps and small caps, respectively. While the Sharpe ratio considers all volatility—both good and bad—the Sortino ratio only considers the standard deviation of the downside movements. Mid caps had higher Sortino ratios 60% and 100% of the time versus large caps and small caps, respectively.
Taking the analysis one step further, each metric was analyzed to ascertain which cap style had the best metrics overall for a given rolling period. Not surprisingly, mid caps posted higher Sharpe ratios than both large caps and small caps at the same time in 61% of the 257 five-year periods analyzed. The same analysis reveals a 60% hit rate for the Sortino ratio for mid caps. Using absolute returns illustrates the same trend, as mid caps have had higher absolute returns than those of both large caps and small caps at the same time in 66% of the periods analyzed.1