Flexibility, versatility, and strength: Mid-cap stocks lead the way, time after time. Historically, mid caps have offered greater growth potential than large caps and less volatility than small caps. For investors who are looking to capture this segment’s unique combination of stability and growth potential, thoughtful implementation is critical. A misstep in implementing a mid-cap strategy can impact a portfolio almost as much as not including mid caps at all.
Active vs. index-based: Implementing an effective mid-cap allocation
High fees and persistent underperformance from active managers make an index-based strategy worth considering. For active managers, rolling returns indicate that outperformance has been challenging:
The five-year rolling period for the percentage of mid-cap managers outperforming their prospectus benchmark has been below 30% since the five-year performance period starting in 2009.1 The median value over this post-crisis time has been 18%.
Additionally, most mid-cap managers have struggled to consistently perform at a high level. Based on the SPIVA® Persistence Scorecard data as of June 2020, there are no top quartile mid-cap managers from 2016 that are still top quartile managers today, based on prior one-year returns. Similarly, only 16% of the managers that were in the top half of performance for prior one-year returns in 2016 remained in the top half of outperformers as of June 2020.
Periodic returns reveal a similarly disappointing result. Mid-cap blend managers have fared the worst over all time periods considered, with 31%, 20%, and 9% of active managers outperforming their respective prospectus benchmark over the past three-, five- and 10-year periods.2
What’s behind this underperformance? Fees charged by active managers are a major driver. Active mid-cap managers charge, on average, much higher fees than index funds, as seen in the chart below.
Source: Morningstar, as of December 22, 2020. Calculations by SPDR ETF Research.
Utilizing ETFs to implement an index-based mid-cap allocation
High fees and weak manager persistence both point to index-based strategies as a potentially smart way for many investors to access mid caps’ positive attributes and returns. When it comes to identifying the best vehicle for implementing an index-based strategy, ETFs offer a distinct set of potential benefits, including:
Transparency – Generally, the securities held within an ETF are known. As portfolio compositions are posted daily, there is no need to wait for the end of the quarter to review the fund’s holdings.
Lower expense ratios – Due to low turnover of most ETFs and the indexes they track, transaction costs are minimized.
Liquidity – ETFs may be used to quickly capitalize on investor convictions regarding the performance of particular market segments.
Tax benefits – Unlike managed funds, individual ETF investors typically do not bear the burden of capital gains taxes resulting from another investor’s buying and selling.
Diversification – ETFs spread investment dollars across many individual securities rather than putting all dollars into one single security.
Trading flexibility – ETFs can be bought and sold through a brokerage account, the same as stocks. ETFs can be bought and sold at their current market price anytime during the trading day.
To learn more about the case for investing in mid caps, check out our latest research report. We took a close look at systemic risk events since the mid-1990s and uncovered a history of great mid-cap comebacks. See how mid-cap stocks outperformed relative to large and small caps as markets entered and exited past crises.
1Morningstar as of November 30, 2020. The analysis is based on the funds within the US Fund Mid Cap Category within Morningstar that have a five-year track record. At the end of November 2020, the current number of active funds was 309. 226% of the US-registered mutual fund and ETFs within the US Large, Mid, and Small Morningstar Category have outperformed their prospectus benchmark in the last year as of November 30, 2020, per Morningstar data and calculations by SPDR ETF Research. Past performance is not a reliable indicator of future performance.
SPIVA, or Standard & Poor’s Index Versus Active A twice-a-year report that compares returns of indexes with related active strategies in both equities and fixed income. The SPIVA data generally show that, on a rolling 12-month basis, roughly two-thirds of active managers do not outperform the indexes they benchmark against. Moreover, the SPIVA report generally shows that the percentage of active managers who fail to beat their benchmarks generally increases over time.
Investing involves risk including the risk of loss of principal.
This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.
Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.
Investments in mid-sized companies may involve greater risks than those in larger, better known companies, but may be less volatile than investments in smaller companies.
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