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

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.

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 just 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). Also, we 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. Those portfolios begin in January of 1995. For Growth and Value, the portfolios start in August of 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, signalling 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

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: 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. Dual Momentum and Inverse Volatility 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.

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.

Source: 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. 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. Those portfolios begin in January of 1995. For Growth and Value, the portfolios start in August of 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.

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.


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