Don't Overlook Market's Middle

Investors are using index-based funds to build asset allocation strategies rather than solely relying on active mutual funds, but the focus has primarily been on the stability of large caps and the growth potential of small caps. CFRA agrees with a recent SSGA report that midcap securities remain under the radar with most investors.

According to Matt Bartolini, author of the "What You Miss by Overlooking Mid Caps" third-quarter 2019 report, and head of SPDR Americas Research, midcaps offer stability and balance sheet strength similar to large caps and growth potential similar to small caps.

For example, companies in the S&P Mid Cap 400 Index have had a similar return on assets, based on median levels since the 2008-2009 financial crisis, but lower total debt to assets than companies in the S&P 500 Index. Meanwhile, since 2000, mid-cap companies have generated average earnings-per-share growth comparable to small caps in the Russell 2000 index—though with lower volatility.

Chart courtesy of StockCharts.com

Bartolini also highlights that the risk-adjusted Sharpe ratios for midcaps were higher in 58% of the 242 five-year rolling periods analyzed versus large caps—and higher in 94% of the same periods versus small caps—for the 15 years ended June 2019.

Problem With Active
There was $520 billion invested in midcap mutual funds in June 2019, nearly three times the $193 billion in midcap ETFs, according to CFRA Research. Historically, investors favored mutual funds with a portfolio team actively aiming to identify winners rather than broadly based and index-based strategies.

Asset managers also have offered a broader supply of small and large cap active mutual funds to meet the demand for stock selection. At the end of 2018, there were 289 unique active midcap mutual funds, excluding multiple share classes, compared with 525 small caps and 784 large caps.

But active management with midcaps has faced performance challenges, as Bartolini points out.

Based on the SPIVA Persistence Scorecard data as of March 2019, there were no top quartile midcap managers from 2015 that are still top quartile managers today, based on prior one-year returns. Similarly, only 2% of the managers that were in the top half of performance for prior one-year returns in 2015 remained in the top half of outperformers as of March 2019. In other words, it may be time for investors to apply an index ETF strategy to the mid-cap equity space.

Midcap Ratings

In rating equity ETFs and mutual funds, CFRA incorporates holdings-level analysis as well as fund attributes, such as expense ratio.

CFRA equity analysts rate 222 stocks inside the SPDR S&P MidCap 400 ETF Trust (MDY) from a qualitative, forward-looking perspective, with 62 of them (28%) rated as Strong Buy or Buy recommendations as of late September.

Reflective of the diversification benefits of ETFs, CFRA has a favorable recommendation on at least one midcap stock in each of the 11 GICS sectors. However, broader equity analytical coverage for midcap companies is often much lower than it is for large caps, confirming that many are under the radar.

For example, MDY constituent MDU Resources (MDU) is a $5.6 billion multi-utilities company with a CFRA Buy recommendation. Outside of CFRA, there are just five analyst opinions available in the Capital IQ database. In contrast, large-cap Dominion Energy (D) is a subindustry peer of MDU that CFRA also has a Buy recommendation on. Twenty analysts provide a rating on Dominion.
Pilgrim's Pride Corp (PPC), another MDY constituent, is another such under-the-radar example. The $7.8 billion packaged foods and meats company, rated as Strong Buy by CFRA, has just 10 other analysts with coverage. Yet large cap peer Kellogg Company (K) has 20 Wall Street recommendations.

CFRA will be hosting a webinar on midcap investing on Oct. 8 at 11 a.m. ET with SSGA's Bartolini. To register for the event, visit https://go.cfraresearch.com/mid-cap-investments. To view the SSGA report about midcap investing, go to https://us.spdrs.com/en/mdy.