Motley Fool once described large-cap equity investing as “swimming with the sharks,” comparing what it said is Wall-Street-analyst infested waters to the “deserted lagoon” that’s small-cap investing—a space where Wall Street pros are harder to find, and everyday investors stand a much better chance at finding “nearly limitless” rewards.
It’s a colorful description. There’s no question that the large versus small-cap comparisons have long captured investors’ imagination. But often lost in this conversation is the overlooked middle-child: midcaps.
Midcap stocks—those falling somewhere between $2 billion and $10 billion in market capitalization—rarely make headlines. And yet, like small-caps, midcaps too have been having quite a stellar year, even if with little fanfare.
Earlier this summer, U.S. small-cap stocks hit new highs—after a weak start to the year—due to what’s seen as favorable tax policy, strong momentum in U.S. economic growth, and even some dollar strength, according to Tushar Yadava, iShares investment strategist.
Small-caps have been stars since February, but midcaps aren’t that far behind.
Source: BlackRock; data from Bloomberg as of 7/10/18
“The S&P Mid-cap index outperformed its large-cap cousin by 0.5% year-to-date and by roughly 4% since February lows,” Yadava said. “Midcap shares have beaten large-caps for the same reasons that small-cap outperformed other styles.
“Midcap’s exposure and sensitivity to U.S growth fall somewhere in between small and large-cap indexes,” he said. “They have benefited from strong domestic economic growth, tax reforms, and limited international exposure, but not to the same degree that small-cap securities have enjoyed.”
Today, there are more than $182 billion invested in U.S. midcap ETFs, the biggest funds including the iShares Core S&P Mid-Cap ETF (IJH) with $48 billion in assets; the Vanguard Mid-Cap ETF (VO), which tracks a CRSP index, has $24 billion in assets and a dirt cheap price tag of 0.05%; the $21 billion SPDR S&P Midcap 400 ETF Trust (MDY), tied to an S&P Dow Jones index, and the $18 billion iShares Russell Mid-Cap ETF (IWR), offering investors access to the 800 smallest companies in the Russell 1000.
Chars courtesy of StockCharts.com
The performance of these leading-in-assets ETFs isn’t all that different, but there’s significant disparity in returns within the segment tied to various methodology differences in ETFs.
For example, consider three different midcap ETFs from one single provider, iShares. IJH, the largest, tracks the S&P MidCap 400 Index. (Vanguard, State Street, Invesco, Oppenheimer are among the issuers to also offer ETFs tied to this index). But IJH also screens companies for financial liability in addition to market capitalization size. That methodology gives the fund a small-cap tilt—one that has allowed it to outperform other mid-cap funds in recent months, according to Yadava.
Compare that to IWR, a market-cap-weighted portfolio of the 800 smaller companies in the Russell 1000. That universe of securities means that IWR has somewhat of a larger-cap bias among its top holdings, making it slightly less risky than some other midcap ETFs, according to our data. Year-to-date, IWR has trailed IJH in returns by about 1 percentage point.
And then there’s the iShares Morningstar Mid-Cap ETF (JKG), which has $766 million in assets. JKG is a market-cap-weighted portfolio of securities selected through a multifactor model. The portfolio owns midcap stocks that don’t show either strong growth or strong value characteristics, giving it a less-risky profile. JKG is underperforming its counterparts as a result.
Chart courtesy of StockCharts.com
As is the case with any ETFs—something we at ETF.com are constantly harping on—indexes matter; methodologies matter; portfolio construction matter—even among what’s seemingly market-cap-weighted funds competing in the same segment. Know what you own.
In this particular case, the broader story is midcap stocks are doing well in the current economic environment, offering investors outsized returns relative to large-cap stocks. They might not be as exciting as swimming with the sharks, nor as risky—and possibly rewarding—as diving into a deserted lagoon, but they have an appeal all their own.
And while there are plenty of midcap ETFs to choose from, there are also plenty of potential outcomes depending on the one you choose to own.
Contact Cinthia Murphy at [email protected]