By Philip van Doorn, MarketWatch
After a 10-year rally for large-cap stocks, a way to diversify your investments and reduce short-term risk is to increase exposure to mid-cap shares.
We recently discussed the long-term outperformance of value stocks and equally weighted index funds — two areas to consider if you wish to cut risk by diversifying beyond the market-capitalization-weighted S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.01% . (The S&P 500 isn’t as diversified as its name implies because the index’s five largest companies — Microsoft /zigman2/quotes/207732364/composite MSFT -0.23% , Apple /zigman2/quotes/202934861/composite AAPL +0.17% , Amazon /zigman2/quotes/210331248/composite AMZN +0.25% , Alphabet /zigman2/quotes/205453964/composite GOOG -1.29% /zigman2/quotes/202490156/composite GOOGL -1.34% and Facebook /zigman2/quotes/205064656/composite FB +1.18% — make up 17% of the market value.)
Leaving cap-weighting aside, mid-cap stocks are often overlooked, despite good performance characteristics.
Amy Zhang, who manages the Alger Small Cap Focus Fund /zigman2/quotes/207263247/realtime AOFAX +0.75% (which has had an incredible performance run) launched the Alger Mid-Cap Focus Fund /zigman2/quotes/212840468/realtime AFOIX +0.08% in June. In an interview at her office in New York, she said mid-cap stocks offered “the best of both worlds,” with quality “close to large-cap” stocks, while the group’s growth “is closer to small-cap.”
She also discussed, below, three of the companies held by the Alger Mid-Cap Focus Fund.
Crit Thomas, global market strategist at Touchstone Investments in Cincinnati, said in a phone interview that mid-cap stocks were “under-represented” in investors’ portfolios as money continues to flow into large-cap index funds. He then helped to explain basic misunderstandings of the Russell 1000 Index /zigman2/quotes/210598144/delayed RUI +0.01% , which consists of the largest 1,000 stocks in the Russell 3000 Index /zigman2/quotes/210598149/delayed RUA +0.0006% .
People often speak of the Russell 1000 as a large-cap index, but it also includes mid-cap stocks. The largest 200 companies in the index account for 73% of the Russell 1000’s market capitalization. This group is called the Russell Top 200 Index /zigman2/quotes/210598138/delayed XX:RT200 -0.01% . The remaining 800 make up the Russell Mid-Cap Index /zigman2/quotes/210598151/delayed RMCC +0.07% .
Here’s a 15-year comparison of total returns (with reinvested dividends) for the Russell Mid-Cap Index against the Russell Top 200 Index, the full Russell 1000 and the S&P 500:
Here’s a performance comparison for the indexes for different periods:
|Index||Total return - 2019 through Sept. 18||Average return - 3 years||Average return - 5 years||Average return - 10 years||Average return - 15 years||Average return - 20 years|
|Russell Mid-Cap Index||23.3%||11.9%||8.7%||13.1%||10.0%||9.3%|
|Russell Top 200 Index||21.2%||15.0%||11.0%||13.3%||8.8%||5.5%|
|Russell 1000 Index||21.8%||14.1%||10.4%||13.2%||9.2%||6.5%|
|S&P 500 Index||21.7%||14.3%||10.6%||13.2%||9.0%||6.2%|
So the mid-cap group has been the best performer for 15 and 20 years, while trailing over the past 10 years, during the post-crisis recovery and the central-bank-driven bull market.
Why mid-cap stocks now?
Reasons to broaden your horizons beyond large-cap stocks, which have worked so well during recent years, include lowering your risk via diversification, especially if you are worried about a significant decline for the stock market. But Thomas pointed out that better earnings growth and better expected earnings growth might also make this an excellent time to consider mid-caps.
From a base line in calendar 2015, here are actual cumulative earnings-per-share growth figures for the Russell Mid-Cap Index and the Russell Top 200 Index through the past three full calendar years, with projected earnings growth through the next three full years, based on analysts’ consensus estimates:
|Russell Mid-Cap Index||Russell Top 200 Index|
The mid-cap group is expected to remain the earnings growth winner, justifying its inclusion in a broad equity investment strategy.
In summary, Thomas called mid-caps ”the best-performing asset class in terms of market cap within equities.”
“These companies are less cyclical because they are a bit larger than small-caps,” he said. “They have a little bit more diversification, which gives them more stability. They are not as deeply indebted.”
He added that their relatively small sizes, when compared with large-cap companies, mean “there is room for growth.”