Want Better Returns? Try Mid-Cap Stocks

money flowFrom David Fabian: Building a diversified portfolio of U.S. stocks is a delicate mix of risk and opportunity that is often driven by attention to the distant boundaries of market capitalization. 

Large-cap stocks are almost always included as a solid foundation and to provide correlation with well-known benchmarks.  These companies are often lauded for their established business practices, healthy dividends and sustainable advantages.  Small-cap stocks may also be recommended for enhanced growth or burgeoning competitive opportunities.  They are often subject to a greater degree of risk in conjunction with a higher expected future return.

The one category in the middle that is often overlooked are mid-cap stocks.  Like the middle child in a 3-sibling household, these companies can offer notable rewards that are easily overshadowed by their higher profile peers.  In fact, several diversified mid-cap indexes are demonstrating superior performance and momentum characteristics through the first seven months of 2016.

The table below shows a comparison of the most prominent mid-cap ETFs versus their small, large, and total market peers over the last three years.

The largest fund in this category is the iShares Core S&P Mid-Cap ETF (IJH), which tracks the S&P MidCap 400 Index.  Qualities for inclusion in this index are publicly traded U.S. companies with a market capitalization between $1.4 billion and $5.9 billion.

IJH has significant exposure to financial, technology, and industrial companies, which make up over 50% of the total sector allocations.  Top holdings include: Mettler Toledo Inc (MTD), Duke Realty REIT Corp (DRE), and WhiteWave Foods (WWAV).

This ETF currently has $29.5 billion in assets under management and charges a very reasonable expense ratio of 0.12%.  It is also one of the top performers for its category in 2016.  Through the first seven months of the year, IJH has gained 12.54% versus a total return of 7.68% for the iShares Core S&P 500 ETF (IVV) and 8.42% for the iShares Russell 2000 ETF (IWM).

This mid-cap index also just recently hit new all-time highs and has managed to climb over 25% from its 2016 low established near the beginning of the year. It should also be noted that the well-knownSPDR S&P 400 MidCap ETF (MDY) tracks the same basket of companies as IJH.

For those looking for a different take on mid-cap stocks, the iShares Russell Mid-Cap ETF (IWR) andVanguard Mid-Cap ETF (VO) are two suitable alternatives.  IWR owns a broader basket of nearly 800 stocks, while VO takes a more concentrated path with 344 underlying holdings.  Both funds charge relatively small expense ratios of 0.20% and 0.08% respectively.

Investors considering a mid-cap ETF should closely evaluate how their underlying holdings and historical performance match up with their objectives and risk tolerance.  Furthermore, index providers define upper and lower limits for “mid-cap” at differing levels, which may cast the net on varying pools of stocks.

It’s also worth noting that mid-cap stocks have been known to experience bouts of heighted volatility compared to their large-cap peers.  Nevertheless, they can also offer exposure to companies on the verge of making the leap to new technologies or growth-oriented sectors.

The Bottom Line

One of the tremendous benefits to using ETFs is the ability to customize your portfolio exposure in limitless patterns.  Using single factor, size, or style funds can allow you to tilt towards areas of the market that may be more attractive than a simple market-cap weighted allocation.

The SPDR S&P 500 ETF Trust (NYSE:SPY) fell $0.20 (-0.09%) in premarket trading to $215.32. The SPY has gained 5.71% this year, versus a 10.11% rise in the mid-cap-focused IJH.


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