Why you should consider investing in mid-cap stocks

Why you should consider investing in mid-cap stocks

Mid-cap stocks are situated in the “sweet spot” of the equities universe, typically offering higher growth rates than large caps and having greater access to capital than small caps.

Australia’s mid-cap sector has outperformed large-cap and small-cap stocks over the past 15 years, but despite this strong performance, the mid-cap sector has been largely ignored.  A key reason is because access to the pure mid-cap sector has been virtually impossible until recently.

Why mid-cap stocks?

Large-cap stocks are generally a favourite among Australian investors because they can offer investors stability and the potential for steady dividend income, however large-cap companies, generally, lack rapid growth potential.  This is because they are already established leaders and have a significant share of the market.  The S&P/ASX 200 is dominated by a handful of large-cap stocks including the big four banks but when their performance takes a dive, investors look elsewhere.  At the other side of the spectrum, small-cap companies have a lot more capacity to grow than large companies, but exhibit greater risk.  Small-cap companies generally have limited access to capital to drive expansion and can fail spectacularly.

 

Finding a diamond in the rough is one of the greatest potential upsides of investing in small-cap companies but it comes with plenty of risk.  Mid-cap companies are situated in the “sweet spot” of the equities universe. They typically offer higher growth rates than large caps and have greater access to capital than small caps.  Mid caps tend to have experienced management teams, established brands and client bases, infrastructure and access to capital markets–advantages that small caps may lack.  At the same time, mid caps grow more quickly than large caps, benefiting from flatter management structures, entrepreneurial drive and quick decision-making.  This agility helps them to respond more quickly to external market forces.

 

Performance of mid caps

Given the positive attributes of mid-cap companies it is no surprise they have outperformed their large-cap and small-cap counterparts over the past 15 years.  The following graph compares the S&P/ASX MidCap 50 Index relative to the key S&P/ASX market capitalistion weighted indices from 1 September 2001 to 31 August 2016.

Exhibit 1: How size biases weigh up (performance 1 Sept 2001 to 31 Aug 2016)


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Source: VanEck, Morningstar, as at 31 August 2016. Results are calculated to the last business day of the month and assume immediate reinvestment of all dividends and exclude costs associated with investing in MVE. You cannot invest directly in an index. Past performance is not a reliable indicator of future performance.

 

According to S&P, the S&P/ASX MidCap 50 Index has recorded higher risk-adjusted returns over one, three, five, 10 and 15-year periods when compared to all other market segments.  The following table shows the trailing performance of the S&P/ASX MidCap 50 Index in comparison to key S&P/ASX indices over the past 15 years.

 

Exhibit 2: Performance of S&P/ASX MidCap 50 Index to 31 August 2016

table

Source: VanEck, Morningstar, as at 31 August 2016. Results are calculated to the last business day of the month and assume immediate reinvestment of all dividends and exclude costs associated with investing in MVE. You cannot invest directly in an index. Past performance is not a reliable indicator of future performance.

 

Mid caps offer better diversification

The outstanding performance of the S&P/ASX MidCap 50 Index is also as a result of sector diversification.  The S&P/ASX Midcap 50 is significantly underweight financials and is overweight to sectors such as healthcare, utilities and consumer discretionary.  For example, consumer discretionary, which is not represented in the large-cap segment at all, makes up nearly 26 per cent of the mid-cap index.  On the other hand, the S&P/ASX 200 is heavily invested in large-cap stocks and has little exposure to mid-cap performance.  Over a decade, there has been little difference between the returns of the S&P/ASX 200 and the S&P/ASX 20 Accumulation Index, with a correlation of 99.2 per cent.  This indicates that the top 20 stocks dominate the market, overshadowing the performance of the other 180 companies in the index.

 

The following chart shows the breakdown of market allocation to sectors of ASX indices.

Exhibit 3: Sector breakdown of ASX indices


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Source: VanEck, Factset, as at 31 July 2016

Investors can now access pure mid-cap performance

Investors can now access the strong performance potential of the S&P/ASX MidCap 50 Index.  The VanEck Vectors S&P/ASX MidCap ETF (ASX: MVE) tracks the S&P/ASX MidCap 50 Index, which means Australian investors can now access companies in the “sweet spot” of the Australian equities universe in a single trade on the ASX.