Mid Cap Plays the Middle

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Mid-sized US companies are easily forgotten. Large cap indexes such as the S&P 500 are by far the most visible, and small stocks most often turn up on big winners or losers lists. Stuck in the middle are mid caps and the ETFs which follow them.

Several elements are in mid caps' favor instead of small cap as a tool to round out core holdings of large companies. Firms of medium size have better liquidity than small firms, in part due to trading volume and in part because a greater percentage of outstanding stock is available to the public. These features help moderate volatility and lower transaction costs. Also, expense ratios are less than small cap ETFs which must trade numerous thinly traded companies and/or deploy sampling techniques. Finally, a quirk of index construction plays in mid cap's favor: the largest mid cap companies often get a speculative boost just before they are promoted to large cap index, once again to the benefit of shareholders.

The main problem with mid-cap is its relevance in portfolio construction. If investors want to add "smallness" to a portfolio, they can get more of it from small cap ETFs. Mid cap tracks in-between large and small cap. The past three years demonstrate almost perfectly what one should expect to get out of each size ETF over the long-term:

Small and mid cap are more volatile, so they dropped hard in the crash, but they rebounded faster than large cap and over time outstripped it. These long-term trends are rarely so neat in such a small period, of course.

Investors are paying more for mid-sized companies with P/Es of around 17 compared to about 14-15 for large cap, which is to be expected.

Exposure to various industrial sectors in recent years has played a dominant role, but we expect this effect to dampen. Financials are now far less volatile than three years ago, and now basic materials and energy (essentially commodities) are showing more moderate price movements. For this part of the cycle we like their exposure overall. Mid-cap has a little more exposure to industries traditionally strong in a recovery like consumer cyclicals and real estate, low exposure to financials which remain risky in our view, and mixed exposure to commodities (more with basic materials and less with energy). An average among ETFs is approximated here:

Mid Cap Large Cap
Consumer Cyclical 14% 9%
Real Estate 6% 2%
Financials 11% 14%
Basic Materials 7% 3%
Energy 9% 13%

Size definitions of mid cap companies by ETFs varies. Major plain-vanilla, low-cost mid cap ETFs with their size range of holdings include:

  • SPDR MidCap ETF ( MDY ): stocks ranked 501-900
  • Vanguard Mid-Cap ETF ( VO ): stocks ranked 301-750
  • iShares S&P MidCap 400 (NYSEArca:IJH) stocks ranked 501-900
  • iShares Russell Midcap ETF (NYSEArca:IWR): stocks ranked 200-800
  • SPDR Dow Jones Wilshire Mid Cap ETF (AMEX:EMM): stocks ranked 501-1000

Fees range from Vanguard's tight-fisted 0.13% per year to as much as 0.25%, but all are reasonable. There is little expense drag to passive size investing in ETFs.

Where does mid cap start and end? Definitions vary by provider. For many investors the S&P 500 is synonymous with large cap, while the next 500 or so smaller stocks are mid cap and the next 2000 or so are small cap. Knowing how much to buy is crucial for over- or underweighting. In this case the first 500 stocks represent about 75% of the US stock market, the next 500 represent about a bit less than 15% and the next 2000 represent less than 10%. A size-neutral portfolio will allocate in these proportions.

Precise numbers for how much to invest in particular ETFs to remain neutral depends on each provider's definition of size boundaries. Allocations can be calculated by summing market capitalization and weightings of holdings of a provider's small, mid and large cap funds vs. the aggregate. Style investing takes a bit of work.

For investors seeking liquidity, IJH and EMM are good candidates. They themselves are quite liquid and complement S&P 500 ETFs which have tight bid-ask spreads due to their enormous trading volume, competitive fees and ample study by Wall St. analysts. They also are easy to follow in the news.

Note that EMM does not complement its sister products SPDR Dow Jones Wilshire Mid Cap ETF (AMEX:ELR) and SPDR Dow Jones Wilshire Mid Cap ETF (AMEX:ELR). ELR contains stocks ranked 1-750 by size and is complemented by small cap ELR which handles stocks ranked 751-2500. Using EMM with them causes double exposure on mid cap stocks. EMM's true purpose is to complement S&P 500 ETFs such as SPY, which is useful for many investors.

In addition to these four plain-vanilla size-based ETFs, there are numerous mid cap ETFs also targeting growth or value:

  • iShares Morningstar Mid Core ETF(NYSEArca:JKG): 0.25% annual fee
  • iShares Morningstar Mid Growth ETF(NYSEArca:JKH): 0.3% annual fees
  • iShares Morningstar Mid Value ETF(NYSEArca:JKI): 0.3% annual fees
  • iShares Russell Midcap Growth ETF(NYSEArca:IWP): 0.25% annual fees
  • iShares Russell Midcap Value ETF(NYSEArca:IWS): 0.25% annual fees
  • iShares S&P MidCap 400 Growth ETF(NYSEArca:IJK): 0.25% annual fees
  • iShares S&P MidCap 400 Value ETF(NYSEArca:IJJ): 0.25% annual fees
  • Rydex ExpressShares S&P MidCap 400 Pure Growth ETF( RFG ): 0.35% annual fees
  • Rydex ExpressShares S&P MidCap 400 Pure Value ETF( RFV ): 0.35% annual fees
  • Vanguard Mid-Cap Growth ETF( VOT ): 0.13% annual fees
  • Vanguard Mid-Cap Value ETF(VOE): 0.13% annual fees
  • SPDR Dow Jones Wilshire Mid Cap Growth ETF(AMEX:EMG): 0.25% annual fees
  • SPDR Dow Jones Wilshire Mid Cap Value ETF(AMEX:EMV): 0.25% annual fees

For traders there are a handful of leveraged funds. They typically deliver two times the daily return of an index (or the inverse for the short funds), less costs of rolling over monthly futures. These deliver a bit more leverage than borrowing on margin from a broker, they cost less per unit of leverage, and losses are limited to your investment in the ETF (no late-night margin calls). A good deal all-in-all but strictly for traders.

  • ProShares Ultra Russell MidCap Growth ETF(UKW): 0.95% annual fees
  • ProShares Ultra Russell MidCap Value ETF(UVU): 0.95% annual fees
  • ProShares UltraShort Russell MidCap Growth ETF(SDK): 0.95% annual fees
  • ProShares UltraShort Russell MidCap Value ETF(SJL): 0.95% annual fees

Unlike large and small cap categories, however, only a few ETFs use fundamental financial ratios to beat popular indexes. These are high quality and at reasonable prices:

  • RevenueShares Mid Cap ETF(NYSEArca:RWK): 0.54% annual fees
  • WisdomTree MidCap Dividend ETF(NYSEArca:DON): 0.38% annual fees
  • WisdomTree MidCap Earnings ETF(EZM): 0.38% annual fees



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: MDY , RFG , RFV , VO , VOT

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